INU- 79 The World Bank Policy, Planning and Research Staff ¡nfrastructure and Urban Development Department Report INU 79 ALTERNATIVE APPROACHES TO POLLUTION CONTROL AND WASTE MANAGEMENT: REGULATORY AND ECONOMIC INSTRUMENTS i -- by Janis Bernstein FILE COPY May 1991 DISCUSSION PAPER This is a document published informally by the Worid Bank. The views and interpretations herein are those of the author and should not be attributed to the Worid Bank, to its affiliated organizations, or to any individual acting on their behalf. Copyright 1991 0 The Worid Bank 1818 H Street, N.W. AJI Rights Reserved First Printing May 1991 This is a document published informally by the Worid Bank. In order that the information contained in it can be presented with the least possible delay, the typescript has not been prepared in accordance with the procedures appropriate to formal printed texts, and the World Bank accepts no responsibility for errors. The World Bank does not accept responsibility for the views expressed herein, which are those of the author and should not be attributed to the World Bank or to its affiliated organizations. The findings, interpretations, and conclusions are the results of research supported by the Bank; they do not necessarily represent official policy of the Bank. The designations employed, the presentation of material, and any maps used in this document are solely for the convenience of the reader and do not imply the expression of any opinion whatsoever on the part of the Worid Bank or its affiliates concerning the legal status of any country, territory, city, area, or of its authorities, or concerning the delimitations of its boundaries or national affiliation. Janis Bernstein is a Consultant with the Urban Development Division. She wishes to thank the following individuais for their valuable contributions and/or comments during preparation of this paper: Carl Bartone, Mike Cohen, Aiain Bertaud, Alcira Kreimer, David Williams, Barbara Lausche, John Dixon, Antonio Estache, Emanuel Jimenez, Gunnar Eskeland, Dennis Anderson, Sudhir Shetty, Mark Kosmo, John Boland, Jack Fritz, lan Heggie, Jose Carbajo, William Dillinger, Kyu Sik Lee, Fitz Ford, Bertrand Renaud, Josef Leitmann, John Courtney, and Mary McNeil. The World Bank ALTERNATIVE APPROACHES TO POLLUTION CONTROL AND WASTE MANAGEMENT: REGULATORY AND ECONOMIC INSTRUMENTS DISCUSSION PAPER FOREWORD This paper has been prepared for the Urban Management and Environment component of the joint UNDP/World Bank/UNCHS Urban Management Program (UMP). The UMP represents a major coordinated approach by the United Nations family of organizations, together with external support agencies (ESAs), to strengthen the contribution of cities and towns in developing countries toward economic growth, social development, and the alleviation of poverty. The program develops and promotes appropriate policies and tools for environmental management, land management, infrastructure management, and municipal finance and administration. Through a capacity building component, the UMP plans to establish an effective partnership with national, regional, and global networks and ESAs in applied research and in the dissemination of information about successful practices and promising alternatives. This background study is part of a series of working papers that, in combination with case studies and research, will be used to develop an overall report on strategic options for urban environmental management. Other papers in the series will cover priorities for urban waste management and pollution control, energy/environmental linkages in the urban sector, local management of wastes from small-scale and cottage industries, land degradation, and the urban environmental planning and management process. Each paper will provide background information on key urban development and environmental linkages and/or suggest elements of an environmental management strategy for cities in the developing world. In addition, research reports are being prepared on the following topics: health impacts of urban environmental problems, economic ramifications of urban environmental problems, urban environmental data collection, and the application of remote sensing and geographic information systems to urban environmental planning. Finally, case studies on important urban environmental problems are being prepared for Sao Paulo, Katowice, Tunis, Accra, Jakarta, Chittagong, and the Singrauli region of India. - ii - EXECUTIVE SUMMARY 1. The purpose of this paper is to present an overview of the most common strategies and policy instruments (that is, regulatory and economic) used in developed and developing countries to achieve pollution control and waste management objectives. Although this topic has been at the center of theoretical controversy both within and outside the World Bank, this paper is not intended to contribute to this debate. Rather, its purpose is to explore how regulatory and economic instruments are used to control air and water pollution, protect ground water, and manage solid and hazardous wastes. The paper is directed to policy makers at the national, state, and local levels of government, as well as to other partíes responsible for pollution control and waste management programs. Given the lack of consensus in this area, the paper does not intend to provide normative guidelines. 2. Since the inception of environmental policy in most developed countries, the command-and-control approach has been the predominant strategy. Thís involves direct regulation, along with monitoring and enforcement systems and relies primarily on applications of regulatory instruments, such as standards, permits and licenses, as well as land and water use controls. The command-and-control approach affords the regulator a reasonable degree of predictability about how much pollution levels will be reduced. Although this approach has been criticízed for being economically inefficíent and difficult to enforce, command- and-control strategies have made significant progress in meeting the objectives of environmental legislation and policies. 3. In recent years, many countries, primarily industrialized ones, have adopted economic instruments to introduce more flexibility, efficiency, and cost- effectiveness into pollution control measures. These instruments act as incentives to polluters to choose their own means of pollution control. When properly implemented, economic instruments have several advantages because they can: promote cost-effective means for achieving acceptable levels of pollution; stimulate the development of pollution control technology and expertise in the private sector; provide government with a source of revenue to support pollution control programs; provide flexibility in pollution control technology; and eliminate a government's requirement for large amounts of detailed information to determine the most feasible and appropriate level of control for each plant or product. 4. In theory, economic instruments have the capacity to regulate pollution according to market mechanisms and thus facilitate deregulation and a reduction in government involvement. In practice, however, they have not eliminated the need for standards, environmental monitoring, enforcement, and other forms of - iíi - government participation. Moreover, in developed countries, there are no known examples of instances where economic instruments have completely replaced direct regulation of polluting activities. Generally, economic instruments supplemnent direct regulation. Economic instruments alone have not produced impressive improvements in environmental quality, primarily because they are difficult to implement and have only been partially applied. 5. The regulatory and economic instruments selected to achieve pollution control and waste management objectives will have broad implications for ínstitutions at the national, state or provincial, and local levels of goverrnent, as well as for nongovernmental organizations (NGOs). The choice of instruments will determine in large part the responsible level of government and the type of institution as well as the mechanisms for enforcement. In general, the activities requiring the greatest degree of political consensus and highest level of complexity (for example, setting standards) and risk are assigned to the national government level. The state and provincial levels tend to be responsible for policies that affect natural resources shared by several municipalities; local government generally is responsible for policy instruments associated with solid waste management, wastewater collection and disposal, air pollution from automobiles or local industries, and ground-water contamination. In some situations, pollution control responsibilities are assigned to watershed or airshed authorities. In addition, NGOs play a significant role in the development and enforcement of pollution control regulations. 6. The agency given responsibility for implementing pollution control or waste management policies must have clearly delineated authority and adequate expertise, staff, equipment, and funds to carry out its enforcement functions. In developing countríes especially, institutions at all levels will require substantial strengthening in human and financial resources as well as in organizational structure to carry out waste management, pollution control, and enforcement responsibilities. In some cases, the development of new environmental agencies or environmental uníts within existing agencies will be necessary. 