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UNIT 9 THEORY OF ENVIRONMENTAL

POLICY

Structure

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9. 0 Objectives
9.1 Introduction
Externality and Pigouvian 'h
9.3 Coase's Bargaining Solution and CollectiveAction

9.2

9.4 PollutionAbatement Options

9.5 Market-based Instruments
9.5.1 Advantages of MBls
9.52 Categories of MBls
9.5.3 Choice among MBls
9.5.4 MBls in Developing Economies

9.6 Informal Regulations on Pollution

9.6.1 Green Technology and Stock Market Performance
9.62 ISO-14001 Certification
9.6.3 Judiciary and Pollution Control

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9.7
9.8
9.9
9.1 0

LetUsSumUp
Key Words
Some Useful BookdReferences
AnswersIHintsto Check Your Progress Exercises

9.0 OBJECTIVES
After going through this Unit you will be in a position to

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explain the divergence between private costs and social costs in the presence
of envi'ronmental pollution;
appreoiate the options available for controlling environmental pollution;

distinguish between command and control measures, and market-based

instruments;

identify various types of market-based instruments and their advantages; and

explain the factors that should be considered while choosing among policy
options.

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9.1 INTRODUCTION

The neoclassical economics mainly deals with efficient allocation of resources

through market mechanism. In the production process, in addition to the private
(or public) good, public 'bad' also emerges in the form of solid, liquid, gas or noise
pollution. For example, when production of cement takes place, there is emission
of dust and harmful chemicals into the atmosphere. Neoclassical theory with its
emphasis on market mechanism takes care of the production of cement (in this case)
but ignores the management (production, pricing, control) of air pollution arising

'Sustainable Development
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out of cement production. Public bad is produced not only during production activities
but also in the course of consumption. For example, when we consume packaged food,
we throw away the polythene cover (which is not biodegradable) here and there as a
result of which land pollution takes place. The management of public bads is beyond the
scope of the neoclassical analysis and therefore is usually ignored.
The main reason behind environmental problem is 'market failure', which we have
discussed in a general context in Units 4 and 5. Market failure in the case of environmental
problems arise mainly due to lack of i) welldefined property rights, and ii) proper valuation
of 'public bad'. Issues related to valuation of environmental resources is already discussed
in Unit 8 while the problem of property rights will be hrther dealt with in Unit I 1 as we
discuss the management of common property resources (CPR). In the present Unit we
concentrate on the issue of the divergence between social and private costs and the
methods available in the literature to internalize the externalities, that is, development of
mechanism through which the social cost of pollution will be borne by the polluters.

9.2 EXTERNALITY AND PIGOUVIAN TAX

The basic principles of environmentalpolicy are based on the theory of extemalities. The
problem of externalitymay be interpretedas an unintended and uncownsated side effect
of a person's or firm's activity on others. In a formal way, environmental externalities
occur when the consumption and production choices of one person or firm enters the
utility or production function of another entity without the said entity's consent or
compensation.Inmany instances, the problem of externalitycreeps into many government
policies having spillover effects. For example, free electricity offered to farmers for
irrigation purposes results in over-extraction of ground water, whidh depletes the water
table. In this case the private cost of lift irrigation borne by the farmer is the price paid by
him, but a larger social cost is involved in termsof reduced availability ofwater to others.
Overall, there is a difference between private marginal cost and social marginal cost in
the presence of extemalities; social marginal cost of pollution being always higher than
private marginal cost. As the producer of a polluting good takes into account the private
cost while deciding on the level of output, there is excessive supply than the optimal level.

An economic solution to the problem was evolved as early as in the 1920sby the wellknown British economistArthur Pigou in the form of pollution tax popularly known as
Pigowian tax. According to Pigou, the social damage or the social cost imposed by a
firm by its pollution activity on society may be neutralised by imposing a pollution tax on
the firm. The rate of the tax, according to him is equal to the marginal environmentalcost
or marginal social damage by the polluting firm on society.
cost while MC, is
We explain the situation in Fig. 9.1 where MC, is the social m-al
the private marginal cost of production of a good. As more output is produced, MC,
increases with the level of pollution. The demand for the pollution good is given by the
demand curve DD' (representing marginal revenue curve, MR). As per market
mechanism, the equilibrium output is q, and price is P, where MCp= MR. Socially
optimum level of output, however, is q* and price P*, where MCS=MR. Ifthe producer
were made to pay for the social costs also, equilibrium output would have been at the
level q'. We observe from Fig. 9.1 that the difference between MC, and MC, at the
socially optimum level output is 'ac'. In order to internalizethe externalities Pigou suggests

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i~n~~osition
of a tax t per unit of output where t = ac. Here it is assumed that pollution
emitted per unit of output remains unchanged as level of output changes.

