Market-Based Environmental Policy - Literature review Example

Contrast policies that aim to correct a market failure of a negative externality such as pollution or congestion. Indicate the respective effects on business Introduction Public awareness of the global warming and the various forms of pollution contributing to it has grown significantly during the last decades. However, awareness without actions cannot produce positive results towards environment protection. While in pure market system both producers and consumers would be expected to reduce consumption and therefore, result in reduced levels of manufacturing/production, the market fails to regulate this issue. Thus, government intervention aimed at protection or regulation of pollution/congestion is expected to correct market failure of this negative externality (Sloman, Hinde, and Garratt 2010). The objective of this paper is to provide an overview of the environmental policies that aim to correct a market failure of a negative externality such as pollution or congestion, and to analyze the respective effects of these policies on business. As environmental government policies have effect not only on the individual firms but also on the whole sector or industry, there will be provided analysis of the impact that the environmental policy has on both microeconomic and macroeconomic environments. Overview of environmental policies Many economists would claim that the businesses incurring damage to the society or environment should be liable for their “harmful” activities and either pay taxes or be excluded from the areas in which its activity has harmful effect on others (Coase 2013). Government usually has similar approach towards managing social and environmental damage caused by the enterprises, and that is why there have been introduced various environmental policies. Environmental policy is defined as government initiative(s) aiming “to ensure a specified minimum level of environmental quality” (Sloman, Hinde, and Garratt 2010, 465). While developing such initiatives the government has to value the environment by estimating the costs of environment pollution. For valuing the environmental pollution or other damage there can be applied three methods, including the following: the financial costs to other users; value based on the stated preference also known as “contingent valuation”; and revealed preferences (Sloman, Hinde, and Garratt 2010). The financial costs to other users is the method, where costs of environmental damage (for instance pollution/congestion) are calculated based on the financial costs imposed on individuals and businesses by polluting activities (Sloman, Hinde, and Garratt 2010). Contingency valuation is the method is based on the individuals’ evaluation of the effect the environmental change will have on them. However, this approach is weakened by two human factors: dishonesty and ignorance (Sloman, Hinde, and Garratt 2010). Revealed preferences method is applied when there is a difficulty to calculate or identify direct financial costs incurred by pollution. In such case the environment is valued based on the individual’s/businesses’ change of behavior in response to environmental change (Sloman, Hinde, and Garratt 2010). Based on the extent of application, there are identified several forms of environmental policies: market based, non-market based, and mixed (Sloman, Hinde, and Garratt 2010). Market-based environmental policy In the market-based environmental policy there are applied taxes and charges on the polluters. Thus, companies should pay for waste disposal, agricultural inputs, energy use, vehicle use, water use, etc. As the size of the penalty is tied to the amount of pollution, businesses/individuals are under a continuous pressure to cut down polluting activities (Sloman, Hinde, and Garratt 2010). Market-based environmental policies encourage firms to adopt better pollution-control and cheaper technologies (Stavins 2001). In order to regulate pollution or congestion problems, there are applied several categories of market-based instrument, including: pollution charges, market friction reductions, government subsidy reductions, and tradable permits Stavins 2001). Based on tradable limit approach, there are set maximum limits for emission levels for a given pollutant for a specific plant or factory. The firms can either use fully their limits or sell the amount of not used credit to the other firms. Thus, the firms distribute the overall level of emissions based on the market needs (Sloman, Hinde, and Garratt 2010). This approach might be good enough from the businesses’ standpoint as they have an alternative, but it might not be effective approach in terms of reduction of the overall level of pollution (Sloman, Hinde, and Garratt 2010). Pollution charge policy implies that a firm or other party pays a tax or fee on the amount of pollution it has generated. There are also special cases of pollution known as a “deposit refund system” (Stavins 2001, 4). If consumers buy potentially polluting products they pay a surcharge