Environmental Economics Essay



This paper discusses how economic policy instruments can address the problem of air pollution. Essentially, the wider ambit this discussion will follow is that of addressing negative externalities and how they can be addressed by environmental management mechanisms and policy. In this vein, this paper will take into account the mechanics and merits of environmental taxation and emissions trading schemes.

Environmental policy has become a major cornerstone of government planning around the world. In short, government intervention can play a pivotal role in preventing a market from failing due to negative externalities. One of these measures is to intervene through price mechanisms, which can be in the form of carbon trading permits and environmental taxation; the second of these price mechanisms is the use of direct governmental rules and regulations backed by monetary sanctions like fines or in worst cases criminal liability (Goldemberg, 1996).

While the aims of such measures are undeniably noble, at least where air pollution is concerned and reflect the governmental concern for the more efficient re-allocation and substitution of these resources, economic theory and recent history alike dictate that government intervention in the laissez faire model of the economy can run the risk of   promoting imbalance and distortion within the market (Kahn, 1998). The most affected industries thus, when it comes to air pollution management remain the car, fuel and crude oil and gas industries.

Negative externalities and the optimization of resource utilization through government intervention

One of the ways for the economic signalling to the consumer and the producer of a product, in this case with the crude, oil, gas, fuel and car industries is to increase the production or retail cost of the same as a means to an end of allocation efficiency these negative externalities in the form of a damaged ozone layer and impure air are internalized (Ekins and Ethridge, 2006). The consumer or the producer will in this case before producing or spending take into account the negative externality and optimize their actions likewise (ibid). This serves as rectifying the failure of the price mechanism to address such negative externalities. Thus, in a way such interventions may be a means to an end of promoting sustainable economic growth (ibid.

The advantage of environmental taxation is that it promotes innovation and it is possible to that see that since countries like the UK have adopted the congestion charge (which discourages the use of cars and encourages public transport use), technologists around the world have put their minds to producing fuels and cars which will produce less air pollution and even be more fuel efficient (Frank et al, 2008). In Britain in particular, the electric car is only just gaining some popularity due to its small and convenient design and the fact the electric cars are not liable to pay the congestion charge (ibid). Thus as a means to an end of achieving dynamic efficiency, well designed environmental/carbon taxes may actually be an advantage for sustainable economic growth in the long run (Khan, 1998).

Another advantage of these taxes can be that the funds from the same can be reallocated towards the socially excluded and economically less fortunate groups in the society, for example towards the development of a better and more environmentally friendly public transport system (Khan, 1998). Economists have also argued that while the environmental tax may be an economic distortion but it offsets against the more noble purpose of ensuring intergenerational equity, whereby it is important to utilize resources responsibly keeping in view what we are leaving for our future generations (Khan, 1998). In the case of UK, apart from the standard vehicle and petrol duties, now more popular measures remain the use of carbon taxes, the landfill tax and finally the ever-popular London Congestion Charge (Open Europe, 2008). These measures have reflected the economic perspective of equating the private marginal with the social marginal cost of production.

The economic and long-term cost of government intervention to reduce air pollution

The question that remains however, as posed by critics of such measures, is that can we put an actual cost of externalities at all? One is tempted to ask therefore, whether apart from monetary “punishment” on the producer are there not alternative ways of reducing consumption of such products to internalize these negative externalities? (Ekins and Ethridge,2006). Another concern is that governments might be avoiding market failure but there is always a possibility that such environmental taxes themselves will be prone to market failure. Coming back to the issue of quantification of such losses it is possible to note that monetary fines to reduce air pollution alone cannot discourage consumption of a product, which has an inelastic demand (Bailey, 2010). Therefore, until we have tried and tested alternative forms of energy, the use of oil and gas will be indispensable to the economy. Such taxes may raise the cost of production in Britain, as they have already done to some extent, and thus make Britain internationally less competitive than say, perhaps, China or Malaysia as production bases and industrial destinations (Open Europe, 2007).

Furthermore, another disadvantage is that the consumer whose welfare is actually being sought here in the form of a pollution free environment may end up paying a heavy cost, as the fuel and car producers will inevitably try to pass the taxation costs to the retail prices of their products. The heart of the matter remains the simple realization that transport, mobility and fuel are goods and services with an inelastic demand (Goldemberg, 1996). The effect of reducing end demand and consumption will remain doubtful and marginal but the economy and the consumer will be unduly inconvenienced.

In the long run of course such taxes and fines cannot remain the same or uniform and will have to be adjusted (Frank et al, 2008). The need and complication of such adjustments will be discussed down below in the context of the UK and EU emissions trading scheme. Furthermore apart from the day-to-day use of cars and transport there is another dimension to fuel use variation especially during peak times of the day and the holiday season (ibid). By utilizing such taxes the government might be setting itself up for gross miscalculation of elasticity of fuel demand fuel in a particular region. This may lead to a distortion in the perception of the reduction in air pollution through taxing transport use and fuel and car production (ibid).

Another dimension to this criticism, which has been, touched briefly is that in the case of inelastic goods the end user, especially the low income or middle class group, suffers (Khan, 1998). Unless the government designs such taxes specifically in order to develop smart tariffs or taxes where as account can be take of the impact of pollution taxes on vulnerable households like the small income groups which might have a greater use for fuel for heating and transport then for the higher income groups who might prefer to use electric heating or can afford electric or fuel efficient cars. The alternative to using environmental fines and taxes in this case remains the substantial investment in subsidizing innovation in industry, which promotes the means and methodologies through which innovation can be subsidized (Khan, 1998). Another question, which arises from the above, is the efficient reallocation of these taxes into innovative pollution reduction strategies for the environment.