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price, cost

9'

ql

output

Fig. 9.1 :Pigouvian Tax

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Keeping in view the nature of the problem, externality may be classified into four
broad types: a) relevant externality- when the unconcerned parties are affected by
an activity and the parties in turn demand for suitable solution to reduce its effect;
Vant externality - in the process of appropriate solution to the problem,
affecte
b,
parties are made better off without adversely affecting any one; c) static
and dynamic externalities - in a static situation, a group overexploits the natural
resource by imposing externality on others (for example, over-fishing), while in a
dynamic case, the exploitation would be on such natural resource which. has high
future value (for example, fishing of juvenile fish species); and d) pecuniary
externality - an activity which imposes higher price or lower cost on people or land
(location of huge business, industry in a particular area).
The disposal of public bad under normal course is done in various forms through
natural resources media like air, water and land by treating earth as a natural sink.
In the process of disposal, ifthe pollution load of public bad exceeds the assimilative
capacity of the natural resource, it will impose serious problem by impairing the
ecological balance. Hence, the main issue is how to abate pollution to the required
level in order to keep both living and non-living organisms in good health and
prosperity.

9.3 COASE'S BARGAINING SOLUTION AND COLLECTIVE

ACTION
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There are two main approaches to solve the environmental externality: a) appropriate
government policies, and b) well-defined property rights. Government policies
pertain to direct regulation (or, command and control approach), and market-based
approach in the form of economic instruments. The property rights approach is
applicable when either community or individual posses welldefined property rights in

Theory or En"hnmen*al
Policy

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Sustainable Development
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canying out the environment related activities. The property rights approach, developed
by Ronald Coase in 1960,suggeststhat an efficient solution to the problem of externality
may be arrived at if property rights are well-defined. This solution, popularly known as
'Coase theorem', states that efficientallocationof resources and solution to Pareto relevant
externality is possible under the following assumptions: i) zero transaction costs - the
cost involved in the bargaining process between the two parties do not exists, ii) welldefined property rights -either of the party or both the parties posses well-defined
property rights, iii) perfect competition prevails in the market, iv) no income or wealth
effects is imposed with the Coasean solution, and v) no fiee rider effects -- since the
parties have welldefined property rights. In this situation. let us illustrate the method of
bargaining for feasible solutionthrough an example.
Let us consider the case of a polluting factory which dumps its eMuents to the nearby
river as a result of which the water downstream gets polluted. The water pollution
has adverse effects on the health and property of the nearby community who use
the river water. Therefore, they want the pollution load released into the river to be
zero. It is possible for the factory to adopt pollution abatement measures which
can purify the effluents and reduce the pollution load to zero level. Installation of
such technology, however, would increase the cost of production for the factory
and keeping up with its objective of profit maximization the factory does not want
to install pollution abatement measures. Thus a conflict in interest between the
factory and the community is generated.
Let us explain the position through Fig. 9.2 using the typical economics analogy.
On the x-axis we measure pollution abatement (that is, removal of pollution) by
the factory and on y-axis we measure the level of pollution cost. The nearby
community faces a downward sloping pollution abatement cost curve (AB). It
indicates that as pollution abatement increases (that is, more amount is pollution is
removed or, less amount is pollution is present in the river), there is a decrease in
the pollution cost to the community. Thus, when pollution abatement reaches the
level 'OB' (that is, all the pollutants are removed from the river), the pollution cost
to the community is zero. On the other hand, the factory has an upward sloping
pollution abatement cost curve indicating the increasing marginal cost of abatement
(OD). When pollution abatement is zero, no pollution cost is borne by the factory.
The factory would like to reduce its pollution abatement expenditure while the
community would like the pollution level to be zero.
Let us take the situation that the community is holding the property rights for clean
environment. Hence, the community can dictate terms to the factory about the
pollution load to be released to the river. In this situation, the factory is generating
pollution and creating problems for a community that demands zero pollution. For
various welfare reasons, the factory cannot be closed down and financial constraints
have made the factory to apply limited pollution abatement measures. In this context,
negotiation is the only solution to resolve the conflict.

In the negotiation, let us assume that the community can accept a slightly lower
Level of pollution emission 'n'. At this level of pollution abatement, however.
pollution cost to the community is 'h' and pollution cost to the factory is 'g'. Hence,
through negotiation, the factory is willing to give compensation up to the extent
'gh' to the community (see Fig. 9.2). The level of abatement reached through the
negotiation in this case is anywhere between the optimum (t) and the maximum (B).

Theory of Environmental
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Fig. 9.2: Quantity of Pollution Abatement

Let us take the other situation where factory has the property rights. Since the polluter
has the property rights, the starting point for negotiation is zero level of pollution
abatement. Obviously, for welfare reasons, the community would like the pollution
level to be reduced by the factory, which in turn implies higher pollution abatement
expenditure by the factory. Suppose the community wants the pollution abatement
to be 'm'. At this level, the pollution cost to the community is 'f while pollution
abatement cost to the factory is 'e'. It is, therefore, viable to the community to pay
compensation to the factory to the extent of 'ef'.
We observe from fig. 9.2 that it is expensive to abate pollution beyond the level
'q'. The government can regulate pollution abatement to be fixed at the level 'q'
through command and control measures. Otherwise, it can impose taxes on the
polluter (the factory, in this case) to the extent 't', which is equivalent to the pollution
cost on the community. The Coasean principle, however, provides an alternative
to pollution tax. Here externality can be internalized through well-defined property
rights and compensation.

