2. Chapter 2: Market and Non-Market Mechanisms: An Overview
2.3 Benefits of Market Mechanisms
MBMs currently play a prominent role in environmental policy on both a national and international level. They have been described as the “keystone of global climate policy”,40 with a price on carbon touted as “our best hope for getting us out [of our current climate predicament)”.41 However, the concept of using MBMs in environmental policy would not have been an instinctive decision even several decades ago. A major stepping-stone in Western society which ultimately resulted in the adoption of MBMs in environmental governance, was a movement in the United States in the 1960s. There was a growing call from the United States’ public during this period for greater environmental protection, largely due to Rachel Carson’s Silent Spring (1962), as well as a greater awareness of ecological interconnectivity.42 This led to the concept of the environment as something that the state should regulate and govern over.43 Recognition of this new field of public policy
36 Directive 2003/87/EC of the European Parliament and of the Council of 13 October 2003 establishing a Scheme for Greenhouse Gas Emission Allowance Trading within the Community and amending Council Directive 96/61; van Asselt 2016, p. 339.
37 Mehling 2018, p. 8.
38 Metz 2010, p. 288-289.
39 SEI et al. 2019, p. 5.
40 Ghaleigh 2016, p. 73.
41 Wagner and Weitzman 2015, p. 152.
42 Caldwell 1971, p. 3, 12–18.
43 Ibid.
meant that the United States’ government was under pressure to develop politically feasible policies which would not significantly impede on the exploitation of natural resources, but would still offer adequate environmental benefits.44
Following this process, the main choice of new environmental policy instruments by the United States’ government in the 1970s were command and control instruments.45 The system was largely based on the concept of Best Available Technology (BAT), which obligated industry to utilise the best available technology in relation to environmental standards.46 As the field of environmental policy matured, these mechanisms faced heavy criticism, particularly following the oil shocks and emergence of issues such as acid rain in the 1980s.47 Writing in 1985, Ackerman and Stewart condemned the command and control approaches as “crude, costly, litigious and counterproductive”.48 Specifically, the authors argued that this system was economically inefficient, with exorbitant transaction costs and misdirection and waste of resources. In addition, they claimed that the system discouraged innovative approaches to reducing pollution due to disproportionately heavy scrutiny of emerging technologies and was applied in a manner which failed to consider regional, organisational and industrial differences.49 They argued in favour of reform of the system, where instead of being sidelined, economic incentives could occupy a fundamental position in environmental law.50 Voices calling for MBMs grew in tandem with the criticisms about the inefficiency of the early command and control mechanisms, leading to more widespread use of MBMs.51
As discussed above, one of the main aims of market-based environmental taxes and permit trading schemes is to internalise the external costs resulting from an activity, while also encouraging a transition away from that activity.52 Carbon markets, for example, aim to
44 Ibid, p. 3–9.
45 Hsu 2016, p. 241.
46 Ackerman – Stewart 1985, p. 1333–1334.
47 Grubb et al. 2014, p. 215.
48 Ackerman – Stewart 1985, p. 1333.
49 Ackerman – Stewart 1985, p. 1333–1336; Keohane et al. 1997, p. 2.
50 Ackerman – Stewart 1985, p. 1333–1334.
51 See e.g., Keohane et al. 1997.
52 Heine et al. 2020, p. 99-100.
support businesses transitioning away from high carbon activities while gradually increasing the carbon price.53 Thus, industry has time to transition without undue disturbance to energy security or supply. Implementing and gradually increasing the price on carbon and other GHG emissions is one way to steadily achieve emission reductions. The IPCC held with high confidence that a high price on emissions would be necessary to stay within a 1.5°C pathway in a cost-effective manner.54 When implemented properly, carbon pricing can also align climate change policies with the key environmental principle of “polluter pays”.55 While Heine et al. acknowledge and explore the complications in relation to its application, the basic concept of this principle is that a polluting entity should be responsible for the costs of the damage arising from their conduct.56 This principle is also rooted in the UNFCCC, as a key principle.57 Therefore, one of the potential benefits of some MBMs is that they aim to make polluters pay for some of the externalities associated with GHG emissions in accordance with principles of international climate change law.
