Framing Environmental Policy Instrument Choice

Abstract:     
This paper helps clarify the relation among the many policy instruments that the government uses when transaction costs limit the applicability of the Coase Theorem. This is accomplished by synthesizing results from the environmental economics, new institutional economics, and public economics literatures into a new conceptual framework and taxonomy of environmental policy instruments. Three primary conclusions emerge. First, the taxonomy of policy instruments frequently described in the environmental economics literature needs to be expanded to recognize that the government can operate in either a coersive (regulatory and taxing) mode or an enterprise mode (subsidies, contracts and government production). Second, the typical characterization of coersive policy instruments as command and control versus taxes/marketable allowances is a false dichotomy. Third, choosing the most cost-effective instruments requires expanding the analysis beyond the typical focus on production costs to include implementation costs and public finance costs. This is accomplished by recasting the evaluation criteria that are typically used in comparative analysis of policy instruments as a constrained cost minimization problem. The paper concludes with a set of heuristic principles indicating which factors raise the relative attrativeness of the various instruments. The result demonstrates that in environmental policy instrument choice, one size does not fit all.

JEL Classification: Q28, Q48, K32, H41

working papers series