and get a refund if they bring end-of-life product to an approved disposal or recycling center (Stavins 2001). Non-market-based environmental policy Non-market-based environmental policy is based on the command-and-control approach, whereas the government sets the maximum acceptable amount of resource use or level of emission and imposes fines to firms exceeding these limits (Sloman, Hinde, and Garratt 2010). Command-and-control regulations set uniform standards for the companies and therefore has limited flexibility comparing to the market based approach. Non-market-based policies often require firms to undertake unduly expensive initiatives for controlling pollution. This uniformity applied to all firms can incur high costs to firms, and sometimes can lead to counterproductive results as technology appropriate in one case may not be cost-effective in another (Stavins 2001). Therefore, the cost-effectiveness of this policy depends on such variables as a company’s production design, age of assets, physical configuration, etc. (Stavins 2001). In terms of environmental effect, this approach has some obvious weaknesses as it fails to incentivize businesses to lower the legally allowed level of pollution in contrast to the market based policy (Sloman, Hinde, and Garratt 2010). Mixed environmental policy Mixed policy implies a combination of both market-based and command-and-control systems. This approach suggests that mixed system may be less costly to society, as the government would set pollution tax rates and introduce flexible direct controls on a standby basis (Baumol and Oates, 1988). This policy provides flexibility, which is not available in the non-market system as the government can have regulations of increasing severity depending on the extent of threatened danger of pollution (Baumol and Oates, 1988). In this case, direct controls instruments will be used when it is necessary to manage temporary periods of accentuated environmental pollution, and taxation instruments will be used for encouraging and incentivizing energy-efficient solutions (Baumol and Oates, 1988). Environmental policies in the European Union Environmental legislation varies from country to country, and the range and scope of these policies often depend on the development level of a given country. Thus, for example, the European Union has introduced a set of environmental policies aiming to reduce significantly soil, air, and water pollution, to protect, enhance and conserve the natural capital of the EU, and to turn the EU into low-carbon, resource-efficient economy (Ec.europa.eu, 2014). The EU environmental policies impose obligations on both industrial and agricultural industries as they have a high pollution potential. Thus, the EU legislation requires agricultural and industrial businesses to use all pollution-prevention measures; use energy in efficient way; prevent all large-scale pollution, etc. (Europa.eu, 2011). Also, there were adopted some direct controls of environmental policy, including emission limits values, waste management measures and market-based measures for exception circumstances (for instance, permanent/temporary stoppages, malfunctions, leaks). The effects of environmental policies As Fullerton (2011) explains, the effects of environmental policy are intricate, indirect and much more varied. As it has been already mentioned, it has impact on both microeconomic and macroeconomic environments. Further is provided analysis of these effects in terms of both microeconomic and macroeconomic perspectives. Environmental policies can have several different effects on the business, including the following: costs to consumers and costs to producers or factors (Fullerton 2011). Both taxes and subsidies change the costs of some businesses and thus affect competition on the market. Taxation policies aiming to reduce pollution or congestion may affect business costs of the firm and therefore increase prices of products sold to the clients/consumers (Businesscasestudies.co.uk, 2014). Moreover, taxation policy based on pollution factor can create entry barriers in a market thus disabling potential players to enter the industry, and enabling existing players to exploit their market power (Office of Fair Trading 2009). When the government imposes pollution taxes and charges on the industries in its country, the products produced for export become less competitive on the world market, causing problems with international trade. In order to keep the industries competitive for international trade, government need to give rebates for export taxes. In the long-term perspective, environmental policies with high taxes also will set a continuous pressure on the businesses. Thus, the firms may either seize their international activity or seek solutions for reducing pollution (Sloman, Hinde, and Garratt 2010). However, there is also an alternative for the businesses to relocate their production facilities to the countries with lax environmental legislation (Hassaballa 2014). This will result in inflow of foreign direct investment (FDI) to the