Experience with Market-Based Environmental Policy Instruments

Environmental policies typically combine the identification of a goal with some means to achieve that goal. This paper, prepared as a chapter draft for the forthcoming Handbook of Environmental Economics, focuses exclusively on the second component, the means—the Ainstruments—of environmental policy, and considers, in particular, experience around the world with the relatively new breed of economic-incentive or market-based policy instruments. I define these instruments broadly, and consider them within four categories: pollution charges; tradable permits; market barrier reductions; and government subsidy reductions. By defining market-based instruments broadly, I cast a large net for this review of applications. As a consequence, the review is extensive. But this should not leave the impression that market-based instruments have replaced, or have come anywhere close to replacing, the conventional, command-and-control approach to environmental protection. Further, even when and where these approaches have been used in their purest form and with some success, such as in the case of tradeable-permit systems in the United States, they have not always performed as anticipated. In the final part of the paper, I ask what lessons can be learned from our experiences. In particular, I consider normative lessons for: design and implementation; analysis of prospective and adopted systems; and identification of new applications.