What explains the recent popularity of market-based environmental solutions? 2

Despite the potential cost-effectiveness of market-based policy instruments like pollution taxes and tradable permits, conventional approaches—including design and uniform performance standards—have been the mainstay of U.S. environmental policy since before the first Earth Day in 1970.

Gradually, however, the political process has   become more receptive to innovative, market-based strategies. In the   1980s, tradable-permit systems were used to accomplish the phasedown of   lead in gasoline (at a savings of about $250 million per year), and to   facilitate the phaseout of ozone-depleting chlorofluorocarbons (CFCs);   in the 1990s, tradable permits were used to implement stricter air   pollution controls in the Los Angeles metropolitan region, and—most   important of all—a cap-and-trade system was adopted to reduce sulfur   dioxide (SO₂) emissions and consequent acid rain by 50   percent under the Clean Air Act amendments of 1990 (saving about $1   billion per year in abatement costs).

Most recently, cap-and-trade   systems have emerged as the preferred national and regional policy   instrument to address carbon dioxide (CO₂) emissions linked with global climate change (see my previous posts:  “Opportunity for a Defining Moment” and “Green Jobs”).

Why has there been a relatively recent rise in the use of market-based approaches? For academics like me, it would be gratifying to believe that increased understanding of market-based instruments had played a large part in fostering their increased political acceptance, but how important has this really been?

In 1981, my Harvard colleague,   political scientist Steven Kelman, surveyed Congressional staff members and found that support and   opposition to market-based environmental policy instruments was based   largely on ideological grounds: Republicans, who supported the concept   of economic-incentive approaches, offered as a reason the assertion   that “the free market works,” or “less government intervention” is   desirable, without any real awareness or understanding of the economic   arguments for market-based programs.

Likewise, Democratic opposition   was based largely upon ideological factors, with little or no apparent   understanding of the real advantages or disadvantages of the various   instruments. What would happen if we were to replicate Kelman’s survey   today? My refutable hypothesis is that we would find increased support   from Republicans, greatly increased support from Democrats, but   insufficient improvements in understanding to explain these changes.   So what else has mattered?

First, one factor has surely been increased pollution control costs, which have led to greater demand for cost-effective instruments. By the late 1980s, even political liberals and environmentalists were beginning to question whether conventional regulations could produce further gains in environmental quality. During the previous twenty years, pollution abatement costs had continually increased, as stricter standards moved the private sector up the marginal abatement-cost curve. By 1990, U.S. pollution control costs had reached $125 billion annually, nearly a 300 percent increase in real terms from 1972 levels.

Second, a factor that became important in the late 1980s was strong and vocal support from some segments of the environmental community. By supporting tradable permits for acid rain control, the Environmental Defense Fund seized a market niche in the environmental movement and successfully distinguished itself from other groups.

Related to this,   a third factor was that the SO₂ allowance trading program, the leaded gasoline phasedown, and the CFC phaseout were all designed to reduce emissions, not simply to reallocate them cost-effectively among sources. Market-based instruments are most   likely to be politically acceptable when proposed to achieve   environmental improvements that would not otherwise be achieved.

Fourth, deliberations regarding the SO₂ allowance system, the lead system, and CFC trading differed from previous attempts by economists to influence environmental policy in an important way: the separation of ends from means, that is, the separation of consideration of goals and targets from the policy instruments used to achieve those targets. By accepting—implicitly or otherwise—the politically identified (and potentially inefficient) goal, the ten-million ton reduction of SO₂ emissions, for example, economists were able to focus successfully on the importance of adopting a cost-effective means of achieving that goal.

Fifth, acid rain was an unregulated problem until the SO₂ allowance trading program of 1990;  the same can be said for leaded gasoline and CFC’s. Hence, there were no existing constituencies—in the private sector, the environmental advocacy community, or government—for the status quo approach, because there was no status quo approach. We should be more optimistic about introducing market-based instruments for “new” problems, such as global climate change, than for existing, highly regulated problems, such as abandoned hazardous waste sites.

Sixth, by the late 1980s, there had already been a perceptible shift of the political center toward a more favorable view of using markets to solve social problems. The George H. W. Bush administration, which proposed the SO₂ allowance trading program and then championed it through an initially resistant Democratic Congress, was (at least in its first two years) “moderate Republican;”  phrases such as “fiscally responsible environmental protection” and “harnessing market forces to protect the environment” do have the sound of quintessential moderate Republican issues. But beyond this, support for market-oriented solutions to various social problems had been increasing across the political spectrum for the previous fifteen years, as was evidenced by deliberations on deregulation of the airline, telecommunications, trucking, railroad, and banking industries. Indeed, by the mid-1990s, the concept (or at least the phrase) “market-based environmental policy” had evolved from being politically problematic to politically attractive.

Seventh and finally, the adoption of the SO₂ allowance trading program for acid rain control—like any major innovation in public policy—can partly be attributed to a healthy dose of chance that placed specific persons in key positions, in this case at the White House, EPA, the Congress, and environmental organizations. The result was what remains the golden era in the United States for market-based environmental strategies.

If you would like to read more about the factors that have brought about the changes that have occurred in the political reception given to market-based environmental policy instruments over the past two decades, here are some references:

• Stavins, Robert N. “What Can We Learn from the Grand Policy Experiment? Positive and Normative Lessons from SO2 Allowance Trading.” Journal of Economic Perspectives, Volume 12, Number 3, pages 69-88, Summer 1998.
• Keohane, Nathaniel O., Richard L. Revesz, and Robert N. Stavins. “The Choice of Regulatory Instruments in Environmental Policy.” Harvard Environmental Law Review, volume 22, number 2, pp. 313-367, 1998.
• Hahn, Robert W. “The Impact of Economics on Environmental Policy.” Journal of Environmental Economics and Management 39(2000):375-399.
• Hahn, Robert W., Sheila M. Olmstead, and Robert N. Stavins. “Environmental Regulation During the 1990s: A Retrospective Analysis.” Harvard Environmental Law Review, volume 27, number 2, 2003, pp. 377-415.

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