Economic Policy Instruments for

Moving Toward a

Greener EconomyMike Toman, Lead Economist and Manager Sustainable Development Research Team,

World Bank19 July 2017

General concepts of “green economy”

1. Improve environmental & natural resource

management to enhance growth, reduce poverty

2. Reduce barriers to development and uptake of

more eco-efficient technologies and sectors

3. Invest in technical innovation and infrastructure

that enhance economic development and reduce

environmental impacts

4. Protect against irreversible damages to natural

systems that would compromise well-being of

future generations

2

Economic instruments for environmental

and natural resource management

Over-use of natural resources or environmental

degradation fundamentally is a problem of prices

being too low for these resources:

Where land, forests, fish stocks, water are accessible to

all, no one has an incentive to control overuse or invest

in resource protection

Subsidies cause natural resource over-use and generate

negative environmental impacts

Environmental and ecosystem services (less pollution or

climate change, more biodiversity) are public goods that

cannot be effectively priced by markets alone3

Different policy instruments are

appropriate for various circumstances

Clarify and enforce “property rights” (private,

communal, governmental) to strengthen

incentives for resource maintenance

Reduce economically wasteful and

environmentally harmful subsidies

Find less costly and distorting ways to attend to the

needs of the poor

Generate economic incentives for more efficient

use of nonmarket environmental and ecosystem

services, through policies that create prices

4

How do economic incentive policies work?

Putting prices on environmentally harmful goods

or activities reduces demand and production

Such prices also create incentives to develop less

harmful substitutes, without need for policy to

prescribe responses, “pick winners”

If policy raises revenue (like a pollution tax), the

funds can be used to

lower other taxes,

assist the poor,

invest in provision of other public goods, and

develop new approaches for reducing environmental

harms 5

One option is imposing prices directly on

environmental harms

This can be done through government-set prices, like a tax on pollution emissions or fees for habitat conversion/destruction

Another approach is creation of a “marketable permits” system for regulating pollution quantities, or limiting fish harvesting

Total allowable emissions or catch distributed among sources

Those with lower compliance costs will sell permits to those with higher compliance costs, as all sources seek to stay within their quotas

Market price of permits incentives like tax6

Examples of economic instruments that

price environmental harms

Water pollution charges in many EU countries and

China, as well as Colombia

Carbon prices in EU, British Columbia, Chile,

Mexico, Colombia

Solid waste charges based on volume and weight

in a number of developed-country jurisdictions

Marketable permits: US SO2 program; ETS for

CO2 in EU, California; tradable fish harvest

quotas in New Zealand

Under consideration in Colombia for CO27

Pricing policies can differ considerably

in specifics of design

Tax rate, or stringency of quota/number of permits available

Sectoral coverage: US SO2 program applies to power sector

EU ETS has covered only about half of total emissions

Chilean C tax applies to power sector and manufacturing; Colombian C tax applies to fuels

Range of pollutants covered

Compliance options For CO2 in particular, various offsets via investments in

reducing other emissions may be allowed

8

Applications

of Carbon

Pricing in

2016

Source: State and

Trends of Carbon

Pricing 2016,

Ecofys and World

Bank9

Source: State and

Trends of Carbon

Pricing 2016,

Ecofys and World

Bank

10

Range of carbon prices in

national policies, 2016

How permits are allocated is crucial to

practical success of trading approach

Incumbent sources like free transfer of permits;

the need to buy permits is a barrier to entry for

new competitors

If more permits are awarded to sources with

lower emissions intensity, the allocation

functions like a subsidy to production

If government auctions some share of permits,

money can be used to reduce burdens on

dislocated workers, cut other taxes, invest in

environmental R&D, fund public services and

social activities11

Indirect approach: tax things correlated

with environmental harms

Particularly relevant for transport, agriculture Motor fuels tax, taxes on potentially polluting

agricultural inputs, congestion pricing

A related option is a refundable deposit if harmful good is returned for safe recycling

Car batteries, tires, fluorescent lights,…

Payments for environmental services (watershed and critical habitat protection)

Indirect approach is less well-targeted than direct pollution charges, but easier to administer – especially for more dispersed sources

12

Also possible to mitigate environmental

harms by reducing subsidies

Energy subsidies are an obvious example

Less obvious is quasi-free access to resources on

public lands

Include in charges for public services the costs of

mitigating environmental harms

Can invest proceeds in improved resource protection

and management

Raising cost of public services works only if

customers believe service quality will improve

Even then, large hurdles to get public acceptance

13

Also possible to mitigate environmental

harms by reducing subsidies

Can charge more for access to public resources

like forest lands in order to fully reflect the cost

of depletion or restoration

However, this will not succeed if enforcement is

weak and illegal extraction is low-risk

Challenge of forest protection in many places

14

Subsidies for environmentally

positive activities?