Check Your Progress 1

1.

Why does Pigou suggest imposition of taxes on polluting agents?

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2.

Explain how the rate of pollution tax is decided under ideal conditions.

Sustainable Development
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9.4

POLLUTION ABATEMENT OPTIONS

Control of pollution has been an important objective of governmentsin various countries,

particularly since the second half of the twentieth century. Several policy measures have
been undertaken by governments in this direction in the form of restrictions, incentives,
dos, and don'ts for the polluting agents. Some of these measures have been effective in
curbing pollution while others have not. Accordingly, there are certain policy instruments
that work while others do not. When we evaluate an environmental policy, it is logical to
look into issues such as efficiency in productionand effectivenessof the policy instrumen~s
in controlling pollution.
The degree of pollution depends upon the amount of pollutants dumped into the
environment vis-a-vis its assimilative capacity. The amount of harmful chemicals
dumped into the air and water through emissions and effluents determine the level
of pollution of air and water. In order to control pollution, therefore, there are certain
'direct policy measures' which regulate the level of the pollutants directly. In many
cases, however, it is difficult to measure the pollution load originating from a firm
or other pollution sources. Nonetheless, it is easier to link certain output produced
(or, input used) to the pollution load. For example, given the level of technology,
the emission from a cement factory is proportional to the quantity of cement
produced. Similarly, the effluents discharged from a paper mill would be
proportional to the wood pulp used or energy consumed. By regulating the
production of such output (or the use of inputs) we can keep pollution under check.
Thus, there are certain 'indirect policy measures' where the impact point is not the
pollutant itself but some other factor.
Globally three types of policies are pursued, viz., i) command and control (CAC)
measures, ii) market-based instruments (MBI), and iii) government production or
expenditure. There are several policy instruments under each of these policy options.
These instruments can be of two types: direct and indirect. We present a taxonomy
of policy instruments for pollution abatement in Table 9.1 below.
Table 9.1: Taxonomy of Policy Instruments for Reducing Pollution

Policies

Direct instruments

Indirect instruments

Command and
control measures

Emission regulations
(source-specific), standards,
bans, non-tradable permit
or quota

Regulation for equipment,

processes, inputs and
outputs

Government
production
or expenditure

Regulatory agency
expenditures on purification,
clean-up,waste disposal, and
enforcement

Development of 'clean'
technologies

Market-based
instruments

Effluent charges
Tradable permits
Deposit refund systems

Inputloutput taxes and

subsidies
Subsidies for substitutes
and abatement inputs

Source:Adapted fiom Eskeland and Jimenez (1 992)

111 earlier tilnes pollution abatement was usually by means of regulatory approach also

Theory of Envimnmental

kuown as CAC measures, which were in the form of imposing bans, specifling quotas
and laying down standards for polluting activities. Under the CAC approach certain
econoinic activities, considered to be polluting, are prohibited. In other cases, a quota
for many polluting activities are determined and allocated among firms through licensing.
According to the CAC approach, either the government or its designated body fixes the
standards for various pollutants (liquid, gas and noise) emerging out of various pollution
sources. The standardsare fixed by keeping in view the assimilative capacity of the ambient
environment as well as the health impacts on human beings living in the area, and existing
natural resources. In order to regulate the environmental pollution there could be two
types of staiidards: a) ambient environment standards, b) industry specific standards. 171e
anibient environment standards refer to the limits set for various pollutants that is
considered to be safe for living beings and property. These standardshave been prescribed
for ingredients of the environment such as air, water and noise. For illustrative purposes,
we present in Table 9.2 the National Ambient Air Quality Standardsprescribed by the
Central Pollution Control Board (CPCB). These standards have been determined keeping
in view the air quality necessary to protect public health, vegetation and property. Different
standards are laid down for industrial, residential and sensitive areas.

Policy

Table 9.2: Ambient Air Quality Standards in India

(in mghd, Annual Average)

Pollutant

Industrial Area

Residential Area

SensitiveArea

171e industry specific standards refer to limits prescribed for the pollutants emerging out
of specific industrial process. For example, the CPCB has set the maximum limits of the
parameters such as acidity (pH), biological oxygen demand (BOD), and chemical oxygen
demand (COD) contained in the effluents discharged into water bodies from various
water-polluting industrial activities. Similarly, parameters are prescribed for suspended
particulate matter (SPM) emitted by air polluting activities. These standards vary across
industries keeping nature of the production activity and technology of production available
in view. For implementation of these standards, appropriate legislations have been
enacted along with penalties and punishments for noncompliance.

