JURIST Guest Columnist Hua Wang, Northwestern University School of Law Class of 2012, writes on the need for policies that combine market incentives with outright prohibitions to achieve enforcement and compliance with international environmental regimes…

A regulatory framework allows countries to solve environmental problems that inherently are similar and conducive to centralized decision-making and coercion. Transboundary environmental issues, such as global warming and acid rain, have no readily calculated market value and mandates are often need to change a state’s behavior.

Engaging states and relevant actors from the beginning and keeping them engaged strengthens national compliance with international environmental regimes. Effective implementation will occur if countries or industries see compliance as serving their interests. Germany, for instance, supported the Convention on Long-range Transboundary Air Pollution [PDF] when its Black Forest was threatened with acid rain. Russia and Norway complied with the Convention on the Law of the Sea to ease political tension in the Barents Sea. Various nations were motivated to become signatories of the Fur Seal Treaty [PDF] upon realizing that the industry would not survive without international protection. As nations become parties to treaties, they take important steps to implement and comply with them. Affected actors participating in the decision making process increase the efficiency and equity of the solution and ensure the responsiveness of negotiations to all relevant parties.

Coercive measures, including sanctions, penalties and withdrawal of privileges under the convention, are sometimes effective in eliciting compliance. The World Heritage Convention downgrades sites that are not conserved and the Montreal Protocol [PDF] removes fund eligibility for countries that do not provide baseline data. Coercive measures create a latent threat against noncompliance and counteract the significant rewards of free riding. Transparency and punishment alter actor incentives by making it costly to defect and advantageous to cooperate and receive political credit for environmental responsibility.

In some cases, environmental regulations can have negative effects on environmental quality. Incentives often exist to circumvent agreements by making performance look attractive. The former Soviet Union, for example, systematically exceeded international quotas and deliberately misreported kills to the International Whaling Commission. Although it is often collectively desirable to reduce environmental degradation, the temptation to free ride leads states to define their interests unilaterally and avoid international cooperation.

Countries that have long land borders have great difficulty controlling smuggling and black markets. The large number of actors and coastal zones in the marine pollution regime and the large number of potential violators of the Convention on International Trade in Endangered Species of Flora and Fauna (CITES) make it difficult to enforce the treaties. The incentive to engage in black markets, coupled with enforcement difficulties, greatly reduces the effectiveness of a trade ban.

While CITES has decreased poaching in areas where law enforcement was heavily augmented by external funds, these funds are drying up and black markets are flourishing. The economic rewards of hunting endangered elephants for their ivory have skyrocketed. Ivory has gone from $200 to $2,000 a kilogram. Without sufficient funds and control mechanisms, CITES can better curb international trade in endangered species through a combination of punishment and incentives. The trade ban creates an undesirable situation where species hover at the brink of extinction and people are forced to absorb the large costs of policing an ineffective ban.

Flexible market schemes provide incentives for real progress in minimizing environmental degradation. Cost advantages arise when those who can achieve reductions in pollution most cheaply make the greatest adjustments. Pollution taxes and user fees discourage environmental degradation by strengthening incentives for waste and pollution reductions and generating revenue for public environmental protection. In climate change, the complexity of multiple pollutants and millions of emitters involved in controlling CO2 substances illustrate a need for market incentives. To finance the costs of sustainable forest management, taxes can be charged on logging and the revenue uses to fund reforestation. Certification and environmental labeling increase the demand for sustainable goods and allow consumers to encourage responsible fisheries management.

Economic instruments provide the means for internalization of environmental degradation and resource depletion costs in a flexible and efficient way. Market incentives can result in sharply reduced compliance costs and ensure that all parties to a convention have both a strong intention and a strong capacity to comply. In cases where a country may intend to comply but place a low value on environmental priorities, market incentives can build capacity and positively change the country’s views on compliance. Incentive-based systems are often more effective in securing compliance from developing countries that lack the financial resources and the institutional capacity needed to undertake the improvement of far-reaching environmental problems. Without the political and economic infrastructure needed to enforce regulations or check the accuracy of required documents, less wealthy countries need to more fully develop property rights in order to create incentives for sustainable management.

By providing incentives for early action, wealthy countries can achieve targets with minimal economic costs. Market-based mechanisms often smooth the transition to national targets and enhance a wealthy nation’s capacity to meet the target during the compliance period. The market mechanisms in climate change provide the needed flexibility for developed countries to comply with treaty commitments, and to facilitate interaction between the public and private sectors. The relatively low-cost reductions of private investments to developing countries are a feasible substitute for the more expensive domestic reductions in industrialized countries.

Many developing countries lack the infrastructure needed to achieve local environmental objectives, and to contribute to the resolution of global environmental concerns. By making available technical assistance and capacity-building programs at the local and national levels, less wealthy countries could more readily comply with their obligations and contribute to the perceived equity of the treaties. Furthermore, countries with insufficient expertise and capital would have the support needed for domestic efforts to reduce environmentally damaging behavior.

Advanced technologies from multinational companies allow developing nations to become regional market leaders in sustainable energy methods, and to achieve development goals in a less environmentally-damaging fashion. In climate change, because private investments in poor countries are cheaper than domestic reductions in rich countries, the cost-effectiveness of environmental aid and the ability of industrialized countries to finance the effort further enhance the probability that the transfers will live up to expectations. Transboundary pollution requires an effective regulatory system that combines restrictive rules and penalties with positive incentives. The combination of market-based instruments with administrative regulations creates flexibility in pollution control investments and is often more successful than outright prohibitions alone. Tradable permits are ideal for transboundary pollution problems with many small polluters and only a few large lawbreakers. Pollution trading and individual transferable quotas achieve conservation at a cheaper cost than absolute mandates and promote efficient use of the scarce resource.