Grants to farmers for less-polluting practices, or

businesses for pollution control equipment

Politically attractive in the face of organized

opposition to other policies

Can lead to environmental improvement

However, subsidies generally are hard to

effectively and efficiently target

Risk of paying for what would have taken place anyway

Subsidies to reduce pollution shifts cost of

environmental protection to broader public15

Economic instruments do not replace

good environmental standards

They are better means to accomplish the

objectives of a green transition

How objectives are set is a separate topic

Pricing policies still require capacity to enforce

fees/punish violators, as well as

monitoring/measurement capacity

Some prescriptive measures also needed to

complement pricing policies

Need for energy efficiency standards, especially for

buildings and their HVAC and water systems16

Examples of potential pitfalls with

incentive based policies

In China, some regulatory authorities became attached to

having revenues from emissions taxes or fees, which would

be lost if emissions declined

In Russia, emissions taxes or fees were too low to do much

in creating incentives for reduced pollution, so regulatory

standards and fines ended up determining emissions (like

command and control but with revenue generation)

Since the EU ETS covers only part of total CO2 emissions,

when regulators allocated too much of the national quotas

to the ETS, the price of permits plunged

High waste collection fees encourage illegal disposal

17

Also need policy to expand access to and

adoption of greener technologies

Transition to more environmentally sustainable

technologies changes the structure and

composition of the economy

What is produced, the types of employment

Even with good environmental policies, there can

be broader barriers to longer-term green

technology access or adoption

18

Barriers to expanding access to and

adoption of greener technologies

Protectionist trade and investment policies can restrict access to greener technologies

Tariffs on more modern and sustainable physical capital (observed for example in parts of East Asia, Africa)

Restrictive climate for foreign direct investment that brings improved technology (limits on ownership, earnings repatriation)

Domestic tax policies can have similar negative effects on greener technology adoption

Higher tax rates on new cars than older cars

Fuel subsidies that undercut incentives for improved energy efficiency

19

Barriers to expanding greener

technology options

Green technology development hindered by

distorted incentives for innovation

The basic science to develop the next generation of

cost-effective green technologies cannot be patented

Need increased public financing and international

cooperation for research and pilot deployments

Difficult for the private sector to adequately hedge

technology and project-specific risks at the pilot stage

of new technology development

20

Institutional reforms for greater use of

greener technologies

Risk-sharing for pilot adopters given

uncertainties about new technology performance

(fluorescent light diffusion in many places)

Information provision can complement incentives

in reducing inertia from ingrained habits

(“nudges” in utility bills)

Overcoming “split incentive” problems – for

example, the apartment owner pays the water

and heating bills, not the tenant

21

Political economy questions – and

possible answers

These economic policy instruments are ruining my profits!

To the extent profits are based on subsidized access to natural resources and environmental goods, they are an unearned transfer from the people. In a sustainable economy, profits need to reflect real costs.

Look at how many of my constituents are losing jobs from these policies!

This is a serious concern and government needs to take measures to protect truly vulnerable workers from the adjustment shocks. This can include help in accessing new opportunities in the green economy, and strengthening social safety nets.

22

Political economy questions – and

possible answers

These policies are ruining my competitiveness in

international trade!

Competitiveness based on use of under-priced natural

and environmental resources is not sustainable.

The shrinking of [a particular sector] is hurting

our ability to collect taxes!

Tax restructuring can be a useful complement to

environmental pricing (including proper pricing of

natural resource access, and imposition of pollution

fees).

23

Political economy questions – and

possible answers

Economic growth and opportunities for poverty

reduction are being harmed by these policies!

Moving toward a green economy can create the

opportunity for improving future economic

development, through greater resource efficiency and

technical innovation.

Green economy measures do not necessarily increase

near-term growth or employment.

Moreover, not every green economy measure will

generate longer-term benefits that justify nearer-term

transition costs.

Choose the opportunities carefully!24

Summary: What pricing policies can and

cannot do

Create incentives for reducing environmental harm

Create incentives for environmentally superior AND economically productive technical innovation

Lower costs of achieving environmental goals than with more technologically prescriptive approaches

But cannot in practice eliminate command and control given monitoring problems, behavioral inertia

Cannot determine which environmental targets are appropriate

Cannot replace environmental standards and monitoring

25

Policy coverage and consistency

Leaving out key sources/sectors raises costs of environmental protection, encourages “leakage”

EU ETS; taxing only e.g. power sector emissions

Policy should provide consistent incentives across different sources

Taxing energy versus carbon content; regulatory requirements that favor one renewable energy type over others

Environmental pricing should not be undermined by other subsidies (energy, land use)

Use of environmental policy revenues should reflect social values (vs. private gains)

26

Timing of policy implementation

For long-lived problems like climate change and biodiversity loss, concern is for aggregated damaging activities, not just rate per year

Pricing policies need to reflect restrictions on cumulative harm

Carbon tax that rises over time

Groundwater extraction fee that rises with depletion

Declining allocations of tradable emission permits so that permit price rises over time

Fish harvest quotas that shrink if stock declines, until it recovers

This creates a difficult dilemma since time horizons for policy decisions generally are much shorter

27

Green transition and sustainability

Defining sustainability objectives goes beyond

economics and engineering

It requires societal debate over ethical principles

for protecting the future, reducing risks of

catastrophe

Well-considered ethical principles also are

needed for how environmental risks and benefits

are distributed across different societal groups

28

Thank you for your kind attention, and I look

forward to your comments and questions. I

hope we can serve you further as you go

forward with greening the Colombian economy.

mtoman@worldbank.org

(Some pictures from freeimages.co.uk)