developing countries. The growth of FDI inflows to developing countries, which exceeded 50% in 2012, is believed to have correlation with the loose environmental legislation in these countries (Hassaballa 2014). Thus, businesses whose polluting activities are subjects to taxation and tariffs might prefer to relocate harmful business operations to other countries. However, there are also the gains which firm enjoys in result of compliance with the environmental policies. First of all, firms increase their competitiveness as consumers become more selective and tend to give preference to environmentally responsible companies. Focus on reduction of pollution and/or congestion also enables the company to minimize taxes and tariffs by investing to more environmentally-friendly business operations. Conclusion The objective of this paper is to provide an overview of the three environmental policies aiming to reduce negative environmental impact such as pollution or congestion. These policies included: market-based policy, non-market based policy, and mixed policy. While all the three policies have common strategic objectives, their characteristics and overall effect vary significantly. In the market-based environmental policy there are applied taxes and charges on the polluters and the size of the penalty is tied to the amount of pollution. Thus, firms are under a continuous pressure to cut down polluting activities. In contrast to the market-based system, non-market-based system implies is based on the command-and-control approach, whereas the government sets the maximum acceptable amount of resource use or level of emission and imposes fines to firms exceeding these limits. In command-and-control legislation, firms are not incentivized to lower the legally allowed limits. Therefore this approach is often viewed as less effective system in terms of environment protection perspective. Mixed environmental policy offers a compromise for the market as it implies a combination of both market-based and command-and-control systems. This policy provides flexibility, which is not available in the non-market system. Application of the environmental policies has both positive and negative effects on business. In terms of negative concerns it may lead to increased costs to producers and customers, affect competition and create entry barriers, challenge international trade activities, and shift FDI from developed/mature economies with strict environment legislation to the countries with lax environment legislation. However, there are also positive effects on business such as opportunity to gain competitive advantage on the market due to cost-effective methods, and thus, increased loyalty of the customers, and subsidies from the government. Still, it is worth to mention that the effect of environmental companies may vary substantially among the firms, depending on the industry, size of the firm, production design, physical configuration technology used, age of assets, etc. Referencing: Baumol, W. and Oates, W.,1988, ‘The theory of environmental policy’. 1st ed. Cambridge [Cambridgeshire]: Cambridge University Press. Businesscasestudies.co.uk, 2014, ‘How businesses are affected by government policy Government influence business studies and business’. Business Case Studies. [online] Available at: http://businesscasestudies.co.uk/business-theory/external-environment/how-businesses-are-affected-by-government-policy.html#ixzz3DkvSnur1 Coase, R H. 2013, ‘The problem of social cost’. The Journal of law & economics , 56 (4), p. 837. Ec.europa.eu, 2014, ‘Environment Action Programme to 2020 - Environment - European Commission’. [online] Available at: http://ec.europa.eu/environment/newprg/index.htm Europa.eu, 2011, ‘Integrated pollution prevention and control (until 2013)’. [online] Available at: http://europa.eu/legislation_summaries/environment/waste_management/l28045_en.htm Fullerton, D 2011, Six Distributional Effects of Environmental Policy, Risk Analysis: An International Journal, 31, 6, pp. 923-929. Hassaballa, H. 2014, "The Effect of Lax Environmental Laws on Foreign Direct Investment Inflows in Developing Countries", Journal of Emerging Trends in Economics and Management Sciences, vol. 5, no. 3, pp. 305-315. Office of Fair Trading, 2009, ‘Government in markets: why competition matters – a guide for policy makers’. Available at: https://www.google.com.ua/url?url=https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/284451/OFT1113.pdf&rct=j&q=&esrc=s&sa=U&ei=dQscVMftKYPrPJiegKgO&ved=0CBMQFjAA&sig2=vXqz5H5g0uRNKZ4fiBl0Zg&usg=AFQjCNGfh-sLKJ-7pdwbHwcSmgZ1hkHX2Q Sloman, J., Hinde, K., and Garratt, D., 2010, ‘Economics for Business’, Harlow: Financial Times Prentice Hall. pp. 465-480. Stavins R. 2001, ‘Experience with Market-Based Evironmental Policy Instruments’. Available at http://www.google.com.ua/url?url=http://www.hks.harvard.edu/fs/rstavins/Papers/Market%2520Based%2520Environmental%2520Policies.pdf&rct=j&q=&esrc=s&sa=U&ei=zRQcVKL0IoiJPdKJgOgO&ved=0CCkQFjAD&sig2=swEVbwBa_mz5KDp25k_b9w&usg=AFQjCNHvwe2KxGQ6CsmRS-rXPo2UT2vNAQ Read More