7. Based on a review of líterature addressing pollution control and waste management, there are few in depth evaluations of the application of regulatory and economic instruments in developing countries. Most reports provide information on the existence of standards or other regulatory or economic instruments and highlight the inadequacy of existing institutions and personnel to carry out effective monitoring and enforcement activities. Very few developing countries (among them, China, Turkey, and Brazil) have been cited as having successfully applied regulatory and economic instruments to environmental management. Nonetheless, experience in developed countries points to the following considerations that should be taken into account when planning environmental strategies and selecting policy instruments for developing countries: economic instruments cannot be successfully implemented without pre- existing appropriate standards and effective capacities in monitoring and enforcement; - iv - economic instruments are not likely to replace traditional regulatory instruments, even if effective monitoring and enforcement capacities are established; in designing new environmental programs, the fundamental challenge will be to determine the most appropriate mix of instruments by taking into account such factors as desire for economic efficiency; compatibility with existing administrative, political, and judicial frameworks, economic conditions, and tax structure; political acceptability of instruments; complexity of application; ease of monitoring and enforcement; consistency with overall environmental policy; and compliance with relevant international agreements or principles; and among the various economic instruments, charges appear to have the most potential for contributing to the achievement of pollution control and waste management objectives in developing countries, given adequate enforcement mechanisms. 8. Further research on environmental management strategies is needed. The research should include in-depth studies on: evaluating the effectiveness of various regulatory and economic instruments in developing countries, the practical aspects of implementing and operating economic instruments and the circumstances under which they can be successfully applied, the combínations of instruments that are most appropriate for developing countries, approaches that take into account cross-media pollution effects, and appropriate standards for developing countries. Further research also is needed to identify means for building appropriate monitoring and enforcement capabilities in developing countries. - V . TABLE OF CONTENTS Foreword.t Executive Suinmary .... .. ......... ii I. OVERVIEW OF THE INSTRUMENTS .1 A. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . 1 B. Command and Control Versus Economic Strategies . . . . . . . . 1 C. Regulatory and Economic Instruments to Control Pollution and Manage Waste .5 Regulatory Instruments. 5 Standards .5 Permits and Licenses .9 Land and Water Use Controls . . . . . . . . . . . . . . . 9 Economic Instruments .... . . . . . . . . . . . . . . 10 Pollution Charges .... . . . . . . . . . . . . . . 10 Market Creation .... . . . . . . . . . . . . . . . . 14 Subsidies .... . . . . . . . . . . . . . . . . . . . 16 Deposit-Refund Systems ... . . . . . . . . . . . . . 16 Enforcement Incentives ... . . . . . . . . . . . . . 17 Mixed Systems .... . . . . . . . . . . . . . . . . . . 18 D. Institutional Implications ................ . 23 Institutional Requirements . . . . . . . . . . . . . . . 23 Responsibilities by Level of Government . . . . . . . . . 25 Need for Institutional Strengthening in Developing Countries ... . . . . . . . . . . . . . . 26 E. Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . 27 Environmental Strategies in Developing Countries . . . . 27 Needs for Further Research . . . . . . . . . . . . . . . 28 II. REGULATORY AND ECONOMIC INSTRUMENTS: APPLICATION TO POLLUTION CONTROL AND WASTE MANAGEMENT . . . . . . . . 29 A. Surface Water Pollution .29 Regulatory Instruments .29 Standards . . . . . . . . . . . . . . . . . . . . . . . . 29 - vi - Permits and Licenses ... . . . . . . . . . . . . . . . 32 Controls on Special Water Uses . . . . . . . . . . . . . 32 Economic Instruments .... . . . . . . . . . . . . . . . 32 Pollution Charges .... . . . . . . . . . . . . . . . . 32 Market Creation (Marketable Discharge Permits) . . . . . 35 Subsidies . . . . . . . . . . . . . . . . . . . . . . . . 36 Enforcement Incentives ... . . . . . . . . . . . . . . 36 Mixed Systems .... . . . . . . . . . . . . . . . . . . . 37 B. Ground-Water Protection .... . . . . . . . . . . . . . . . 39 Regulatory Instruments ... . . . . . . . . . . . . . . . 39 Standards . . . . . . . . . . . . . . . . . . . . . . . . 39 Permits and Project Review . . . . . . . . . . . . . . . 40 Land Use Controls .... . . . . . . . . . . . . . . . . 41 Controls on Ground-Water Extraction . . . . . . . . . . . 43 Economic Instruments ... . . . . . . . . . . . . . . . . 44 Subsidies .... . . . . . . . . . . . . . . . . . . . 44 Enforcement Incentives ... . . . . . . . . . . . . . . 44 C. Air Pollution Control .... . . . . . . . . . . . . . . . 44 Regulatory Instruments ... . . . . . . . . . . . . . . . 44 Standards . . . . . . . . . . . . . . . . . . . . . . . 44 Permits and Licenses ... . . . . . . . . . . . . . . . 47 Land Use Controls .... . . . . . . . . . . . . . . . 48 Economic Instruments .... . . . . . . . . . . . . . . . 48 Pollution Charges ... . . . . . . . . . . . . . . . . 48 Market Creation (Emissions Trading) ... . . . . . . . 51 Subsidies . . . . . . . . . . . . . . . . . . . . . . . 53 Enforcement Incentives ... . . . . . . . . . . . . . . 53 D. Solid Waste Management .... . . . . . . . . . . . . . . . 53 Regulatory Instruments ... . . . . . . . . . . . . . . . 53 Standards . . . . . . . . . . . . . . . . . . . . . . . 53 Permits and Licenses ... . . . . . . . . . . . . . . . 54 Solid Waste Plans .... . . . . . . . . . . . . . . . 55 Economic Instruments .... . . . . . . . . . . . . . . . 55 Charges .... . . . . . . . . . . . . . . . . . . . . 55 Subsidies . . . . . . . . . . . . . . . . . . . . . . . 57 Deposít-Refund Systems . . . . . . . . . . . . . . . . . 57 E. Hazardous Waste Management ... . . . . . . . . . . . . . . 59 Regulatory Instruments ... . . . . . . . . . . . . . . . 59 Standards . . . . . . . . . . . . . . . . . . . . . . . 59 - vii - Permits and Licenses . . . . . . . . . . . . . . . . . . 60 Land Use Controls ... . . . . . . . . . . . . . . . . 61 Economic Instruments . ................. . 61 Pollution Charges ... . . . . . . . . . . . . . . . . 61 Subsidies . . . . . . . . . . . . . . . . . . . . . . . 61 Enforcement Incentives . ............... . 62 FIGURES Figure 1: Alternative Locations for Applications of Regulatory and Economic Instruments . .............. . 19 BOXES Box 1: Definitions . . . . . . . . . . . . . . . . . . . . . . . . . . 6 Box 2: Secondary Effects of Land Use Controls to Protect Ground Water . . . . . . . . . . . . . . 42 Box 3: Wellhead Protection . . . . . . . . . . . . . . . . . . . . . . 43 Box 4: Emissions Trading Program .................. . 52 Box 5: Incentives for Reducing Municipal Solid Waste ........................ . 56 TABLES Table 1: Regulatory and Economic Instruments . . . . . . . . . . . 20 - 22 BIBLIOGRAPHY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63 ALTERNATIVE APPROACHES TO POLLUTION CONTROL AND WASTE MANAGEMENT: REGULATORY AND ECONOMIC INSTRUMENTS I. OVERVIEW OF THE INSTRUMENTS A. Introduction 1.1 Environmental managers can achieve their pollution control and waste management objectives through a variety of policy instruments. The purpose of this paper is to present an overview of the most widely used strategies and policy instruments (that is, regulatory and economíc) that address urban environmental problems. Although this topic has been at the center of theoretical controversy both within and outside the World Bank, this paper is not intended to contribute to this debate. Rather, its purpose is to explore how regulatory and economic instruments are used in developed and developing countries to control air and water pollution, protect ground water, and manage solid and hazardous wastes. The paper also is intended to highlight general considerations for officials in developing countries in the process of establishing and implementing environmental policies and programs. 1.2 The paper is presented in two chapters. Chapter I presents a discussion of the two main approaches to pollution control and waste management as well as the principal regulatory and economic instruments to meet environmental objectives. It also addresses institutional implications of regulatory and economic instruments and draws conclusions on environmental strategies in developing countries and needs for further research. Chapter II discusses regulatory and economic instruments as they apply to surface water pollution control, ground-water protection, air pollution control, solid waste management, and hazardous waste management. This chapter presents examples of how individual countries, both developed and developing, have used these instruments to achieve environmental objectives. Information on the results of applying the selected instruments is provided. B. Command-and-Control Versus Economic Strategies 1.3 The two principal approaches to pollution control and waste management are the command-and-control and economic strategies. Since the inception of environmental policy in most industrialized countries, governments have tended to use command-and-control (that is, direct regulation along with monitoring and enforcement systems) as the predominant strategy in pollution control and waste management. This approach generally requires a government to set health- or ecology-based ambient environmental objectives and specify the standards or amount of pollutants that can be discharged or the technology by which polluters should meet those objectives. In most cases, the command-and-control approach also specifies schedules for meeting the standards, permitting and enforcement procedures for facilities, liability assignment, and penalties for non- compliance. The responsibility for defíning and enforcing the standards and other requirements is shared in legislatively specified ways between the national, state, and local governments. 