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Market Based Incentives

Market-Based Incentives for Sustainable Resource Management

Markets play a major role in environmental degradation, but can also be a force for environmental improvement. Early research focused on the causes of environmental damage, in terms of market imperfections and policy failures (externalities, public goods, uncertainty, inappropriate fiscal policies, weak enforcement of environmental regulations, etc.). More recently, economists have focused on how to "internalise" environmental values in private production and consumption decisions, through the use of market-based incentives (MBIs). Theory suggests that MBIs can help achieve environmental goals at a lower cost than "command and control" regulations, whilst also creating incentives for on-going innovation and improvement.

Examples of environmental MBIs include:

· pollution taxes and tradeable permits for air and water pollution control in industrial sectors (in the USA and other developed countries)
· deposit-refund schemes to finance solid waste management
· payments for conservation set-aside
· allocation of tradeable water use rights in the agriculture sector
· congestion charges for road transport
· commercial carbon trading and sequestration projects.

Experience has provided important lessons regarding the design of MBIs, so that they are not only economically efficient, but also administratively feasible and politically acceptable. However, despite some promising examples, MBIs have not been widely adopted. Many governments remain concerned about the potential adverse fiscal and distributional impacts of MBIs, and their coherence with existing national and international policies. Use of MBIs in the developing world is in its infancy, particularly in low-income countries.
While governments have been slow to introduce environmental MBIs, voluntary market-based incentives have been introduced in several sectors. These include social and/or environmental certification schemes (e.g. the Forest Stewardship Council), as well as so-called "fair trade" schemes, "socially responsible" investment funds, voluntary environmental reporting by companies, etc.. To judge the overall value of these schemes, it is important to assess their potential adverse impacts on developing world exporters, who bears the costs of improving social and environmental performance, and how performance standards and criteria for certification are determined. As with actual MBIs, awareness and adoption of voluntary initiatives is limited in most developing countries.

Three CREED projects examined the potential of MBIs for environmental management. One study in Costa Rica explored the potential of market-based incentives for watershed protection, in conjunction with a detailed evaluation of the hydrological impacts of forest conversion to cattle ranching. This project was exceptional, not only in its careful estimation of environmental externalities, but also in the way it grounded the analysis of incentive mechanisms in a thorough assessment of local and national institutions. Researchers found that appropriate incentive measures could have an economically significant impact on water supply for irrigation and hydroelectric power generation.

A second project involved case studies in both Costa Rica and Brazil, focusing on the potential of vehicle characteristic taxes as a tool for controlling pollution in the transport sector. The Costa Rican case study concluded that existing taxes favouring the import of used rather than new cars had significant adverse environmental impacts. Equalizing rates of tax on new and used car imports would reduce pollution, but would also have a regressive impact due to the greater reliance of poor consumers on the used car market. The results of this study attracted considerable attention from the media and policy-makers in Costa Rica.

Finally, in India, a further CREED project modelled the effects of introducing alternative incentive schemes for regulating air and water emissions from the steel industry. The results of this project fed into a process of national policy dialogue on industrial pollution prevention, involving stakeholders from industry, government and NGOs.

Priorities for the PREM Programme include the following:
· How to reduce uncertainties and remove barriers to environmental MBIs, using a political economy approach to identify major stakeholders and their interests, and to design strategies for achieving policy change.
· What are the costs and benefits of voluntary market-based initiatives, such as forest certification, and who sets the standards and judges performance. How costs and benefits are distributed along the supply chain, what conflicts typically occur with official government policies and how to minimize them.
· The institutional context underlying resource management and the implications of changes in property right regimes, taking into account distributional issues, for example the impacts of privatisation of utilities.

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