2. Chapter 2: Market and Non-Market Mechanisms: An Overview
2.2 Defining Market-Based Mechanisms
Once an environmental problem has been identified, there are a wide range of approaches and mechanisms which may be used to try and address it. In the field of international climate change policy, MBMs play a substantial role in international emission reduction targets.
Generally speaking, MBMs can be defined as “policy instruments that seek to harness market forces to either reduce pollution or reduce compliance costs”, both actions which can contribute positively to environmental regulation.20 MBMs can be used to affect the market in different ways, for instance, to phase out environmentally harmful activities or to support the establishment of a market for environmentally-friendly technologies. The dominant method to achieve this is to impose a price on pollution, i.e. GHG emissions, so industry will avoid extra costs by reducing or avoiding activities which result in the regulated pollution.
MBMs are far from homogenous and different authors highlight different features of MBMs in order to categorise them or distinguish them from NMAs. Hahn and Stavins, for example, note that economists in 1992 tended to use the concept of flexibility to distinguish between policy mechanisms; namely, command and control mechanisms which allow little flexibility
20 Carlarne et al. 2016, p. 17.
and market approaches which “provide firms with greater flexibility and incentives” to achieve beneficial outcomes.21 By contrast, Hsu emphasises the transactional nature of MBMs, describing them as voluntary transactions made between at least two private parties, which result in one of the parties conferring environmental benefit, in a process which involves “little or no administrative adjudication”.22 He also states that MBMs are decentralised and offer greater autonomy for private entities.23 In the context of climate change mitigation, market mechanisms could be defined as policy instruments which distort the price of emitting GHGs.24 However, MBMs have also been defined more narrowly in specific UNFCCC contexts. For example, during the Paris Agreement, some country Parties sought to narrow the definition to only mechanisms which result in internationally transferable mitigation outcomes.25 As NMAs and MBMs are generally positioned as mutually exclusive, the changing definition of MBMs results in difficulty solidifying a definition of NMAs.
In general, market mechanisms are now broadly, but not universally, accepted and seen as increasing the efficiency of environmental laws.26 The main forms of MBMs currently in use in environmental policy are taxes on pollution and the trading of permits which enable an entity to partake in a specific amount of an environmentally damaging activity. The concept of taxing units of pollution in order to internalise external costs was devised by A.C.
Pigou in 1920 and is consequentially known as a Pigouvian tax.27 The aim is to increase the price of an undesirable activity, such as emitting carbon, in order to decrease it from occurring.28 Following a government decision to implement Pigouvian taxes, there is an element of power transfer. Rather than a centralised authority deciding upon an acceptable level of pollution, private entities are able to determine how much of the taxed activity they engage in, when they do so and then pay the appropriate level of taxes.29 However,
21 Hahn and Stavins 1992, p. 464.
22 Hsu 2016, p. 245.
23 Ibid.
24 Mehling et al. 2018, p. 659.
25 FCCC/TP/2014/10, para [10].
26 Hsu 2016, p. 241.
27 Hsu 2016, p. 242; Hahn and Stavins 1992, p. 464.
28 Metz 2010, p. 293.
29 Hsu 2016, p. 242–243.
policymakers retain control to the extent that they set the level of the tax and retain autonomy over imposing further limits or future amendments to the policy.30 A key motivation for utilising Pigouvian taxes is to ensure that industry are held responsible for indirect environmental costs of pollution. For instance, in the 1980s there were efforts in the United States to introduce taxes on sulfur dioxide emissions which cause acid rain in order to reflect the damage to forests, marine life and other economic losses.31 While this was not successful, the model of Pigouvian taxes was applied to carbon emissions in the form of carbon taxes throughout Northern Europe (Finland, Sweden, Norway and Denmark) in the 1990s, with more countries closely following.32 The use of carbon taxes continues to grow around the globe as one of the biggest uses of MBMs, and indeed any mechanisms, in climate change regulation.
A second common form of an MBM comes from John H. Dales in 1968. Dales envisioned a system in which companies would have to purchase transferable rights to pollute, thus creating a market for pollution.33 Similar to Pigouvian taxes, the purposes of such a scheme would be to internalise otherwise external costs of environmental damage caused by industry activities and enable these to be remedied in the most cost-effective manner. Indeed, in an ideal world, the set tax costs, and the price of transferable pollution rights would be same, reflecting the most cost-effective action being taken via the market in order to reduce pollution levels.34 The efficiency of such a scheme depends on its structure, environmental integrity, oversight and enforcement, meaning the perfect market does not function in the real world. Transferable pollution permits are usually a politically popular option, which offers greater flexibility to industry. In the US, for example, after a lack of appetite for a taxation scheme, emissions causing acid rain were eventually regulated via a trading permit system.35 Similarly, the European Union (EU) introduced an GHG emissions trading scheme (ETS) after failing to gain support for a carbon tax due to sovereignty fears and financial
30 Hsu 2016, p. 242–243.
31 New York Times 1983, n.p.
32 Weishaar 2018, p. 1.
33 Hsu 2016, p. 240–241; Hahn and Stavins 1992, p. 464.
34 Hsu 2016, p. 251.
35 Hahn and Stavins 1992, p. 464; Parr 2013, p. 24.
reasons.36 In relation to climate change, this process involves distributing rights limited by duration and quantity to emit GHG in order to create a market for carbon. 37
Other forms of market mechanisms include subsidies and incentives. This category of mechanisms involves financial transfers from the government to companies, taxation exemptions and reductions and other forms of direct financial support.38 Subsidies come in a wide variety of forms and made be applied in specific sectors, such as the transport sector, or for particular activities, including research, development or for winding down operations, including decommissioning costs and remediation of sites.39 Subsidies tend to be a politically attractive option, but their effectiveness in terms of environmental protection is variable depending on what is being subsidised.