Economic instruments as a lever for policy


Economic Instruments encompass a range of policy tools, from pollution taxes andmarketable permits to deposit-refund systems and performance bonds. The common element of all economic instruments is that they effect change or influence behaviour through their impact on market signals. Economic instruments are a means of considering "external costs," i.e. costs to the public incurred during production, exchange or transport of various goods and services, so as to convey more accurate market signals. Those "external costs" may include natural resource depletion, environmental degradation, health impacts, social impacts, etc. Economic instruments facilitate the implementation of Principle 16 of the Rio Declaration, commonly known as the "Polluter Pays Principle." The article states: "National Authorities should endeavour to promote the internalisation of environmental costs and the use of economic instruments, taking into account the approach that the polluter, should in principle, bear the cost of pollution with due regard to the public interest and without distorting international trade and investment."


Economic Instruments can be designed in a variety of ways, and for a variety of applications, including the following:

  • Increasing prices of goods and services that damage health and environment, as well as increasing financial returns in the case of more sustainable approaches that foster more environmentally- friendly production and consumption patterns.
  • Reduction of compliance costs by providing flexibility to polluters or users of natural resources to chose the most cost-efficient and environmentally-effective measures.
  • Incentives for investments in innovation and improved environmental technology so that both environmental and financial benefits are generated.
  • Allocation of property rights and responsibilities of firms, groups or individuals in a manner so that they have both the incentive and the power to act in a more environmentally- responsible manner.
  • The raising of revenues to achieve environment and health objectives via tax policies.

Relevance to policy-making

Economic instruments are o ften contrasted to "command and control" policy approaches that determine pollution reduction targets and define allowable control technologies via laws or regulations. In reality, however, command and control policy and economic instruments frequently operate in tandem. A government may set limits on permitted pollution levels for a region or a country in order to meet a certain health or environment objective. Market-oriented approaches such as tradable permits might then be used to allocate the allowable emissions in an efficient manner. Tax breaks or other financial incentives might be offered to groups, individuals or industries investing in cleaner technologies.

UNEP has established a Working Group on Economic Instruments for Environmental Protection. The Working Group consists of 30 developed and developing country experts from governments, research institutions and relevant international organizations. A technical document is being prepared in the framework of this working group identifying opportunities to use economic instruments at the national and international level. The document will address policy in terms of legal and fiscal issues, ministerial coordination, macro-economic conditions, industry structure, specific pollution issues, and conditions under which economic instruments can succeed. It is expected to be finalized during the first half of 2003. The Working Group is also currently engaged in developing a reference manual for the use of economic instruments to meet the objectives of selected biodiversity-related conventions.

Examples 1: Vehicular emissions in India

A study of the automotive industry in India developed policy options for reducing vehicular emissions. One of the options considered was an environmental excise duty to encourage production of cleaner vehicles. The duty levied would vary in relation to the level of pollution emissions generated by the vehicles produced. The excise duty would thus recover from vehicle manufacturers the cost imposed by their product on health and the environment. This economic instrument was to be complemented by regulations that would require existing vehicles to undergo inspection and maintenance programmes to reduce emissions.

Example 2: Subsidies

UNEP is exploring means by which environmentally- harmful subsidies to various industries or enterprises can be reduced. Subsidies, usually provided by government for natural resource exploitation, often create perverse economic incentives; they can encourage producers to generate higher levels of environmental pollution -- and higher levels of associated health impacts. Such subsidies conflict with the polluter and user pays principles by sending false price signals. They also divert scarce resources, distort competition and inhibit the develop ment of substitutes that are more environmentally-friendly. In a recent joint initiative on energy, for example, UNEP and the International Energy Agency (IEA) identified challenges policymakers face in reforming energy subsidies while pursuing sustainable development.


UNEP, Opportunities, Prospects and Challenges for the Use of Economic Instruments in Environmental Policy Making, under preparation.
UNEP, Reforming Energy Subsidies: An Explanatory Summary of the Issues and Challenges in Removing or Modifying Subsidies that Undermine the Pursuit of Sustainable Development, UNEP/IEA, 2002.
UNEP, Energy Subsidies Reform: Lessons Learnt in Assessing Their Impacts and Designing Policy Reform, under preparation.
UNEP, Environmental Impacts of Trade Liberalization and Policies for Sustainable Management of Natural Resources: A Case Study on India's Automobile Sector, UNEP, 1999.
UNEP, Economic Instruments for Environmental Management - A Worldwide Compendium of Case Studies, UNEP, 2000.
UNEP, Environmental Valuation - A Worldwide Compendium of Case Studies, UNEP, 2000.