Total allowable catches in international fisheries presented too many loopholes, such as misreporting, and the practice is largely discredited by the fishing industry. The lack of individual ownership created cost externalities and individual incentives to take more fish than is collectively rational. The conventional regulatory approaches, including limited seasons and net size, cause fishermen to put out more boats or buy more costly equipment, but do not ease the pressure on fish stocks. Tradable fishing rights, on the other hand, create a mutually beneficial quota exchange by cushioning the transition to the new international fishing regime, restoring stocks to sustainable levels and increasing fishermen’s profits. The cap-and-trade approach to over-fishing creates sustainable harvests by distributing individual fishing permits on the basis of historical participation in the fishery, and allowing individuals to buy or sell shares. This mechanism works because fishermen are able to reduce fishing costs and minimize ecological damages caused by too many boats chasing too few fish.

Enticing economic incentives provide many communities with a stake in local conservation. Clear and enforceable property rights prevent environmental degradation by providing strong incentives for preservation. In CITES, many members are shifting away from trade prohibitions to create positive incentives for environmental protection. Zimbabwe’s Community Areas Management Programme for Indigenous Resources has achieved double the reduction in elephant poaching necessary for sustainable management. It generates revenues from legal elephant hunts and returns some of the money to villages and individual households as incentives for sustainable management. Recognizing the value of their wildlife, local villagers have established anti-poaching squads to protect elephants for the future. The assignment of property rights to local communities can provide resource-owners with an incentive to protect endangered species and reduce enforcement costs.

Opponents of market incentives oppose the idea of creating “rights” to pollute and to allowing rich countries to buy their way out of domestic reductions. Some developing countries distrust market principles because of their negative implications for national sovereignty. They fear that investors’ economic motivations conflict with social and environmental development. In trying to maximize profits, developed countries might dictate the direction of projects, overlook the benefits of existing technology in developing nations and focus on large-scale, centralized projects that do not serve the rural poor. The gap between the seller’s goal of monetary gain and the beneficiary’s goal of development create conflicting objectives and tension.

Improperly constructed and executed mechanisms may be ineffective and will underachieve either through outright internal collapse or the inability to approach the cost savings that such mechanisms promise. Because developing countries vary in their industries, ownership and culture, the design and enforceability of economic instruments must incorporate local conditions and not borrow standards from other countries that have more capacity or capital at their disposal. The likelihood of agreement between the global North and South depends on improving commercial incentives for private investors that bear all the costs and commercial risks of technology transfers.

Market-based mechanisms present large uncertainties in the potential costs and approaches to achieving reductions, while transboundary environmental problems pose special challenges to the internalization of externalities. The Clean Development Mechanism, defined in the Kyoto Protocol, has run into problems in measuring emissions, establishing baselines for taxes and building agreement about allocation of taxes. In the ozone regime, emission permits did not work efficiently when the cost of finding buyers and sellers was high, or when a market leader used its market power to engage in monopolistic behavior.

Although it is very difficult to improve the design of market mechanisms, there are several conditions that contribute to its success. Equity must be incorporated into the design of any market system, if the system is to meet its promise of delivering a successful, market-based strategy for meeting environmental obligations. Instead of a one-time “parachute drop” of new equipment, industrial countries need to provide the necessary infrastructure for the long-term success of development projects. Multinational companies must assess local socioeconomic conditions to determine whether there is sufficient market demand and local support for successful adoption.

To achieve environmental aims, there needs to be clear and verifiable guidelines on reporting and accountability mechanisms for international taxes and emissions trading. Without these protocols, market schemes will suffer from a lack of confidence in its fairness and accuracy. A legal framework and executive body of North and South representatives must be established to monitor the effectiveness of new investment, quantify progress and assign liability for failed projects.

Traditional regulations allow relatively little flexibility in the means of achieving environmental goals and rely too heavily on monitoring, enforcement and a complex administrative system. While this has protected the environment, it has resulted in a policy framework that is rigid and costly and its effectiveness in further improving the environment may be diminishing. International environmental problems that involve a huge number of small and diverse sources of pollution do not easily lend themselves to command-and-control regulation. In these cases, a combination of markets and mandates are needed to create sustained efforts at environmental protection.

A proven pathway to environmental protection lies through ensuring that environmental policies are compatible with economic incentives. The performance of market-based instruments for environmental protection provides evidence that these approaches can achieve major cost savings while accomplishing their environmental objectives. Both regulators and the regulated community must move beyond simple pollution control to focus on preventing pollution at its source.

Although the threat of punishment forces many countries to comply with strict regulations, the integration of regulatory control and market-based mechanisms often create more efficient and cost-effective results. Long-term environmental progress requires a flexible, results-oriented approach that gives people the ability to act as private stewards of the environment. A hybrid system of flexible economic instruments and command-and-control regulations can correct market imperfections and avoid rigid and bureaucratic rules.

Hua Wang completed her undergraduate studies at Duke University. Upon graduating, Wang worked as an investment banking analyst at Lehman Brothers. She later joined Accenture, and focused on health care consulting and business development for outsourcing. Hua has worked on global projects and helped guide large companies and organizations through difficult market corrections while advising them on growth strategies and acquisitions. She will be joining Proskauer in the fall.

Suggested citation: Hua Wang, Markets and Mandates in International Environmental Regimes, JURIST – Dateline, Nov. 12, 2011, http://jurist.org/dateline/2011/11/hua-wang-environment-regulation.php.