Green Laws and Incentives

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Author: Dan C. Shahar
Editors: Julie Newman and Paul Robbins
Date: 2011
Green Ethics and Philosophy: An A-to-Z Guide
Publisher: Sage Publications, Inc.
Series: The SAGE Reference Series on Green Society: Toward a Sustainable Future
Document Type: Topic overview
Pages: 4
Content Level: (Level 5)

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Green Laws and Incentives

In recent decades, a number of environmental policy makers have been moving away from “command-and-control” paradigms of regulation in favor of policies that operate by changing the incentives that people face when making decisions. In the traditional view, the job of the regulator was to tell people what to do and when in order to bring about desired environmental goals. But today, many regulators strive to avoid such rigid demands, instead seeking to build institutional structures in which individuals are encouraged to make better choices and to share the burden of environmental protection in socially beneficial ways. In this article, we will first review the development of ideas in the field of economics that define the role of incentives in green policy and then explore how some of those ideas have been put into practice. Finally, we will briefly consider some potential objections to incentive-based approaches to environmental policy making.

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Theories of Market Failure

In The Wealth of Nations, Adam Smith famously observed that even though people typically pursue their own self-interest, they nevertheless help to bring about positive social outcomes as if by an “invisible hand.” This happens because in a market economy, individuals can best promote their own interests by producing for other people. When we sell our products to people who value them, we make them better off, and we are also made better off by the profits on the sale. By placing our self-interest in the service of others, the market system encourages us to act in ways that benefit both ourselves and society at large.

In The Economics of Welfare, however, Arthur Pigou pointed out that sometimes the benefits of an action to an individual and the benefits of that action to society can diverge. If individuals do not receive all of the costs and benefits from their actions, then they may choose things that are good for them but not ideal from a social standpoint. Or they may avoid doing things that are personally costly but highly beneficial to society. In these situations, the market fails to effectively coordinate the interests of individuals to the benefit of society. The operators of a polluting factory, for example, might profit from the fact that others have to bear the burdens of their activities while they keep all of the proceeds from their products. Or a landowner might neglect to create a refuge for an endangered species on her property because she would have to pay the full cost but would not realize much personal benefit from doing so. Pigou suggested that sometimes the best way to deal with these sorts of scenarios would be for the government to step in and create legislation to make people do the right thing.

Since Pigou's era, thinkers like Ronald Coase and Garrett Hardin have provided the foundation for alternative forms of intervention besides direct regulation. Coase pointed out that sometimes socially inefficient outcomes arise from the fact that people have trouble negotiating mutually beneficial solutions. And Hardin observed that undesirable consequences can result when resources are left for common use and people are unable to preserve them for personal gain—in situations like these, people may use the resources irresponsibly, to the detriment of society as a whole. These insights emphasized the notion that instead of using legislation to tackle problems directly, regulators can help bring about better outcomes by empowering people to negotiate with each other and by creating more functional institutional structures to guide people toward better choices.

From Theory to Practice

Most environmental legislation to date has been administered through centralized commands. Typically, environmentally harmful activities are restricted, forcing individuals to obtain permits for the right to engage in those activities at acceptable levels. Such policies have been criticized for being rigid and vulnerable to the shortcomings of the regulators charged with implementing them. It is difficult for regulators to decide how much of the activity to allow and how permits should be distributed, and the fairest distribution may not be the most cost efficient. Regulators may also be subject to political pressure that could taint the process. But when successful, these policies can address incentive problems by prohibiting the harmful activities in which individuals might otherwise engage.

Policies based more explicitly on adjusting incentives can help environmental policy makers to avoid some of the difficulties associated with centralized, command-based regulations. There are a number of different ways to craft these policies, each with its own strengths and weaknesses. We will focus on three types of examples: privatization and community ownership schemes, taxation and subsidies, and the use of marketable permits.

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Privatization takes resources that were formerly owned by the government (or not owned at all) and grants exclusive title over them to private individuals. Community ownership schemes involve the transfer of titles to community groups. Such policies encourage the new owners to be responsible stewards because destroying the resources will make them less valuable in the long run. Ownership-based policies face important challenges in deciding how to distribute resources and how to allocate decision-making authority to the new owners. If owners are not likely to be effective in safeguarding resources (or if they are not inclined to do so), then ownership-based policies may not be appropriate for achieving environmental goals. But in some situations, they can help to overcome adverse incentive problems by allowing owners to capture more of the benefits of socially responsible behavior. In parts of South America, ownership of forests is being transferred to communities with apparently positive results, and in a number of African nations the privatization of wildlife refuges has been instrumental in encouraging conservation.

Regulators can also discourage environmentally harmful actions by imposing taxes on them; similarly, they can promote beneficial actions by subsidizing them. These policies work by bringing the costs and benefits faced by individual decision makers into line with the corresponding costs and benefits for society. Limits on regulators' knowledge can compromise these policies, especially when it is difficult to know how large an effect will be produced by a particular rate of tax or subsidy. And while subsidies are typically not met with too much political resistance, taxes are generally politically unpopular. Accordingly, examples of environmentally motivated subsidies are ubiquitous, while examples of similar taxes are harder to come by. Nevertheless, several European countries have introduced taxes to discourage the use of polluting fuels and waste-generating products.

An alternative scheme, pioneered by John Dales, involves the issuing of permits for environmentally harmful activities as in traditional command-and-control policies, but establishes a mechanism for parties to trade those permits with each other. Marketable permits still force regulators to find fair ways to allocate permits initially, and it is still necessary to decide just how much of the permitted activity will be allowed. But permit-trading schemes have the advantage of enabling parties who would have difficulty reducing their impacts to effectively pay others to take on the reductions in their stead. This means that impact-reduction goals can be achieved as cheaply as possible, and it also means that individuals gain a positive incentive to find inexpensive ways to reduce pollution—if they succeed, then they can sell their excess permits for a profit (or avoid having to buy permits). The European Union has adopted a carbon dioxide emissions trading scheme as part of its climate policy, and the United States has a similar program in place to combat acid rain.


Incentive-based policies have been criticized by environmental advocates for allowing people to pay for the right to engage in morally objectionable actions. For example, if it is morally wrong to emit dangerous pollution, then providing an incentive to stop polluting will be inappropriate: we should prohibit the pollution. Defenders of the policies argue, however, that stopping all pollution would be infeasible—the goal of environmental policy should be to find ways to keep pollution at tolerable levels. A related criticism, which can be traced to Aldo Leopold, is that the constraints and incentives that can be produced by public policies are no substitute for the self-control that only comes with real moral change.

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A different kind of criticism can be traced back to ideas articulated by Friedrich Hayek and James Buchanan. On this view, the extreme complexity of the market system and the wide range of different values held by citizens make it impossible for regulators to adjust incentives to reflect what is truly best for society. Defenders of incentive-based policies argue that even if they will never be perfect, regulatory regimes can nevertheless be better than the systematically imperfect market.

Further Readings

Dales, John Harkness. Pollution, Property & Prices: An Essay in Policy-Making and Economics. Cheltenham, UK: Edward Elgar, 2002.

Pennington, Mark. “Liberty, Markets, and Environmental Values: A Hayekian Defense of Free Market Environmentalism.” The Independent Review, 10/1 (2005).

Rose, Carol. “Liberty, Property, Environmentalism.” Social Philosophy & Policy, 26/2 (2009).

Schmidtz, David. “When Preservation Doesn't Preserve.” Environmental Values, 6/3 (1997).

Dan C. Shahar
University of Arizona

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Gale Document Number: GALE|CX1560200089