1.4 The command-and-control approach gives the regulator maximum authority to control where and how resources will be spent to achieve environmental objectives. The major advantage of this approach is that it provides the regulator a reasonable degree of predictability about how much pollution levels will be reduced. Moreover, based on experience in the United States, this approach also protects competition among facílities. In the case of air pollution control, for example, all new facilities must adopt uniform abatement technology. In the case of water pollution control, uniform pollution control technology applies to an industrial class, regardless of facility age (Moore et al. 1989). 1.5 Although command-and-control strategies have made substantial progress in reducing pollution, this approach has been criticized for not achieving varíous legislative mandates and deadlines and for being economically inefficient and difficult to enforce. These strategies are inefficient for the regulatory agency, which must have detailed information concerning production processes and the suitability of various pollution control devices. With diverse industries, it is extremely expensive and time-consuming to obtain the necessary information and expertise on each industry. Other problems with this approach are the high costs for pollution control that leave little opportunity to take advantage of economies of scale. Although standards may be applied differently depending on the age or type of facility, most polluters using the same production process are required to meet the same standards. Polluters that could reduce pollution at a lower cost are not given the opportunity. Further, there is little flexibility for polluters who already have invested in some type of pollution control system. Consequently, the command-and-control approach provides little incentive for innovation in pollution control technology once the standards are achieved. Moreover, this approach is insufficient or ineffective in addressing many of the more recent pollution control and waste management problems confronting environmental managers, such as nonpoint source pollution (that is, urban and agrícultural runoff), solid waste disposal, and global envirormiental problems (for example, stratospheric ozone depletion and climate changes). 1.6 In recent years, many countries have adopted various economic instruments (that is, pollution charges, marketable permits, subsidies, deposit and return systems, and enforcement incentives) to introduce more flexibility, efficiency, and cost-effectiveness into pollution control measures. Most of these instruments operate as incentives to polluters who can determine the most efficient and cost-effective means for achievíng environmental targets. To various degrees, they incorporate the polluter-pays and user-pays principles. According to the polluter-pays principle, the polluter pays a financial penalty for higher levels of pollution and pays a smaller penalty or receives a financial reward for lower levels of pollution. According to the user-pays principle, the user of a resource pays the full social cost of supplying the resource, such as for water and related services including treatment costs (OECD 1990). While some economic instruments apply direct costs (for example, charges based on the volume and toxicity of discharges, pay-per-bag systems for soLid waste disposal, permit fees for air emissions where the fee varies wíth the volume emitted, refundable deposits on containers), other instruments involve indirect costs such as pollution taxes on inputs (for example, fuel taxes). 1.7 Overall, the economic approach has several advantages. When properly implemented, it can: promote cost-effective means for achieving acceptable levels of pollution; stimulate development of pollution control technology and expertise in the private sector; provide government with a source of revenue to support pollution control programs; provide flexibility in pollution control technologies; and eliminate a government's requirement for large amounts of detailed information needed to determine the feasible and appropriate level of control for each plant or product (OECD 1989). 1.8 Despite these strengths, economic instruments have certain disadvantages. One significant problem is that the effects of economic instruments on environmental quality are not as predictable as those under the traditional regulatory approach, since polluters may choose their own solutions. Moreover, in the case of charges, some polluters may choose to pollute if the charge is not set at an appropriate level. From the perspective of developing countries, another major weakness of economic instruments (particularly marketable permits and effluent or emission charges) is that they require sophisticated institutions to implement and enforce them. Other disadvantages associated with specific instruments are discussed in Section C of this chapter. 1.9 As mentioned above, economic instruments often incorporate the polluter-pays principle. The aim of this principle is to integrate, at minimum social cost, expenditures on environmental protection in conjunction with standards or charges. According to Coase, however, there is no efficiency reason for a government to be involved in the regulation of pollution damage, except to enforce property rights. Depending on who possesses property rights, either the polluter will pay the victim to tolerate the damage or the victim will pay the polluter not to pollute (Pearce and Turner 1990). As long as the negotiations are not costly, the socially optimal amount of pollution will result in eíther situation. When there are few polluters and victims, and the number of beneficiaries from an agreement is given, negotiations may allow the internalization of environmental externalities. The validity of this approach, however, is based on two assumptions: the transaction costs are negligible (specifically, where the number of victims and polluters is not large) and the bargaining is successful with agreements enforced. In the absence of either condition, however, public intervention may be the only effective solution (Eskeland and Jimenez 1990). 1.10 Theoretically, economíc instruments have the capability to control pollution according to market mechanisms and thus facilitate deregulation and a reduction in government involvement. In practice, however, they have not - 4 - eliminated the need for regulations, enforcement, and other forms of government participation. In industrialized countries, there are no known examples of instances where economic instruments have fully replaced direct regulation of polluting activities. In almost all cases, economic instruments supplement direct regulations, thereby contributing to the achievement of policy objectives. In mixed water effluent control systems, for example, charges have not eliminated the need to regulate discharges through licensing. With emissions trading, approval by authorities of environmental discharges have been replaced by approval of trading transactions (OECD 1989). In the case of marketable permits and effluent and emissions charges, which allow greater latitude in how and where reductions occur, the systems of monitoring and enforcement required are likely to be more complex and expensive than those needed for regulatory instruments (Moore et al. 1989). Nonetheless, not all economic instruments require expensive monitoring and enforcement. For example, beverage container deposit schemes (see Chapter II) do not require expensive monitoring and enforcement. In addition, sewer effluent charges generally are based on water consumption, which already is monitored in most jurisdictions (Anderson et al. 1989). 1.11 In their effect on environmental quality, economic incentives have not produced impressive results. The direct effect of both charges and marketable permits on environmental quality appears to be neutral or slightly positive. The direct effect of charges as an incentive has been modest, although the indirect environmental effect of earmarking the revenue raised by charges for pollution control actions has been positive (Hahn 1989). 