In India three main pollution control acts are enacted for the purpose of environmental
protection. These are the Water ('prevention and control of pollution) Act, 1974;the Air
(prevention and control of pollution) Act, 198 1;and the Environment (protection)Act,
1 986. These acts prescribe i) rules and regulation for pollution control, ii) duties and
methodologies to be followed for environmental compliance, and ii) penalties and
punishments for non-compliance. The evolution of environmental policies in India along
with the important provisions under various acts is given in Unit 12.
Government production or expenditure through its regulatory agencies on pollution
abatement pertains to various activities undertaken for cleaning up water bodies
(Ganga Action Plan in India, for example), treatment of effluents by setting up
treatment plants, proper disposal of household wastes, etc. Moreover, goverhment
incurs expenditureon research and development activities for invention of less-polluting
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or clean technologies.A major hurdle for government production is the limited budgetary
resource available for such activities.
The CAC measures are found to be inefficient as it imposes higher cost on society for
realizing a target. As the CAC approach does not distinguish between polluting agents
and puts a universal ban on certain activities, it does not leave any scope for innovation
in clean technology. Studieshave shown that similar objectives can be achieved at a much
lower cost through MBIs. The major types of MBIs, both direct and indirect, are given
in Table 9.1. As there are a number of instruments, each having its own importance and
relevance. we devote Section 9.5 below to furtherelaboration on MBIs.

9.5

MARKET-BASED INSTRUMENTS

As mentioned earlier, there is a divergence between private cost and social cost in the
case of polluting activities. In order to regulate these activities the CAC approach puts
emphasis on impositionof bans and controls.The h/lBIs, on the other hand, use economic
incentivesor market stimuli for internalizing the environmental costs. The main aim of the
MBIs is creation of a market mechanism where the social cost of pollution will be borne
by the polluters. Thus, the divergencebetween private cost and social cost will be avoided
and polluting goods will be produced at their socially optimum level. The MBIs are
developed on the basis of the principles of the market qtructure, and attempt to remove
the distortions emerging out of inefficient use of resources by removal of subsidies and
introduction of environmental charges on emission, input and output.

9.5.1 Advantages of MBIs

There are several advantages of economic instrumentssuch as: i) these are eflicient in
allocation ofresources; ii) they provide incentivesfor innovations in clean technology; iii)
they are more appropriate when policy emphasis is shifted towards a preventive measure,
and iv) they can be an important source of revenue for the government. In fact, the MBIs
are considered to provide 'double dividend', in the sense that they control pollution on
the one hand, and generate revenue on the other. The revenue generated through MBIs
can further be utilized for environmentalprotection.
In order to achieve the objectives, MBIs use the market system to evolve two kinds of
policy measures such as i) administeredprice, and ii) administered market. In the case of'
administered price, existing price of ablluting good is modified through policy measures
to include the social cost of environmental degradation. In this situation obviously,
environmental valuation quires special sigdicance in advocating the administered price
concept. Hence, administered price either creates price or modifies the existing price to
reflect the environmental impact. Similarly, administered market creates a market for
environmental pollution, which did not exist before. Tradable permits are the best example
for this concept as it creates market for 'pollution abatement' (that is, removal of pollution)
through emission trading. The flexibility of MBIs is reflected through selection of
appropriatetechnology for pollution control which minirnises cost of compliance but,
without any interferenceof the regulatory authorities.

9.5.2 Categories of MBIs

In Table 9.1, we have mentioned certain market-based instruments - hoth direct and
indirect. The direct imtmments,viz,effluent charges, tradable permits andldeposit refund
schemes, are imposed on the polluting activity itself. On the other hand, indirect
instruments, as you can see from Table 9.1, are imposed on inputs used for production

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of the polluting good. The MBIs can be broadly put under seven categorieson the basis
of the type of economic instruments. These are i) fi& inslruments, ii) financial instruments,
iii) charge instruments, iv) deposit-refund system and bonds, v) market creations, vi)
liability, and vii) redefining property rights (see Table 9.3).
Table 9.3: Taxonomy of Market-based Instruments

Broad Category

Detail Types

Fiscal Instruments

1. Pollution taxes
2. Input taxes
3. Import tariff

Financial Instruments

1.
2.
3.
4.

Charge Instruments

1.
2.
3.
4.
5.
6.
7.

