Using financial incentives and market-based schemes to promote global environmental objectives: some cautionary considerations

C. The process of creating market-based regimes can reveal marginal cost differentials and make markets superfluous

Market-based solutions to environmental issues appeal in part because they are based on an analogy with conventional consumer markets. It is an economic truism that voluntary exchanges among buyers and sellers under such circumstances generate demonstrable efficiency gains compared with other methods of allocation.

Proponents of international trading and fiscal incentive regimes often speak as if markets for environmental "goods" will generate comparable efficiencies by similar means. In a mature market system, however, producers and consumers do not have to grapple with crucial foundational matters such as the rules that govern their transactions before buying and selling goods. In contrast, any emissions or pollution rights trading proposal must concern itself first with creating background trading institutions.

To mollify skeptical advocates and regulators, project proponents almost always invest substantial time and money in developing information that verifies mitigation option marginal cost differentials and illustrates how exchanges will beneficially achieve regulatory goals. Dischargers, in effect, establish up-front what markets will do. They produce extremely detailed studies of marginal costs and anticipated market performance that, with more or less accuracy, clarifies how different compliance options compare.

In many instances, pre-market studies generate new information that allows for substantial regulatory compliance without any market trading taking place. To be sure, the pre-market studies contributed to knowledge about the problem of concern, but, ironically enough, they made actual market implementation far less imperative.

Similar considerations will likely emerge as international pollution rights trading programs are pursued. Once a reasonably defensible model of efficient CO₂ emissions trading outcomes is available, however, the attractiveness of ever building a functioning carbon market is substantially reduced. Armed with an understanding of how nations would sell and buy carbon rights if allowed to do so, global negotiators may achieve much more, at less political cost, to negotiate for and impose cutbacks based on market simulations rather than gamble global trading might someday comparable results. Enlightened policy must recognize and respond to such opportunities as they emerge.

D. Market-based regimes can undermine the legitimacy of the global financial system

Environmental controls are typically highly regressive. The few studies that have seriously examined the relative burdens imposed by major environmental programs demonstrate that large-scale programs burden poorer families and households much more than others.

Market-based regimes can also create "hot spots", places where cost differentials or other factors make clustering emission and discharge sources more likely. Marginal cost differentials for various mitigation options, moreover, are inescapably a function of the political power and wealth of the affected communities. Well-organized, influential, and richer societies can insist on domestic rules and constraints that drive up pollution costs in the regions they inhabit. Market-based systems will naturally exploit these differentials and locate less desirable emission activities in areas where the affected population is least able to protest.

There is a growing suspicion among many less advantaged groups and nations that environmental concerns in general address relatively slight risks that may matter to a privileged few but divert attention and resources from more pressing matters with far more significant health and ecological consequences. The costs associated with toxic emission controls are much higher per life saved, or illness averted, than almost any other regulatory expenditure option, including medical interventions and improved consumer and blue-collar workplace safety regulations. These facts have recently stimulated a powerful critique of the class bias latent in the environmental movement that might easily be extended to the international arena.

Market regimes address social inequities, if at all, by reducing mitigation costs. They do not eliminate the problem of justifying and prioritizing among various issues and choosing those of greatest urgency and concern. If controversial or poorly justified market regime objectives are married with world-wide financial and market institutions, faith in global finance more generally will likely suffer.

III. Potential guidelines for fashioning international market-based environmental regimes