1.12 Notwithstanding the potential benefits of economic instruments-- raising public revenues, promoting innovation in pollution control technology, and lowering pollution control costs--government authorities, polluters, and environmentalists have not always supported the economic incentive approach. Regulatory agencies have objected to these instruments largely because they afford government less stringent control over polluters and provide less predictability about the amount of pollution emitted into the environment. In developed countries, industry and other polluters have resisted economic instruments such as effluent and emissions charges because they contend that they have greater negotiating power over the design and implementation of regulations than they do over economic instruments. Economic instruments act as an additional constraint on industry when they supplement exísting regulations; some economic instruments (especially charges) impose a financial burden beyond the cost of complying with regulations (OECD 1989). When existing firms are protected from new competition by new source restrictions, they likely would object to lowering barriers to entry (Anderson et al. 1989). Further, if high charges are introduced in one country, more favorable market conditions will result in those countries with less stringent environmental controls. Lastly, not all types of pollution are appropriate for an incentive-based approach. For example, toxic substances, which can cause serious acute and chronic health problems, are better suited to some form of direct regulation. Further, some environmentalists historically object to any principle that implies a right to pollute, even though the existing regulatory system operates under permits to release stated quantities of pollutants at little or no cost to the polluter (Anderson et al. 1989). - 5- C. Regulatorv and Economic Instruments to Control Pollution and Manage Waste 1.13 The command-and-control approach to pollution control and waste management relíes primarily on regulatory instruments (for example, standards, permits, licenses, land use controls); the economic approach usually incorporates regulatory instruments as well as economic instruments such as charges, marketable permits, and subsidies. Following is a brief description of the principal regulatory and economic instruments used to control pollution and manage waste in both developed and developing countries. The instruments described in this section, however, do not constitute a complete inventory. Some instruments, for example, have limited applications (for example, best management practices and controls on ground-water extraction) and are díscussed in Chapter II of this paper. Pricing policies, which are not directly concerned with environmental protection but indirectly affect the environment through their effects on production technologies and decisions, lie beyond the scope of this paper. Other potentially important pollution control instruments such as environmental impact assessments, technical assistance, negotiation, land acquisition, and public pressure (such as, boycotts, demonstrations, lobbying) also are not addressed in this paper. Regulatorv Instruments Standards 1.14 Standards are the predominant means for direct regulation of environmental quality throughout most of the developed world. They define environmental targets and establish the permissible amount or concentration of particular substances or discharges into air, water, land, or consumer products. Types of standards include: ambient environmental quality standards, effluent or emission standards, technology-based standards, performance standards, product standards, and process standards (See Box 1). Standards also may include technological specifications for the performance or design of equipment or facilities and the standardization of sampling or analytical methods. In some cases, a regulator takes into account the transfer of pollutants from one medium to another as well as total environmental exposure to specific pollutants in determining ambient standards or discharge limits. Each of the various types of standards are used to provide a reference for evaluation or target for legislative action and control. Generally, standards are established by central goverrnents; in some instances, however, central governments set out framework regulations to be carried out by local, state, or regional authorities. Sub- national standards can be more stringent than those of the central government. In general, they are not less stringent, unless there are exceptional círcumstances. 1.15 Standard setting presupposes the existence of a monitoring agency that oversees polluters' activities and has the power to impose a penalty for noncompliance. If the agency has no enforcement powers, the only incentive the polluter has to stay within the standard is social conscience. Thus, standards typically are associated with penalties (such as, noncompliance fees, loss of license); polluters also can be prosecuted or at least threatened with prosecution (Pearce and Turner 1990). -6- Box 1: DEFINITIONS Criterion - Scientific information (for example, concentration-effect or dose-effect data) used as a basis for setting environmental quality objectives. It assesses the risk to a given victim and the amount of damage caused by a known amount of pollution or dose of exposure. Oblective - A designated concentration of a pollutant in an environmental medium or a narrative statement (for example, adequate to support aquatíc life, zero pollutant discharge). The objective is based on scíentífic criteria, local natural condítions, and socioeconomic and environmental factors. Standard - A legally defined regulatory instrument for limiting pollution. Several types of standards are commonly employed: a. Ambient Environmental Quality Standard - Establishes the highest allowable concentration of specified pollutants in the ambient air or water. For example, an ambient standard for a specific river may require that dissolved oxygen, averaged over a 24-hour period at a selected river mile point, must not fall below 4 parts per million on more than one day per year. b. Effluent or Emissíon Standard - Establishes the legal ceiling on the total quantity or concentration of a pollutant discharged from a pollution source (for example, mg/liter, grams/24 hours, kg/ton)). Effluent standards may include maximum effluent limitations for specified time periods (for example, maximum for any one day, maximum averages of daily values for 30 consecutive days, or for one year) and monitoring requirements. c. Technology-Based Standard - A type of effluent standard that specifies a specific technology a firm must use to comply with environmental laws and regulations. For example, a utility may be required to use a scrubber to control sulphur oxide emissions. d. Performance Standard - A type of effluent standard that defines a performance measure (for example, volume or concentration of a pollutant in a discharge, percent pollutant removal to be achieved) and allows dischargers the flexibility to select the best means to meet this standard. For example, automobile companies may be required to develop a technology for new automobiles that limit tailpipe emissions to no more than .41 grams of hydrocarbons, 3.4 grams of carbon monoxíde, and 1.0 grams of nitrogen oxides per mile. e. Product Standard - Establishes a legal ceiling on the total quantity or concentration of pollutants that can be discharged into the environment per unit of product output (kg per 1000 kg of product). Product standards also prohibit the addition of certain substances to products, for example, to eliminate lead discharges from the burning of gasoline, authorities prohibit the addition of lead to gasoline. f. Process Standard - Limits the emission of pollutants associated with specific manufacturing processes (for example, the mandatory replacement of mercury cells by diaphragm cells to prevent mercury emissions from chlor- alkali manufacture). 1.16 Ambient Environmental Quality Standards. Ambient environmental quality standards are used principally for protecting water and air quality. Ambient water quality standards, for example, specify the minimum conditions that must be met for specific parameters at specific locations in a water body. They are set on the basis of scientific criteria that assess the risk to a given victim and the amount of damage caused by a known dose of exposure to a pollutant. They also may be based on the possible uses of a specific body of water. The advantage of ambient water quality standards is that they establish the constraints that water quality objectives may impose on economic development, particularly for industrial and urban development. To achieve a certain standard requires establishing a threshold limit that a residual amount of pollution discharged must not exceed. Thus, setting a quality objective restricts development of an area to a certain level. The only way to expand, while ensuring the fixed level of environmental quality, is through technological innovation that increases the effectiveness of water treatment (OECD 1988). Another advantage of ambient water quality standards is that they provide a basis for the evaluation of the effectiveness of controls on discharges. They also establish priorities and targets to be achieved by such controls. 1.17 Two problems are associated with relying on ambient water quality standards alone to control pollution. First, when the combined effect of several discharges exceeds the assimilative capacity of the receiving waters and the standards are not achieved, responsibility cannot be assigned to a specific source. Moreover, it is also possible for the source farthest upstream to consume more than its share of the receiving water's self purification capacity, leaving little or no capacity for the downstream dischargers (Pallange and Zavala 1987). Second, the problem of determining acceptable concentrations of various pollutants is complicated by inadequate knowledge of the pollutants' effects, particularly in small concentrations, on human health and animal and plant life. These uncertain hazards must be weighed against other, often-competing economic and social interests (WHO 1983). 1.18 Ambient air quality standards are limits established for air pollutants inambient (outdoor) air. The standards are to be met through the application of control technology that reduces emissions continuously and results in improved air quality. These standards provide the targets for most command-and-control approaches as well as economic strategies for air pollution control (See Chapter II). 