Deposit-Refund
System and Bonds

1. Deposit-refund schemes to
encourage recycling
2. Environmental performance bonds
3. Land reclamation bonds

Market Creations

Tradable emission permits

Liability

Liability Insurance legislation

Financial subsidy
Soft loan and grants
Sectorall revolving funds
Financial aid in installing new
technology
5. Subsidies for environmental
research and development
expenditure
Effluent charges
User charges
Product charges
Administrative charges
Impact fees
Access fees
Non-compliance fees

Redefining Property Rights 1. Changes in ownership

2. Use and developmentrights
Taxes and user charges have the advantage that they reduce the compliance cost of
attaining a set target thereby enhancing economy wide performance. The
disadvantage with taxes and charges, however, is that it is politically difficult to
raise them to optimal level. Subsidies and soft loanslgrants on pollution abatement
inputs are highly popular both in developed and developing countries. There is the
danger of dead-weight loss (defined as the difference between the monetary values
of what the government loses and what the beneficiaries gain due to the subsidy)
largely due to high costs relative to benefits.
The MBIs have been based on the economic principles such as tax, user charge,
incentive, markets, compensation, and property rights. It is worth distinguishing
these instruments further on the basis of the instruments that follow polluter-pays
principle and other instruments. The polluter-pays principle underlines the fact that
the polluter should pay for the use, damage and scarcity of natural resources. The

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fiscal instrumentsand charge instruments. on the basis oftheir implied command for the
payment for having used the resources and contributed to their pollution level. may be
categorized as the instruments which follow polluter-pays principle (Table 9.4). On the
other hand, other instruments work on the economic principles like incentives (financial
instruments). creation of rights (redefining property rights), creation of markets (tradable
emissionpermits, deposit-refund system and bonds), and compensation for inflecting the
damage (liability).
Table 9.4: Taxonomy of MBls
based on the Polluter-Pays Principle and other Instruments

Market-based Instruments

Detail Types

Instruments based on

1. Fiscal Instruments

Polluter-pays Principle

1. Fiscal Instruments
2. Charge Instruments

Other Instruments

1. Financial Instruments
2. Deposit-Rehd System and Bonds

3. Market Creations
4. Liability
5. Redefining Property Rights
In fact, in the environmental economics literature, both tax and charge are being used
interchangeablyindicating that a negative price is levied in proportion to the amount of'
dzmage imposed on society due ta pollution. It is also known as the price to be paid to
internalize the social cost emerging out of environmental problems. While tax has a
straightforward single connotation,however, user charge has many. The four broad types
of user charges being practiced are:
a)

emission charge - charge levied on the pollutant to internalize the social damage
emerging out of pollution activities.

b)

user charge - fee levied for using the environmental resources.

cj

product charge -taxes are levied on the goods produced with polluting inputs.
Carbon tax is the best example.

d)

administrative charge - fee levied by the government for implementation or

monitoring various environment associated legislations.

In comparison with fiscal instruments, incentive mechanism performs better in

controlling pollution. It has been theoretically proved that paying pollution tax is
always costlier than adopting pollution control measures. Thus, it is cheaper for
the firm to adopt pollution abatement measures (installation of clean technology.
emuent treatment plants and more efficient utilization of exhaustible resource) than
paying the taxes.
Financial instruments or subsidies are the incentives given to the polluting agents to abate
pollution. As described, it may.be in various forms such as financial subsidy, soft loan
and grants, sectorall revolving funds, financial aid in installing new technology, subsidics
for enviscnmental research and development expenditure. It is an important instrument
of environmental protection in developing countries. Surprisingly, subsidy is being

promoted in the developed world too but in different forms. In developed countries, the
environmental taxes imposed and collected on various environmental items are being
exclusively used for environmental protection activities in the form of soft loans or grants
(or the development of improved technologies and resources, and related infrastructure
development. In a way, such an encouragement has been very effective in environmental
management in developed countries.

9.5.3 Choice among MBIs

Fmnomnic instruments or MBIs influence decision-making in such a way that the chosen
alternatives would lead to an environmentallymore desirable situation than in the absence
of the instrument. Hence, economic instruments allow the polluting agents the freedom
to opt for instruments in a way they themselves think are most beneficial to abate
pollution.
The presence of a number of policy instruments makes it difficult to choose the correct
one. Some of the factors that should be taken into consideration while evaluatinga policy
iilstrurnent are given below.
a)

Effectiveness:Apolicy instrument should bejudged on the basis of its effectiveness

in controllingpollution. If the particular policy instrument does not give intended results
it should be avoided.

b)

Socio-economicefficiency:The environmental objective should be realized at the

minimum cost so that society's resources are utilized in an optimal way, i.e., without
any wastage or additional costs. For a policy should be considered 'efficient', the
total costs (including costs to the government, individuals and firms) involved in
implementing the policy must not outweigh the total benefits.

c)

Dynamic efficiency: The policy instrument should provide incentives for

environmental improvement over time and space.A policy instrument may also be
judged by the extent to which it can be adapted to changing market, technology,
knowledge, social, political and environmental conditions.

d)

Equity:The costs and benefits of the policy instrument should be distributedequitably

among sectionsof society; particularly the interest of the poor and vulnerable sections
should be protected. Moreover, the richer section should not be in a position to
influence policy-making to safeguard their interest.

e)

Operational feasibility:Given the level of socio-economicdevelopment of the

economy, it should be feasible to implement the policy instrument. The political and
bureaucratic machineries also should back its implementation.

f)

Community acceptance:The successof a policy instrumentcriticallydepends on

the degree to which the community accepts it. In order to make the community
understand the objectivesand benefits of the policy instrument there should be public
consultations and education programmes.

