Energy, Environment and Climate: Economic Instruments
Authors: Kohn Michael ,   Co-authors*
Published: January 2017

The Report discusses the role and effectiveness of Economic Instruments in the field of energy and environment. Economic Instruments are applicable to a wide range of environmental concerns around the world, but this Report focuses primarily on potential global climate change. Although the emphasis for action on potential global climate change presently rests firmly on the shoulders of the industrialised countries and economies in transition, actions should be taken on the basis of equity and in accordance with the common, but differentiated responsibilities and respective capabilities of different countries. Thus, this Report is directed mainly at the North, but also has relevance for the South.

To determine which policy instruments is most appropriate, cost/benefit analysis should be used, but environmental impacts are difficult to value in monetary terms. Thus, only qualitative criteria (effectiveness, efficiency, equity, flexibility and acceptability) can be used to determine which instrument, or mix of measures, would be most effective in mitigating potential global climate change. This Report concludes that:

Direct regulation has historically been the most common means by which governments have limited pollutant emissions. The main drawbacks of direct regulation are their lack of flexibility and the increasing costs and complexity of this form of instrument. Tradable permit schemes distribute emissions permits between businesses and enable companies to buy and sell unused emissions quotas and have the potential to achieve more cost-effective emissions reductions than direct regulation. There is an increasing possibility of an international system for controlling emissions of carbon dioxide, although there are significant difficulties to overcome in allocating initial permits/quotas. Subsidies can be used to artificially improve the economics and acceptability of a policy. Short term subsidies can produce environmental benefits, but if applied in the longer term they give the wrong economic signals and distort market behaviour. Ecotaxes relay on market forces to lead producers and consumers towards more environmentally-acceptable goods and services, and are limited to cases where there is price elasticity in energy demand. Energy and carbon taxes are ineffective at reducing carbon dioxide emissions unless set at unrealistically high rates. Tax measures can detrimentally remove capital for environmental investments and improvements from industry and commerce. Ecotaxes need to be co-ordinated internationally to avoid distortions on export competitiveness, that would require an unprecedented degree of co-operation. Thus, it appears that ecotaxes are not the panacea they are widely promoted to be. Voluntary approaches (including joint implementation) seem to offer flexibility, which is a key attraction for industry. They have the potential to reduce administration and implementation costs, although it is recognised that the operation of such schemes requires close monitoring. Voluntary approaches are expected to receive wider support than non-voluntary approaches. Joint implementation schemes have been highlighted as a potentially powerful mechanism for mitigating potential climate change.

A mix of economic and voluntary approaches offers the optimal solution: the mix should be tailored to the needs of individual country situations and priorities. A minimum regret policy should be followed. Until a full understanding of environmental problems has been determined on a sound, scientific basis, caution needs to be exercised in the use of economic instruments.