1.19 Effluent and Emission Standards. Effluent or emission standards are mean or maximum values for allowable concentrations or quantities of pollutants that may be discharged into a water body or emitted into the atmosphere; they must be achieved by an individual source at the point of discharge. Limitations may be applied to the entire plant or to each pipe discharging from the plant. Special effluent standards may be set for particular industries. In some cases, a distinction is made between standards applicable to all industries and standards specific to particular industries. Different standards also may apply to new and existing plants. Standards also may define the means for achieving specific environmental targets. Generally, ambient and effluent standards are complementary components of a regulatory scheme to control water or air pollution. 1.20 A technology-based standard is a type of effluent or emission standard that specifies particular technologies that firms must use to comply with environmental laws and standards. They afford no flexibilíty to firms in determining what control technology to use in order to meet such requirements. By contrast, performance standards specify the amount of pollutants that can be discharged, the allowable discharge concentration, or the amount of pollutants that must be removed prior to discharge, but allows firms to select the best way to meet the standard. The implementation of performance standards requires only that the pollutíon control agency define permit conditions in terms of performance rather than in terms of equipment or processes that will be adopted. The advantage of performance standards ís that they allow polluters the flexibility to meet environmental requirements using the least-cost technique.Y Performance standards are considered to be a low cost approach to pollution control than technology-based standards. Lastly, performance standards may be best suited to large, complex enterprises that can choose the most efficient pollution control techniques. For small, relatively simple operations, it might be preferable to impose technical specifications or general rules which are easier to apply by activity and easier to enforce by the regulatory agency (OECD 1987). 1.21 Effluent standards generally provide a dírect and manageable means for controlling pollution with a reasonable degree of predictability regarding the quality of surface water. Thus, establishing appropriate effluent standards is probably the best approach to controlling water pollution for developing countries. Nonetheless, there are several weaknesses associated with this instrument. First, uniform effluent standards do not take into account the water quality requirements of local water bodies. They can provide for overprotection in some river stretches and insufficient protection in others (Helmer 1987). Where there are numerous waste dischargers, however, achieving an ambient water quality standard through independent regulation of various discharges will be impossible. Instead, the government must coordinate the various effluent standards so as to achieve the desired goals in the receiving water body. Moreover, enforcement is usually carried out by spot-checks by government inspectors with penalties imposed on violators. The violators in turn may prefer to delay compliance with standards and to engage the government in lengthy legal battles. Another disadvantage of this approach is that it requires enormous administrative and enforcement costs (Fano et al. 1986). 1/ In the enforcement of performance standards, an important prerequisite is the clarity of the standard and its measurement. In some cases, it has been difficult to determine whether the agency is issuing performance standards or technology-based standards. For example, an agency may set the standard on the basis of what the best available technology will achieve. This can be expressed as a technology-based standard, in which the agency requires the discharger to install the best available technology, or as a performance standard, by whích the agency requires the discharger to meet the standard that can be achieved with the best available technology without specifying a particular technology. In the latter case, however, the performance standard may be equivalent to a technical standard because there is only one demonstrated technique that achieves the performance standard (OECD 1987). - 9 - 1.22 Product and Process Standards. Product and process standards establish a legal ceiling on the amount of polluting products that can be discharged into surface water, ground water, and the atmosphere. For example, product standards prohibit the addition of lead to gasoline to eliminate lead discharges from automobiles. Similarly, the problem of aquatic blooms caused by detergents has been addressed by the removal of phosphates from detergents. An example of a process standard is the prevention of mercury emissions from chlor-alkali manufacture in Japan through the mandatory replacement of mercury cells by diaphragm cells. Outright bans on the use or production of a product that has no close substitute may be the strictest form of regulation. Nonetheless, close substitutes are often available at little extra costs (Bohm and Russell 1985). Bans on products or processes, therefore, may be an efficient policy instrument when there are close alternatives at low additional costs. Permits and Licenses 1.23 The grantíng or withholding of permits, licenses, or other authorizations is another important tool for controlling pollution. The permits or licenses are generally tied to an air or water quality standard and may be subject to the fulfillment of specific conditions such as compliance with a code of practice, selection of the location that minimizes environmental and economic impacts, installation of a treatment plant or pollution control equipment within a certain time period, or adoption of other environmentally protective measures. One major advantage of permits and licenses is that they facilitate the enforcement of environmental programs by including in one document all of a facility's pollution control obligations. Other advantages are that they may be withdrawn or suspended according to the needs of the national economy or other social interests and often require a fee that can be used to cover the costs of the pollution control program. Nonetheless, the use of permits and licenses normally involves regular monitoring and facility reporting. Land and Water Use Controls 1.24 Land use controls (such as, zoning, subdivision regulations) are principally local government tools that can be applied to environmental protection. Zoning may be defined as the division of a municipality or other jurisdiction into districts and the regulation within those districts of the allowable uses of land, height, and bulk (for example, maximum usable floor area as a percentage of lot area) of buildings and other structures; minimum allowable lot sizes; and populatíon density. Thus, zoning can prevent the location of polluting industries in inappropriate areas or control the density of development in specific districts. In Brazil, for example, under Decreto-Leí 1413, an urban zoning program must be adopted in officially designated critical areas of pollution, which covers all major metropolitan areas and most industrial areas of that country. The objectives of this program include relocation of some existing facilities and installation of pollution control equipment at others (Findley 1988). 1.25 Performance zoning allows flexíbility in design as long as certain standards are achieved. For example, performance zoning has been applied to industrial zones where any industry is permitted as long as its discharges do not exceed certain límíts. Generally, performance standards are expressed as - 10 - ratios of open space, density, and floor area. As long as standards are achieved, development can be clustered in one or more parts of the tract, leaving other areas in natural cover (U.S. Department of the Interior 1982). 1.26 Subdivision regulations are locally adopted laws governing the process of converting raw land into building sites. They control the physical layout of new development by establishing standards such as lot size, width and length of streets, and sites for public facilities. They also include provisions for adequate space for traffic, utilities, recreation, installation of water and sewer services, and the avoidance of population congestion. Subdivision regulations are accomplished through plat approval procedures; a developer is not permitted to make improvements or divide and sell his land until the plat (map) of the proposed subdivision is approved by the planning authority. Although these regulations, as well as zoning, can be used to promote a balanced pattern of urban development, land use controls can have negative effects on local populations in search of affordable housing (see Chapter II). Moreover, land use controls often are vulnerable to economic and political pressures that may override environmental objectives. 1.27 Controls on special uses of water can be used to limit or ban energy development, exploitation of natural resources in river banks and beds or seabeds, recreational activities (fishing, swimming, boating) and other potentially polluting uses in designated waters. In many cases, these regulations form part of regional or special planning measures for purposes of managing coastal zones, national parks, seashores and recreational areas, and/or marine sanctuaries. Economic Instruments Pollution Charges 1.28 Pollution charges establish the expenditure that will be made to control incremental units of pollution, but leave uncertain the resulting level of environmental quality. Their application is particularly appropriate when the damage from incremental units of pollution can be estimated reliably and least appropriate when regulators require certainty in the level of environmental quality achíeved (Anderson et al, 1989). They encompass several types of instruments used for the purpose of controlling environmental degradation. They include effluent or emission charges, user charges, product charges, administrative charges, and tax differentiation. 