A more recent take on the problem of managing air pollution has been the use of the ETF’s or the Emissions trading schemes which is a way of tampering with the market mechanism by the governmental authorities by altering the relative prices and incentives of producers and consumers.

A case study of the ETS in UK and the EU as a means of controlling Air Pollution

In the context of the Oil and Gas industry a lot has happened in the past two decades due to the growing concern to rectify the problem of air pollution as it arises from gas flaring and other wasteful activities during the production of oil and gas hydrocarbons (Dratwa, 2009). This is particularly true for the crude oil sector where gas flaring is viewed as a significant problem due to its wasteful nature. Gas flaring can occur during the drilling and testing of oil wells and thus creates a gaseous release of poisonous substances which can not only cause valuable hydrocarbon loss but also serious environmental damage (Bailey, 2010). The United Kingdom Continental Shelf is more prone to such environmental damage in its offshore oil and gas drilling and exploration activities and thus its control and prevention becomes a significant part of the UK climate policy agenda and the zeal of honouring its international commitments to bring about a clean environment (Bailey, 2010).

The economic policy for the UKCS at least from the UK perspective has been that of self- regulation where as the key hydrocarbon industry players join hands to make internal efforts in the form of policies, procedures and best practice procedures to control air pollution typically caused by such production activities (Open Europe, 2008). The UK ETS was more voluntary and was launched by the UK between the years of 2002-2006 premised on its Kyoto Protocol commitments. At the same time it was also running concurrently with the compliance oriented framework of the ET-ETS phase 1 between the years of 2005-2007 (Dratwa, 2009).

Many economic commentators feel that the self-regulatory nature of the UK ETS was more effective as it boasted of 33 voluntary participants from all energy sectors and also experimented quite successfully with the idea of trading or selling carbon allowances under the Change Levy[1] program (Bailey, 2010) Currently the EU ETS is in its second phase and the third phase of EU-ETS-III is now expected to run between 2013 till 2020 (Data, 2009). The industry and economists alike have disputed the effectiveness of these measures as they only contribute to the rising costs of business in a maturing UKCS, and this can act as can act as potential deterrents to attracting investments from foreign countries (Open Europe, 2007, 2008).

The work of the EU ETS has however been commendable in the sense that hydrocarbon operators, which are responsible for air pollution, are given enforcement notices under the regime and their failure to   comply with such notices becomes a statutory offence, punishable with fiscal penalties (Frank et al, 2008). Another innovative method of enforcing social-corporate responsibility by these operators is done by the EU publication of the names of operators who have faced a civil penalty under the Regulations (Frank et al, 2008). This can have a serious impact upon the credibility of the company as it affects their marketing strategies. One does not have to go too far back in time to be reminded of the impact of the Brent Spar Spill and the Green Peace accusations that brought down the Shell oil business badly in 1995.Therefore the naming and shaming approach is hoped by many to be able to create more transparency in the air pollution management process and it is hoped that a positive impact can be brought about once there is a better informed public and consumer base (Eakins and Etheridge, 2006).

The UK itself is now moving towards a more regulatory and sanction-orientated approach towards the reduction of air pollution with the introduction of the recent Climate Levy Charge Act and The Climate Change Act 2008. It is interesting to note the perceived role of The Climate Change Act 2008, which sets emissions reduction targets in a statutory form and provides for carbon budgeting all the way up to 2050..In the light of this it can be said that the UK air pollution management framework has been more organized as it is now possible to see budgetary allocations to meet the air pollution control targets and the government has set up independent advisory bodies and reporting frameworks to deal with carbon targets have been brought about accordingly and the act also creates a new reporting framework and an independent advisory body dealing with carbon budgeting (Bailey,2010). Domestically, while the ETS is expected to remain at the forefront of emissions schemes the future of the EU ETS is slightly complicated.

The first phase of carbon permits, which were given by the government, was criticized as the product of unfair grandfathering as these permits were given as free allowances to industries and were perceived as a license to pollute (Dratwa, 2009). However this has been countered by the contention that in the second phase of the EU based ETS there will be a scarcity of Carbon permits being created now as no new ones have been issued or floated in the market (Bailey, 2010).  Thus this will push for greater technological and innovative efforts on behalf of these countries in order to ensure that there is a reduced amount of green house gas emissions through combustion installations in the oil and gas industry (Frank et al, 2008).

After its first phase, however, many critics have still been sceptical of the main impact of this measure in achieving actual decrease in carbon emissions (See Open Europe, 2007, 2008). Many view the possible handing out for any more “free permits” in the ongoing second phase as a definite recipe for policy failure (Bailey, 2010). Many economists have criticized the economic inadequacy, which lies within the allocation of the same.

Ian Bailey has commented that the ETF fails because it is a:

System, whose success essentially depends on the stringency of its overall cap, must either delegate this decision to an independent authority or give it the necessary powers to enforce scarcity and determine equitable allocation criteria. Second, a scheme, which decentralizes important decisions regarding its design, can only function if its members are sufficiently homogeneous and committed to ensuring its efficiency. This is probably not true of the EU ETS.” (Bailey, 2010:45)



Finally, it should be noted that in the past few years the ETS may well have become an integral part of the UK policy and agenda for the environment due to its EU commitments, but in the long run it could seriously damage the competitiveness of the UK continental shelf internationally as a key producer for oil and gas. In conclusion, this question has made an effort to assess through the use of examples like the Carbon Taxes and Emissions Trading Scheme, the effectiveness of economic policy in dealing with the problem of air pollution,





























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Open Europe (2008) “A Comparison of the Costs of Alternative Policies for Reducing UK Carbon Emissions”, Europe Economics Report for Open Europe www.europe-economics.com,January 2008


[1] As implemented by the Finance Act 2000 in the UK.