9.5.4 MBIs in Developing Economies

In developing economies the market mechanism is not fully developed as production
is often for self-consumption. There is considerable unemployment and underemployment that prompts people to venture into nearby forests to collect he1 wood
and other forest products. Industries also are yet to develop fully in the sense that
R&D expenditure is the barest minimum in developing economies. The scale of
operation in many cases, particularly in small scale industries, is such that installation of

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pollution abatement technology is not cost ef'ective. Moreover, many developing

economies are more particular about growth than environmental concerns. In order to
attract investment &en governments in developing economies compromise on thc
technology of production. Provision of subsidized raw materials and land to industries
is a common phenomenon in developing economies. Under such circumstances adoption
of MBIs need to be with caution; particularly the following points should be paid
attention.
a)

There should be adequate knowledge base on benefits and costs of policy

instruments in developing economies. Moreover, institutional and
technological constraints should be kept in mind while designing MBls.

b)

There should be a strong legal structure, clear definition of property rights,

and the ability to transfer such rights.

c)

Many of the policy instruments, particularly tradable permits, require the

existence of a competitive market. If competitive market does not exist, and
cannot be created, the policy instrument may not be effective.

d)

Enforcement is one of the major problem areas in developing economies. There

should be adequate administrative capacity to design, implement, monitor and
enforce the MBIs.

We have mentioned earlier that MBIs offer double dividend. If environmental taxes
are introduced mainly as revenue raising instruments than as an environmental
protection measure, then it may boomerang, and lead to inefficiency in resource
allocation. Notwithstanding the above limitations, MBIs are making their headway
in developing countries like Korea, Malaysia, Chile, China, Thailand and Taiwan
and many Latin American and African countries.

9.6 INFORMAL REGULATIONS ON POLLUTION

It is observed that in developing countries environmental problems have been
attributed, in addition to other constraints, to inefficient enforcement of pollution
control measures by government agencies. This void has, to some extent, been filled
by other agents like community, self-regulation by corporate sector (corporate
responsibility for environmental protection), and judiciary who have turned out to
be very powerful in regulating environmental problems.
Communities have taken initiatives in regulating pollution activities in developing countries;
this has happened in counties like India, Indonesia, and Bangladesh. It has been identified
that socio-economic characteristics of communities such as literacy, household income,
and participation in election have significant influence in regulating industrial pollution.
Increasing public awareness on adverse effects of environmental degradation has also
resulted in several social movements for protection of environment. Narmada Bachao
Andolan (save Narmada movement) and Chipko movement are examples of public
concern for environment protection.

9.6.1 Green Technology andstock Market Performance

Of late, marketshave played significant role speciallyin regulating pollution.Thishas been
achieved by publishing environmental performance of industries in the form of raw
materials used, production process, pollution abatement policy adopted, conservation
of resources, and methodologies adopted for output use and disposal. On the basis of
such infomation, the stock markets evaluatethe environmentalperformance of industries

through stock values. Some countries includingIndia have s t .green ratingof pollution
prone industries.

The regulation process works as follows: Normally an investor will look into overall
performance of a unit before investing in it. If its production is not efficient due to
various environmental problems, this will obviously reflect on the overall performance,
and hence, the financial benefits. As a result, the environmentally inefficient industrial
units with weak performance are rated low compared to the units with good
perforn~ance.In other words, the industrial units with bad environmental performance
have significant negative impact on stock values. Though relevant to both developed
and developing countries, this practice has yielded good results in developing countries
by effectively regulating the pollution activities of the industrial units.Some of the studies
have estimated the loss of polluting firms in the stock market to be up to 11 per cent
(see Table 9.5).
Table 9.5: Performance of Stock Markets and Polluting Industry

Author and country

Impact on stock market

Mugoghalu et al(1990)

Average loss of 1.2%

Lanoie, Laplante (1994)

Average loss of 1.6%to 2%

Klassen, McLaughlin (1996)

Average loss of 1.5%

Hamilton (1995)

Average loss of 0.3%

Lanoie, Laplante and Roy (1997)

Average loss of 2%

Gupta and Goulder (2005), India

Average loss of 11%

Source: World Bank (2000);Gupta and Goulder (2005)

9.6.2 ISO-14001 Certification

Of late, corporate sectors have realized that pollution control has greater benefits
in achieving overall development of a fum in the form global recognition in terms of
marketing opportunities, better profits, and increased production due to smooth
functioning of the units. As a result, several leading corporate firms throughout the
globe have started the p ~ sofsself-regulation in meeting the environmental standards
on their own without the compulsion of the regulatory bodies. In fact, this has become
inore popular in developing countries in order to achieve the global recognition for
marketing strategies. The process has got identified with the IS0 certification in the
form of ISO: 14001. If an industry is holding the ISO- 14001 certificate it has all
the characteristics of global competence in the environmental standards. The firms
have an incentive to obtain ISO-14001 certificate, as it provides a firm with greater
access to international market. This certification is issued by the global organization
called the International Organization for Standardization (ISO), the world's largest
developer of quality standards on various aspects of production and service. This
certification involves sophisticated elaborate process in order to meet the international
standards. However, it is purely a voluntary one. As on April 2005, almost 88,800
firms have acquired this certification and interestingly majority of the firms are in the
developing countries (Table 9.6). Hence, self-regulation has also emerged as an
instrument for pollution control.