1.29 Effluent and Emission Charges. Effluent or emission charges are fees levied by a government authority based on the quantity and/or quality of pollutants díscharged into the environment by an industrial facility. Under an effluent or emission charge system, a discharger is required to pay a certain amount for every unit of pollution discharged into surface water or emitted into the atmosphere. Generally, effluent and emission charges are used in conjunction with standards and permits and allow ambient air and water quality standards to be achieved at the least possible cost. 1.30 An effluent or emission charge is based on some measure of the pollution dispensed in the environment. To control water pollution, for example, - 11 - the charge can be based on: water quality objectives, the costs for financing a pollution abatement scheme, or effluent standards. Under the first scheme, individual sources are induced to take internal measures to reduce the quantities of pollutants in their discharges and thereby reduce their payments for pollutants that affect preexisting water quality standards. If the goal of the program is to meet a given ambient water quality, the most efficient charge would probably vary from location to location and from time to time. For example, the charge for discharging pollutants that do not degrade in the environment would be higher if they occurred upstream rather than downstream or if they occurred during low flow rather than high flow periods. The more sophisticated the pollution charge system, the more difficult it will be to implement and enforce (Palange and Zavala 1987). 1.31 Under the second scheme, the charges are used for financing a basin or regional control program to be shared by all users so that charges are allocated among dischargers in terms of a given pollution indicator (expressed as a unit measure) or presence of a toxic substance. Another form of this method is to levy ad valorem taxes to recover municipal cost charges based on volumes discharged or a combination of volumes with excessive pollutant concentrations over preestablished values. The third scheme involves charges imposed on all discharges in excess of established standards (Palange and Zavala 1987). 1.32 The most commonly proposed effluent charge schemes encompass whole regions. To ensure effective implementation of such a system, however, a number of institutional, political, and technical conditions must exist or be created. First, the responsible institution (often a regional authority) should encompass natural boundaries such as watersheds and airsheds and have the legal authority to impose and enforce charges on polluters. This authority would require: analytical methods and data to establish the monetary value of damages caused by various pollutants or a method for estimating the level of the fee necessary to meet environmental quality standards, adequate resources to monitor emissions for each source of pollution, self-monitoring with periodic verification and enforcement, and legal power over the disposition of revenues (Moore et al. 1989). When pollution charges and permits are used together, it is important to ensure close coordination between the two instruments. Accordingly, specifications for polluting díscharges must be identical in the permits and in the computation of charges. If these specifications differ, it increases enforcement difficulties since both types of requirements must be checked and monitored unless permits regulate one category of substances and charges another, which generally is not the case. 1.33 In theory, effluent and emissíon charges have several advantages: they induce firms to reduce pollution at lower costs than those under a command-and- control approach; they provide incentives to firms to invest in new pollution control technology; and they generate revenue, which can be used to finance and enhance enforcement activities. Lastly, effluent and emission charges can compensate, at least partially, for the unpaid costs of industrial activity usually borne by society at large. These include government expenditures associated with the development and enforcement of environmental regulations as well as the costs arising from discharges that are legal but still cause damage to natural resources (Hamrin 1990). - 12 - 1.34 The principal disadvantages of effluent charges relate to practical and political considerations. First, industry always prefers control through standards over a system of fees with the same abatement costs because payment of the fee on remaining discharges will cost more in total. Another weakness is that there is no scientific or politically accepted way to assign monetary values to pollution damage. Charge setting is further complicated because the location of individual pollution sources will determine the extent of damage to ambient quality, thus requiring firm-specific rates. This results in areas competing for economic development by reducing charges, thus penalizing areas trying to improve environmental quality. Due to the complexity of pollution sources, developing and adminístering fees for numerous pollutants from single or multipoint sources would probably not be feasible with available resources for monitoring and enforcement in developing countries or even developed countries. Further, local authorities in most areas would not be strong enough to handle the complex planning, analysis, monitoring, enforcement, litigation, and interjurisdictional negotiation that would be required under an effluent or emission charge system. In addition, defining regional boundaries to apply the fee presents major difficulties. In the case of water, for example, watersheds are relatively easy to define, but the extent of an authority's jurisdiction throughout the tributaries is often unclear. The problem is significantly more complex in the case of airsheds given the variability of pollution dispersion (Moore et al. 1989). 1.35 In practice, charges are used primarily to control water pollution rather than air pollution. The charges generally are designed to raise revenue for the purpose of funding activities that promote environmental quality. Thus, the revenue from the charges ís typically earmarked for specific environnmental purposes rather than contributed to the general revenue. For more detailed discussions of effluent and emission charges as they apply to water and air pollution control, see Chapters II. 1.36 User Charges. User charges are direct payments for the costs of collective or public treatment of pollution. They are used most often in the collection and treatment of municipal solid waste and for the discharge of wastewater into sewers (See Chapter II). With respect to water pollution control, for example, user charges are fees paid to water authorities to allow discharges of industrial wastes into public sewers. Through these charges, which are related to the quality and characteristics of the effluent, the public authority receiving the waste discharge is compensated for the effort involved in its disposal. At the same time, the scale of the charges ensures that the plant has an economie incentive to improve the quality of the effluent. This approach, however, is not appropriate when disposing of certain toxic pollutants (for example, mercury) that never should be permitted to enter watercourses. Another application of user charges is in the area of vehicle-related taxes and charges. 1.37 Product Charges. Product charges are fees added to the price of products or product ínputs that cause pollution in either the manufacturing or consumption phase or for which a special disposal system has been established. They function like effluent and emission charges in that they allow users to determine their own cost-effective means for reducing pollution. For example, all members of the European Community (EC), except Denmark, have levied a product - 13 - charge on lubricating oils as a result of a 1975 EC directive to adopt measures to recycle waste oil. The system involves a tax on lubricating oil and subsidies provided for recycling oil. In Germany, this program was highly successful until the country encountered problems with illegal PCB contamination. In France and Italy, where the systems have less of an incentive effect, oil collections have at least doubled since the beginning of the programs. In Norway and Sweden, other product charges connected to environmental goals include charges on non- returnable containers, batteries, lubricating oil, fertilizer, and pestícides (Anderson et al. 1989). 1.38 The effectiveness of a charge on polluting products or product inputs will depend on the availability of substitutes. For example, where input costs are a small fraction of total costs, doublíng or tripling the price through an input tax is unlikely to have a significant effect on consumption unless there are suitably priced substitutes. If less polluting substitutes are available, small increases in input prices may induce substitution and innovation over the longer term (Moore et al. 1989). Revenues from product charges can be used to treat pollution from the product directly, to provide for recycling of the used product, or for other budgetary purposes. 