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Economic Instruments

Economic instruments should be used to enhance better practices and avoid harmful ones. Economic instruments for environmental protection are policy approaches that encourage behaviour changes through their impact on market signals rather than through explicit directives regarding pollution control levels or methods or resource use.

Given the complexities of environmental problems and the impact of environmental policies on social and economic activities, specific environmental problems are usually addressed by employing a “policy mix” consisting of various command and control instruments, economic instruments, and persuasive instruments. It is important to stress, therefore, that using economic instruments alone usually is not the ideal and only solution. Regulation or voluntary agreements may also be appropriate where there are a limited number of polluters, therefore the costs of setting up a scheme based on an economic instrument may outweigh the benefits.

Why use economic instruments?

Economic instruments have a number of benefits compared to other measures. They can allow internalisation of environmental costs, in line with the polluter pays principle, and give polluters flexibility in the way they respond. The main advantage of using economic instruments is that they have the potential to change the behaviour of the users. When environmental costs are fully internalised into the price of a product or an activity/service, consumers are encouraged to substitute away from these products with higher relative prices to alternative products that are relatively cheaper priced and more environmentally friendly.

Types of economic instruments

The list of economic instruments is long and the literature describing them is abundant, to name just a few: Emission charges/fees/taxes; User charges/fees/taxes; Product charges; Tradable permit systems; Non-compliance fees; Deposit-refund systems; Non-compliance bonds; Performance bonds; Liability payments; Subsidies.

Problems with economic instruments

One size does not fit all. There is substantial variation in the needs, opportunities, and constraints facing each country. Even within countries, there is a substantial variation in the capacity to implement economic instruments across different regions or sectors.

Some desired changes are easier to implement through economic instruments while others are easier to implement through command and control regulations. It is not an either/or situation. For each country, the balance between regulatory controls and economic instruments will depend on local conditions and preferences. In high-income countries with well-staffed and well-equipped regulatory agencies, as well as strong judicial response systems, specific regulatory standards may be readily implemented on an equitable basis. Thus, economic instruments used in these countries may be designed to encourage super-performance. However, in many developing countries the inspection and enforcement resources are limited and political influences may lead to inequitable compliance requirements. In such cases, economic instruments may be designed for the achievement of more modest standards of performance rather than super-performance.