The Making of a Conventional Wisdom

Despite the potential cost-effectiveness of market-based policy instruments, such as pollution taxes and tradable permits, conventional approaches –  including design and uniform performance standards – have been the mainstay of U.S. environmental policy since before the first Earth Day in 1970.  Gradually, however, the political process has become more receptive to innovative, market-based strategies.  In the 1980s, tradable-permit systems were used to accomplish the phasedown of lead in gasoline ­(at a savings of about $250 million per year), and to facilitate the phaseout of ozone-depleting chloroflourocarbons (CFCs); and in the 1990’s, tradable permits were used to implement stricter air pollution controls in the Los Angeles metropolitan region, and –  most important of all – a cap-and-trade system was adopted to reduce sulfur dioxide (SO2) emissions and consequent acid rain by 50 percent under the Clean Air Act amendments of 1990 (saving about $1 billion per year in abatement costs).  Most recently, cap-and-trade systems have emerged as the preferred national and regional policy instrument to address carbon dioxide (CO2) emissions linked with global climate change (see my previous posts of February 6th on an “Opportunity for a Defining Moment” and March 7th on “Green Jobs”).

Why has there been a relatively recent rise in the use of market-based approaches?  For academics like me, it would be gratifying to believe that increased understanding of market-based instruments had played a large part in fostering their increased political acceptance, but how important has this really been?  In 1981, my Harvard colleague, political scientist Steven Kelman surveyed Congressional staff members, and found that support and opposition to market-based environmental policy instruments was based largely on ideological grounds: Republicans, who supported the concept of economic-incentive approaches, offered as a reason the assertion that “the free market works,” or “less government intervention” is desirable, without any real awareness or understanding of the economic arguments for market-based programs.  Likewise, Democratic opposition was based largely upon ideological factors, with little or no apparent understanding of the real advantages or disadvantages of the various instruments.  What would happen if we were to replicate Kelman’s survey today?  My refutable hypothesis is that we would find increased support from Republicans, greatly increased support from Democrats, but insufficient improvements in understanding to explain these changes.  So what else has mattered?

First, one factor has surely been increased pollution control costs, which have led to greater demand for cost-effective instruments.  By the late 1980’s, even political liberals and environmentalists were beginning to question whether conventional regulations could produce further gains in environmental quality.  During the previous twenty years, pollution abatement costs had continually increased, as stricter standards moved the private sector up the marginal abatement-cost curve.  By 1990, U.S. pollution control costs had reached $125 billion annually, nearly a 300% increase in real terms from 1972 levels.

Second, a factor that became important in the late 1980’s was strong and vocal support from some segments of the environmental community.  By supporting tradable permits for acid rain control, the Environmental Defense Fund seized a market niche in the environmental movement, and successfully distinguished itself from other groups.  Related to this, a third factor was that the SO2 allowance trading program, the leaded gasoline phasedown, and the CFC phaseout were all designed to reduce emissions, not simply to reallocate them cost-effectively among sources. Market-based instruments are most likely to be politically acceptable when proposed to achieve environmental improvements that would not otherwise be achieved.

Fourth, deliberations regarding the SO2 allowance system, the lead system, and CFC trading differed from previous attempts by economists to influence environmental policy in an important way:  the separation of ends from means, that is, the separation of consideration of goals and targets from the policy instruments used to achieve those targets.  By accepting – implicitly or otherwise – the politically identified (and potentially inefficient) goal, the ten-million ton reduction of SO2 emissions, for example, economists were able to focus successfully on the importance of adopting a cost-effective means of achieving that goal.

Fifth, acid rain was an unregulated problem until the SO2 allowance trading program of 1990; and the same can be said for leaded gasoline and CFC’s.  Hence, there were no existing constituencies – in the private sector, the environmental advocacy community, or government – for the status quo approach, because there was no status quo approach.  We should be more optimistic about introducing market-based instruments for “new” problems, such as global climate change, than for existing, highly regulated problems, such as abandoned hazardous waste sites.