1.39 Administrative Charges. Administrative charges are fees paid to authorities for such services as chemical registration or the implementation and enforcement of environmental regulations. They usually are a component of direct regulation and are intended primarily to finance the licensing and control activities of pollution authorities. In Norway, for example, these charges are levied to finance the registration and control activity for fish farming and agricultural pollution, control of emissions from industrial sources, and for the licensing of chemical products. In some cases, administrative charges can have an incentive purpose as well. For example, a registration charge based on the relative hazards of pesticides or other chemicals may be imposed to encourage the use of less harmful products. In practice, administrative charges are similar to product charges in that the levels of such fees are usually low and do not provide significant incentives for changes in purchasing patterns. Revenues from administrative charges usually are added to the general budget rather than the budget of the pollution authority involved. In Belgium, for example, the mandatory registration fee for imported and exported waste is not earmarked for environmental purposes (OECD 1989). 1.40 Tax Differentiation. Tax differentiation is used to promote consumption of products that are environmentally safe. This instrument involves a combination of two surcharges added to other product charges: a positive charge levied on a pollutíng product and a negative charge on a cleaner alternative. It is used primarily in the context of transport to discourage consumer purchases of polluting vehicles or fuels (OECD 1989). Differential taxation of leaded and unleaded gasoline is a common practice throughout Europe. In the Netherlands, for example, unleaded gasoline is taxed at 0.1 ECU per 100 liters (about US$.004 per gallon) and leaded gasoline at 1.74 ECU per 100 liters (about US$.08 per gallon). Other taxes are levied on diesel and other fuel oils. The fuel taxes are designed to have some incentive effects. Generally, the levels of the charge are calculated so as to keep the total financial effects budget neutral. Differential taxation of new automobiles based on pollution is practiced in the Netherlands, Norway, Sweden, Finland, and Germany (Anderson et al. 1989). - 14 - Market Creation 1.41 Under this approach, markets can be created in which actors can buy "rights" for actual or potential pollution or where they can sell these "rights" to other actors. Market creation generally takes one of two forms: marketable permits or liability insurance. 1.42 Marketable Permits. Under a marketable or tradeable permit system, the responsible authority determines a target level of environmental quality defined as an allowable level of emissions or an ambient environmental quality standard. This level of environmental quality is then translated into a total number of allowable emission that can be discharged and then allots discharge ríghts to firms in the form of permits.3 Permits are then distributed to firms with each permit allowing the owner to discharge a specified amount of pollution. This permit to discharge may be transferred from one source to another. The demand for the permits is derived from the discharger's marginal costs of treatment; the discharger will treat waste as long as the marginal cost of treatment is less than or equal to the cost of buying a permit. 1.43 There are two basic approaches to implementing a marketable díscharge permit system: government auction of permits or free distribution of permits to dischargers followed by tradíng among dischargers to establish a market price. Under the first approach, permits are sold for a single market-clearing price, which might be the lowest accepted bid, the highest rejected bid, or some value in between. Alternatively, the permits are allocated to the highest bidders. Under the second approach, permits might be distributed initially to duplicate the effect of uniform removal regulations or to allocate permits to communities on a basis such as population or to firms based on value added. After the initial distribution, the method for exchange of the permits could be centralized market or bilateral exchanges (Lyon 1989). 1.44 Marketable discharge permíts that are transferable across jurisdictional boundaries have the potential for strengthening long-range pollution control. If applied, each source would be allowed to transfer all or part of its permitted emissions to another agency for monetary compensation. Sources that would incur high abatement costs could compensate sources in other jurisdictions for cutting back further than otherwise required. Differences among jurisdictions in marginal pollution-control costs would thus tend to narrow. Moreover, should some jurisdictions experience exceptionally high 2. Marketable permits also can be used to reduce stress on an overly exploited renewable resource. In New Zealand, for example, a particular fish species was being depleted. To reduce the amount of fish being taken, regulators imposed catch quotas on which fishermen had to pay an annual fee. The revenues from this fee were used to buy out fishermen who were willing to forgo future fishing for the endangered species. Each fisherman stated the lowest price that he or she would accept for leaving the industry; the regulators selected those who could be induced to leave at the lowest price, paid the stipulated amount from the tax revenues, and retired the licenses that had enabled the fishermen to fish for the endangered species. In a relatively short time, a sufficient number of licenses had been retired and the fish species was protected (Tietenberg 1990). - 15 - damages from pollution originating elsewhere, they could compensate sources in the offending region for cutting back more than the minimum prescribed amount. To achieve these benefits, however, cooperation is essential (Repetto 1990). 1.45 The most important advantages of marketable discharge permit programs are that they tend to be cost-effective and that they generate revenues. Marketable permit systems also have an advantage over pollution charge systems in that they ensure a given level of envíronmental quality. The potential savings under marketable discharge permit programs generally depend on the cost structure of the particular management program. Cost savings tend to be greater where there are several types of discharges, where there are opportunities to exploit economies of scale, and where standards are not so stringent as to require nearly all dischargers to remove 100 percent of their wastes. The system also affords great flexibility in terms of time; polluters would have increased incentives to invest in emission-reducing technologies during periods of regional growth (Hamrin 1990). 1.46 According to numerous reports, emissions trading can achieve substantial cost savings. In the United States, for example, emissions trading activities have resulted in aggregate cost savings in the billions of dollars (Hahn 1989). There is more evidence of cost savings associated with marketable permits than with charges. With respect to developing countries, where initial envirorunental quality standards often are fairly modest, there may be opportunities for substantial cost savings through trades. Another important advantage of this system is that it facilitates continuous economic growth in polluted areas without further increases in pollution levels. Nonetheless, the effect of marketable permit systems on environmental quality has not been impressive; the direct effect of these instruments has been reported to be neutral or slightly positive. 1.47 In planning marketable discharge permit systems, several potential implementation problems should be considered. First, the issue of defining exactly what "emission ríght" is being traded, and making adjustments in the value of the right depending upon where and when it is used, is one of the more complicated problems. For the program to work efficiently, the regulatory agency must be able to define these rights quickly, be able to compute any changes in the value of the rights easily, and have an efficient system for keeping track of who owns what rights. For example, the discharge of a thousand kilograms of a pollutant will have a different impact on ambient air quality depending on where it is discharged and the conditions of díscharge (such as stack height, flow rate, temperature). Thus, trades that involve significant changes in the location of the discharge may require the establíshment of a location-based `exchange rate." Successful implementation also requires the development of a robust market for permits. Without such a market, one firm may hoard permits and thus delay attainment of environmental standards and development of new pollution control technology. Another potential difficulty lies in determining a basis for the initial allocation of the permits. Where there is no existing regulatory framework, the initial distribution without charge may be problematic. Ensuring compliance may also be more complicated than with some forms of technology-based standards. For decision makers in developing countries that have limited technical resources, all of these potential difficulties may take on greater significance. Even in the world's most technologically advanced - 16 - countries, the movement to introduce systems of permits that are fully transferable has been slow (Lyon 1989). 