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Sustainable Development
and Environment

Table 9.6: Distribution of Countries by Number of ISO-14001

Certificate-holding Firms as on April, 2005

Syrian Arab Republic (48), Serbia and

Liechtenstein (22), Sri Lanka and Morocco (2 1),

Venezuela (20, Zimbabwe (l9), Saudi Arabia (I 7),
Bolivia and Ghana (1 4), Bahrain (1 3), Ecuador
and Mauritius (1 I ), Bosnia and Herzegovina,
Macau and Nigeria ( 1 0), Qatar (9), Kenya (8),

< 25

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Kuwait, Trinidad,and Tobago, Lebanon and

Bangladesh (7), Puerto Rico, Honduras, Kazakhstan
and Oman (6), Palestine, Azerbaijan, Swadiland,
Iceland and Namibia (5), Botswana, Tanzania,
Brunei, Guyana, Malta, Paraguay, Jamaica and
Uganda (4), Algeria, Guatemala, Barbados,
Turkmenistan, Senegal, Malawi, El Salvador
and Monaco (3),Andora, Belize, Cameroon,
Greenland, PapuaNew Guinea, Myanmar,
Niger, Panama, Nepal, San Marino and Zambia
(2), Cambodia, Cuba, Dominican Republic,
Fiji, FYR of Macedonian, Mozambique,
Saint Lucia, Sudan, Seychelles, Madagascar
and Nicaragua (1)
World

88,800

Source: Website of IS0 World

Note: Figures in parentheses indicate the number of firms holding ISO-14001 certificates in the
country.

9.6.3 Judiciary and Pollution Control

Thejudiciary has been very active in environmental protection throughout the world in
recent years. Notwithstanding the fact that there are several limitations of thejudiciary in
handling environmental issues, it has several advantages also. We discuss some of the
issues related to the involvement ofjudiciary in environmental protection.
a)

b)

C)

Judges are usually non-specialists in environmental aspects, which limit their

capabilities in dealing with environmentalissues.Nonetheless,they have broad vision
of national development based on the existing national policies of the country
concerned.
Wheneverjudicial process is involved in environmental protection, due to various
technological clarifications,by and large environmental protection expenditure will
be on the higher side.
Judiciary has its limitationsin protecting the environment holistically as it responds
only against the litigation brought to the court by the affected party.

d)

Judiciary,by its very nature, is not continuouslyinvolved in envirorpnentalprotection

process and hence, judicial verdict relating to environment protection may be difficult
to integrate into the national policy process.

e)

Judges are not involved in electoral politics and are freefi-om political interventions,
and hence, they can take extreme steps in a pronouncingjudgments to protect the
environment.

In Indiajudiciary is involved in several landmark judgments concerning environment

protection such as the Bhopal Gas Tragedy, Pollution of River Ganga, Tehri Dam
project. Narmada valley project, Delhi air pollution, and forest protection in Jammu
and Kashmir. Though judiciary has been involved in environmental protection since
long, the inrolvement has been more prominent since the mid-1990s. As we observe
from Table 9.7, of the 409 environment-related cases handled by the judiciary in
India, 163 (that is, nearly 40 per cent of the total) are handled during the period

Sustainable Development
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1996-2000. In terms of the environmental issues handled, although it has handled all
related issues, the issues relating to the ecosystem (27.6 per cent of the total) followed
by urban development and air pollution (see Table 9.8) have been prominent.
Table 9.7: Number and Percentage of Environmental Cases Handled by
Judiciary in India (year-wise)

Source: Divan and Roseancranz (200 1 )

Table 9.8: Percentage of Cases Handled by Judiciary

by Environmental Issues, India

Source: Divan and Roseancranz (200 1 )

Check Your Progress 2

1)

Explain the advantagesof MBIs over CAC measures in controlling pollution.

.........................................................................................................................

.........................................................................................................................
.........................................................................................................................

.........................................................................................................................
2 ) What are the factors that should be kept in mind while evaluatinga policy instrument?

3)

Why should developing countries be more careful in adopting market-based

instruments?

.........................................................................................................................
4) Explain the role of judiciary in environmental protection.