One of the other main purported benefits of MBMs is cost-effectiveness in comparison to more administratively intensive regulation.58 This makes MBMs attractive for a number of reasons. Firstly, when selecting policy options, governments generally “seek to achieve positive environmental outcomes in the most economically efficient manner possible”.59 Depending on design and implementation specificities, MBMs have the potential to reduce administrative costs, while also reducing the financial burden of compliance on industry.60 The World Bank has, for example, stated that a well-functioning carbon market could
“significantly” reduce the cost of mitigation and adaptation action in comparison to a scenario when countries only took domestic action.61 Secondly, cost-effectiveness increases the attractiveness of investment. Climate policies must be able to engage the private sector,
53 Parr 2013, p. 24.
54 Rogelj et al. 2018, p. 95.
55 Ibid, p. 95.
56 Heine et al. 2020, p. 95-96.
57 Metz 2010, p. 320.
58 Ackerman – Stewart 1985, p. 1341.
59 Carlarne et al. 2016, p. 17.
60 Schneider 2013, p. 130; Hsu 2016, p. 242; van Asselt 2016, p. 337; Ackerman – Stewart 1985, p. 1341–
1342.
61 World Bank 2019, p. 55.
governments from countries in many different economic circumstances and other relevant stakeholders. This is because addressing the threat of climate change requires unprecedented levels of investment to fund the transition away from old fuel sources and infrastructure towards new, innovative solutions.62 This process is not, according to Keohane, going to occur inevitability as a result of the free market.63 Rather, governments, companies, investors and other entities, guided by and guiding via appropriate policies, can result in environmental gains by harnessing market forces.64 Reducing the cost involved in this process is vital in order to encourage participation and ambitious action, otherwise efforts may well fall short of the level of investment required.65
Another benefit mentioned in Party submissions related to MBMs is their flexibility.
Australia noted that MBMs enable countries to “mobilise private finance” and make climate change plans which “fit national circumstances”.66 MBMs also empower industry by enabling individual companies to make decisions and set priorities about where reductions should take place.67 This delegation of decision-making power, according to Ackerman and Stewart, is appropriate because it enables decisions to be made by individuals involved in industry activities who are familiar with specific details.68 Overall, they claim that this process should enable decision-makers to “set intelligent priorities, make maximum use of the resources … encourage environmentally superior technologies, and avoid unneeded penalties on innovation and investment”.69 Diversifying from the use of public funds and adapting in accordance with national industry and revenue streams may significantly and positively impact on the political feasibility of climate change policy, a matter of critical importance.70 This flexibility must be, however, restrained by the need to have appropriate enforcement and procedures in place to ensure environmental protection is also achieved through MBMs. Specific to trading market mechanisms, for example, there were four key
62 Mehling 2018, p. 4-5.
63 Keohane 2016, p. 3.
64 Ibid, p. 3.
65 Mehling 2018, p. 4-5.
66 FCCC/AWGLCA/2011/MISC.2, p. 3-6.
67 Ackerman – Stewart 1985, p. 1335–1340.
68 Ibid, p. 1335–1340.
69 Ibid, p. 1352, 1365.
70 Gupta et al. 2007, p. 752.
criteria identified by Ackerman and Stewart in order to have successful MBMs.71 Namely, the ability to accurately establish a baseline of emissions, to conduct fair auctions for industry to purchase emissions, to maintain a registry for permit rights and to encourage observance of the permits by use of penalties in cases of non-compliance.72 Modern markets for tradeable pollution rights continue to highlight the significance of these criteria to ensure success.73 This demonstrates the balancing process involved in MBMs, and indeed almost any policy mechanisms, between stakeholders such as policy-makers, environmental advocates and industry.