1.48 Liability Insurance. Liabilíty insurance is another market creation mechanism in which risks for damage penalties are transferred from indívidual companies or public agencies to insurance companies. Insurance premiums reflect the probable magnitude of the damage and the likelihood it will occur. An incentive is created by the possibility of lower premiums when industrial processes are more secure or, in the case of accidents, result in less damage (OECD 1989). Subsidies 1.49 Subsidies include grants, low interest loans, and tax incentives that act as incentives to polluters to change their behavior or reduce the costs of pollution abatement to be borne by polluters, both private and public. For example, central governments provide grants to índustry primarily to help finance pollution abatement equipment purchases or to subsídize personnel training. In some countries, they make available grants to state and local governments for technological research and development programs or for assisting in the adoption of new techniques required by legislation or regulations. They apply to pollution control, recycling, and resource recovery. 1.50 Tax incentives involve tax credits or accelerated depreciation for industrial investments in equipment to abate or control pollution. This incentive also may take the form of special tax reliefs for firms that adopt management practices and production technologies that minimize the release of environmental pollutants. In the United States, for example, a tax rule enacted in December 1990 in Louisiana links the amount of business property taxes a company pays to its environmental record (Schneider 1991). In some cases, governments offer tax incentives to industries to site their facilities away from urban concentrations. The extent to which tax incentives can be used for environmental purposes depends on the particular taxation system and politícal structure of the country. In general, however, tax incentives should be used only where it can be clearly demonstrated that the costs of pollution abatement investments or relocating impose severe financial burdens on firms. In the case of relocation, which involves considerably higher transaction costs and freeing up of land for more productive uses, tax incentives appear to be more justifiable (Kosmo 1989). 1.51 Subsidies can provide a genuine incentive to industry to reduce its discharges. Nonetheless, they do not discourage the continuation of highly polluting industries, nor do they encourage alterations in polluting production processes or inputs of raw materials. Moreover, the taxpayer, rather than industry, bears the costs of these pollution control subsidies. Deposit-Refund Systems 1.52 Under this approach, consumers must pay a surcharge when purchasing potentially polluting products. When the consumers or users of the product return it to an approved center for recycling or proper disposal, their deposit will be refunded. This instrument is applied to products that are either durable - 17 - and reusable or are not consumed or dissipated during consumption such as beverage containers, automobile batteries, and pesticide containers (see Chapter II). They also can be applied to substances that have significant potential for damaging the environment (for example, CFCs). 1.53 To establish most deposit-refund systems, new organizational arrangements would be needed for handling the collection and recyclíng of products and substances as well as for managíng the financial arrangements. National or state statutory authority also would be required for establishing the system. The advantages of deposit-refund systems are that most of the management remains with the private sector and incentives are built in for third parties to establish return services when users do not participate. One disadvantage of these systems, however, is that the costs of managing deposit- refund programs--which involve administration, collection facilities, recycling, and disposal expenditures--fall to the private sector; the only compensation is raising prices. Another weakness is that a refund for the return of polluting substances has the potential to create an incentive for counterfeiting (Moore et al. 1989). Enforcement Incentives 1.54 Enforcement incentives are economic instruments tied to direct regulation. They are designed to encourage dischargers to comply with environmental standards and regulations. As described below, enforcement incentives include noncompliance fees or fines, performance bonds, and liability assignment. They also include denial of public subsidies and financing and partial or total suspension of plant operations. 1.55 Noncompliance Fees. Noncompliance fees are charged to polluters when they emit or discharge pollution that exceeds levels imposed by regulations. When regulatory rather than economic instruments are the prime method of pollution prevention, enforcement generally is weak in that fines for violations are so low that it pays polluters substantially to break the law. To avoid time- consuming litigation, it is better to use noncompliance fees rather than criminal prosecution, provided that these fees are set so that firms have a strong incentive to abide by the regulations. Noncompliance penalties should be related to the extent and duration of the violation and exceed the source's estimated costs of compliance (Repetto 1990). 1.56 Performance Bonds. Performance bonds are payments to regulatory authorities before a potentially polluting activity is undertaken. The payments are returned when the environmental performance of the activity is acceptable. Like deposit-refund systems, performance bonds are charges for potential pollution; they are refunded when adequate measures are taken to prevent pollution. For example, restoration of production sites after shut-down may be required to avoid accident risks or environmental damage. The producer would be required to pay a deposit, determined by a court estimate of the likely maximum restoration costs or the maximum damages, to be refunded once certain conditions are met. In this way, society is protected against incomplete restoration due to intentional or unintentional bankruptcies. In the case of potential risks of innovation, performance bonds allow the introduction of new products or processes without having to await the results of government administered or supervised tests. If the government does not trust a firm to - 18 - meet its obligations without a financial commitment, the firm may convince a bank or insurance company that its product is safe. If convinced, the bank or insurance company may assume the fínancial liability at a price (Bohm and Russell 1985). 1.57 Liability Assignrnent. Assignment of liability provides incentives to actual or potential polluters to protect the environment by making them liable for the damage they cause. This ensures that victíms of envíronmental damage are compensated and serves as a preventive measure. If the polluter knew with certainty that he would be required to pay the cost of the damage, he would be encouraged to take action that would mínimize risks. In contrast to pollution standards or charges, liability rules are administered by the courts after a problem has occurred and payment goes to the victims (Moore et al. 1989). 1.58 In common-law countríes, polluters have been responsible for their damages before as well as after the enactment of pollution control legislation. This liability is based on the common law of private and public nuisance and is enforceable through the courts, by damaged parties and by the government. Its apparent independence of government regulatory activity has made it attractive to those who favor minimal government ínterference with the functioning of the market system (Bohm and Russell 1985). Nonetheless, making polluters clearly liable for any damages they cause, with the burden of proof on the polluter to establish harmlessness unless the emissíon level falls within established safety standards, has proven effective in obtaining industry's cooperation in standard setting. When the burden of proof is on the victim to establish that emissions aboye a standard have caused harm, industries have frequently resisted standard setting (Repetto 1990). 1.59 A liabílity system can be an effectíve way to deal wíth environmental problems when information is scarce and expensive. In the case where the potential damages of a proposed action (for example, construction and operation of a hazardous waste dump site) cannot be estimated, the designation of strict liability can be desirable. The liability payment might be guaranteed by a performance bond. It can provide incentives for the project proponent to gather information and take preventive actions, particularly those where the costs are small and the information or prevention effects are likely to be substantial (Bohm and Russell 1985). Where environmental injury is long-term in its effects, however, litigation and liabiíity assignment may be prohibitively expensive and thus impractical (Moore et al. 1989). Mixed Systems 1.60 In practice, economic instruments are rarely used alone to achieve environmental protection objectives. Generally, they supplement direct environmental regulations to raise revenues for financing pollution control activities or other environmental measures, provide incentives to better implement regulations, and stimulate technical innovation. Figure 1 illustrates the various locations for imposing regulatory and economic instruments within the life cycle of pollutants. As indicated, they are applíed at the point of input to production through final discharge into the ambient environment. Table 1 presents an overview of the regulatory and economic instruments indicating the environmental application and the main advantages and disadvantages of each instrument. FIGURE 1: ALTERNATIVE LOCATIONS FOR REGULATORY AND ECONOMIC INSTRUNENTS PROJTSTANARDS PROOUCT CNARGES MEFFUENTIESSION ST ) ADrMIMISTRA11VE CHARGES EFFLUENT/EMSSION CMARCEs TAX DIFFERENTIATION MARKETALE PERMTS DEPOSIT-REFUND SYSTEMS § PRODtJCT | WASTES GENERATED OUTPUT B w N SR AIR V ~~~~~~WATER PRODUCTION WATES ON-SITE OR WA8TES LAND INPUT ASSEMBLY ~~~~~~~COLLECTIVE