9.7

LET US SUM UP

Environmentalpollution is consideredas 'public bad' thatarises mostly due to the problem

of externalitiesand the lack ofproperty rights. As the polluter does not take into account
the social cost due to pollution in his decision-making,there is more than optimal supply
of polluting goods. Earlier public policy to control pollution was in the form of command
and control measures. In recent years, however, policy instruments in the form of taxes,
charges and tradable permits, which arelmsed on market incentivesand polluter-pays
principles, have been quite popular, particularly in developed countries. These instruments
are considemi to be better than government regulations as the compliancecost is lower
and it provides scope for innovation.
7

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Sustainable Development
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Although market-based instrumentshave made inroads into developing countries,they

are not used extensively. The level of economic development,nature of technology used,
and priority assigned to growth over environment, are some of the factors responsible
for the slow pace of MBIs. In such circumstancesinformal regulations- by judiciary,
corporate h s , and community groups-have been quite popular in developing countries.

9.8 KEY WORDS

Assimilative capacity:It reflects the extent to which the pollutants can be absorbed by
the environment. For example, the air can assimilate gaseous emissionsto a limited extent
beyond which its quality will deteriorate.
Carrying capacity:The carrying capacity of an ecosystem is defined as the size of the
population or community that can be supported by the resources available in the
ecosystem.
Command and Control: CAC regulations demand very specific actions h m pollution
sources for compliance, such as installing a specific type of scrubber or a strict emissions
rate. It lacks the flexibility of MBIs.
Deposit Refund System: Under this system a surcharge is collected on the price of
potentially polluting products. When pollution is avoided by returning the products or
their residuals, arefund of the surcharge is granted. An example could be the requirement
to deposit certain security while purchasing a dry cell, which will be refimded only after
the used dry cell is disposed off properly.
Ecological balance: Ecology is the study ofthe interaction ofthe living organismsto
one another, and to their surrounding. Similar categories of animals compete among
themselves for food (for example, plant eaters like cow, horse, deer, etc. compete for
grass). Flesh eaters like lion and tiger compete for their food (other animals in the forest).
On the whole a food chain is maintained where one species depends upon others. The
relation between different speciesof plants and animals, including human being. should
be such that each group gets adequate food and shelter and leads a healthy life. In the
ecosystem a balance is maintained naturally.
Emissions Trading:Under this approach a fm,which releases less pollutants than the
limits specified, is allowed to sell its permit to another firm with higher emission. 'fie
objective is to maintain total emission at a constant level, which could be the assimilative
capacity ofthe environment. Thus reduced emission of one firm is offset by higher emission
by another.
Natural sink: Environment acts as a natural sink for many pollutants as it assiinilates
these pollutants. Trees and plants are examples of 'carbon sink' as they absorb
compounds of carbon from the atmosphere and store it.
Tradable permit:Alicense granted by government to pollute the environment that can
be bought and sold. Theoretically the go\~ermnentprovides property rights to a firm to
pollute the environment to certain extent.Tradable permits are allocated on the basis of
auctioning so that the auction price will eventually approach the pollution abatement cost
through installation of better technology.
User Charge:Apiyment made for the direct benefit derived from using a good or service.
It is different fiom a tax in the sense that a tax is paid without receiving a reciprocal benefit.

r
9.9 SOME USEFUL BOOKSIREFERENCES
Cropper, M. L. and W. E. Oates, 1992, 'Environmental Economics: ASurvey', Journal
of'Economic Literature, vol. XXX, June.
Divan, S. and A. Roseancranz, 2001, EnvironmentalLaw and Policy in India: Cases,
Materials and Statutes, Oxford University Press, New Delhi.
Eskeland, G. S. and E. Jimenez, 1992, 'Policy Instruments for Pollution Control in
Developing Countries', The World Bank Research Observer, 7,2, pp. 145-169.
Gupta, S. and B. Goulder (2005) 'Do Stock Markets Penalize Environment-unfriendly
Behaviour; Ecological Economics, 52,8 1-95.
Sankar, U, 2001, 'Environmental Policy', in Sankar (ed.), Environmental Economics,
Oxford University Press. New Delhi.
World Rank, 2000, Greening Industries: New Rotesfor Communities, Illarkets and
Government, Oxford University Press, New York

9.10 ANSWERSIHINTS TO CHECK YOUR PROGRESS

EXERCISES
-Check Your Progress 1
1) Elaborate on the point that MCsand MCpare different in the case of a polluting
firm. Pigou suggested the imposition of pollution tax so that both are made
equal.
2)

Explain by using Fig. 9.1. The rate of tax is equal to the divergence between
MCp and MCs at the point of equilibrium.

Check Your Progress 2

I)

Go through Sub-section 9.5.1 and answer.

2 ) The criteria for evaluation of a policy instrument are effectiveness, efficiency,

equity, operational feasibility, and community acceptance. See Sub-section
9.5.3.

3.

See Sub-section 9.5.4 and answer.

3.

Go through Sub-section 9.6.3 and answer.

Theory of Environmental
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