Sixth, by the late 1980’s, there had already been a perceptible shift of the political center toward a more favorable view of using markets to solve social problems.  The George H. W. Bush Administration, which proposed the SO2 allowance trading program and then championed it through an initially resistant Democratic Congress, was (at least in its first two years) “moderate Republican;” and phrases such as “fiscally responsible environmental protection” and “harnessing market forces to protect the environment” do have the sound of quintessential moderate Republican issues.  But, beyond this, support for market-oriented solutions to various social problems had been increasing across the political spectrum for the previous fifteen years, as was evidenced by deliberations on deregulation of the airline, telecommunications, trucking, railroad, and banking industries. Indeed, by the mid-1990s, the concept (or at least the phrase), “market-based environmental policy,” had evolved from being politically problematic to politically attractive.

Seventh and finally, the adoption of the SO2 allowance trading program for acid rain control – like any major innovation in public policy – can partly be attributed to a healthy dose of chance that placed specific persons in key positions, in this case at the White House, EPA, the Congress, and environmental organizations.  The result was what remains the golden era in the United States for market-based environmental strategies.


If you would like to read more about the factors that have brought about the changes that have occurred in the political reception given to market-based environmental policy instruments over the past two decades, here are some references:

Stavins, Robert N.  “What Can We Learn from the Grand Policy Experiment? Positive and Normative Lessons from SO2 Allowance Trading.” Journal of Economic Perspectives, Volume 12, Number 3, pages 69-88, Summer 1998.

Keohane, Nathaniel O., Richard L. Revesz, and Robert N. Stavins.  “The Choice of Regulatory Instruments in Environmental Policy.” Harvard Environmental Law Review, volume 22, number 2, pp. 313-367, 1998.

Hahn, Robert W.  “The Impact of Economics on Environmental Policy.” Journal of Environmental Economics and Management 39(2000):375-399.

Hahn, Robert W., Sheila M. Olmstead, and Robert N. Stavins.  “Environmental Regulation During the 1990s: A Retrospective Analysis.” Harvard Environmental Law Review, volume 27, number 2, 2003, pp. 377-415.

One thought on “The Making of a Conventional Wisdom”

  1. The article above implies that cap and trade of CO2 will somehow solve the problem of climate change and make the use of fossil fuels sustainable in parallel fashion to the examples of lead, CFC and SO2 pollution. This premise is patently false.

    The recent Copenhagen climate conference, ahead of the formation of a Copenhagen Protocol later this year to replace the Kyoto Protocol, gives us a clear indication that climate scientists are converging upon a consensus that the only sustainable level of CO2 emissions is zero. Indeed, if we are to take Nasa’s Jim Hansen seriously, even zero emissions going forward would not be enough to stop the climate change we have already set in motion.

    But it doesn’t take a NASA climate scientist to understand that just because you smear a problem out diffusely doesn’t mean it makes the problem go away. Children in gradeschool can see through these shenanigans: if you told a class of third graders that each student was only permitted to get into one fight per week, and that they could trade these ‘permits’ amongst themselves, would the students think this would solve the problem of fighting? Of course not. Because the amount of fighting that is acceptable is … zero.

    CO2 is fundamentally, ecologically, biophysically different from other forms of pollution. It is profoundly naive to assume otherwise, as so many economists seem to do. There are clear and readily available substitutes for the industrial and technological processes that cause lead, CFC and SO2 pollution. The same is not at all true for CO2. There is no technology available that can, over any reasonable timeframe, substitute for fossil fuels while maintaining our current level of economic activity – indeed, nothing that comes even close. Moreover, at least 25% of CO2 emissions come not from burning fossil fuels but from changes in land use such as deforestation.

    Cap and trade may improve the efficiency with which economic activity emits CO2 into the atmosphere on the basis of $ of GDP per kg of CO2, but this is incidental to the underlying problem of CO2 emissions, which will continue unabated.

    It would be more honest for Stavins and other to cite past examples of efficiency gains which cap and trade of CO2 is likely to follow, such as improvements in automobile miles-per-gallon, rather than cherry picking cap and trade ‘success stories’. In the case of automobiles, gains in miles-per-gallon efficiency have been eclipses by absolute increases in miles driven, yielding an increase in gallons burned. The same pattern is almost certain to hold for CO2: an increase in the _rate_ ($GDP/kgCO2) will be eclipsed by GDP growth and an absolute _increase_ in CO2 emissions.

    The environment – the atmosphere and oceans – care not a whit about how efficient we are. They care only whether or not we are putting out any CO2 at all. Anything else is merely fiddling on the deck of the Titanic.

    It would also be more honest to omit CFCs from the list of cap and trade success stories, since ‘success’ in that case only came _after_ an outright ban on production and use of CFCs in OECD countries.

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