Department of Agricultural and Resource Economics

University of California at Berkeley

David Zilberman and Jennifer Alix
PRINCIPLES OF ENVIRONMENTAL POLICYMAKING
Table of Contents
Introduction

Identifying the problem

Global versus Local
Causes
Externalities
Tragedy of the Commons
Public Goods
Myopic Behavior
Failures of Governance

2
4
5

Towards Policy Interventions

Policy Objectives
Efficiency
Cost Effectiveness
Distributional Objectives
Variability Reduction
Environmental and Health Quality Parameters
Policy Outcomes
Behavior Modification
Resource Reallocation
Resource and Capital Augmentation
Policy Tools
Incentives
Direct Control
Establishment of Property Rights and Trading
Education, Information and Communication
Improvements in Governance
A few words on Public Goods

9
9

Constraints on Policymaking and Implementation

Budget
Knowledge
Ability to Enforce and Monitor
Dynamic Considerations
Heterogeneity
Political Economy

23

References

29

14

16

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Introduction
From aqueducts to water treatment plants, wind-blown pollen to gene splicing, carriages
to electric cars, there seems to be no end to mans ingenuity in designing technologies and
improving processes to minimize the time spent on satisfying basic needs. Nevertheless, even the
most industrialized of countries have yet to invent food that doesnt require earth, ozoneabsorbing air, or self-cleaning water. All around the globe, we cannot escape the ties that bind
our existence to that of the environment where we live and the natural resources we consume.
Environmental problems present a particular challenge to policymakers, as their causes
and manifestations occur on local, regional and global levels. In addition, the nature of
environmental policymaking requires close coordination between social and natural scientists.
This paper develops a way to categorize some of these problems and think about their causes.
This will be the basis for developing policy responses to them.

Identifying the problem

One way of beginning to classify environmental problems is to divide them into three
groups:
1) Pollution
2) Resource Depletion and Extinction
3) Resource Preservation and Restoration
The opposite side of these divisions is to view the environment as a provider of certain
services to society, including sustaining production of goods consumed by humans, being a
source of recreational activities, and providing aesthetic or religious value. For example, people
may benefit from the existence of a forest for multiple reasons: wood to build houses, increased
production of carbon, shelter the woods provide to animals consumed by a village, religious value
associated with burial places in the forest, and others. In this case, policy intervention is
warranted if one of these services is threatened.
The manifestations of these problems vary in scale and intensity both within and between
nations. In more industrialized countries, resource depletion has inspired the formation of
powerful environmental advocacy groups and extensive legislation protecting air and water
quality, as well as preserving resources for aesthetic and recreational value. In developing
countries, on the other hand, some of the most severe health problems result from environmental
mismanagement. Malaria and dengue are in large part pest problems, while typhoid, diarrhea and
other water-borne diseases can been viewed as a pollution issue (associated with poverty and lack

of access to basic health care). In 1992, the Financial Times reported that 80% of all diseases and
33% of all deaths in developing countries result from sorely inadequate access to clean drinking
water and hygiene.
Within regions of a country, the variation in environmental problems can be extreme. In
rural areas of developing countries, the interface between man and nature is even more immediate
- survival for subsistence farm families often depends on favorable rains, the flow of a stream and
fertile soil on a small parcel of land. According to the World Bank (2001), 70% of the worlds
extremely poor live in rural areas. In general, this implies that their subsistence depends directly
upon agricultural and pastoral activities. Declining soil fertility, depleted aquifers and worsening
water quality have no easy solution, especially in areas where input-enhancing technologies are
non-existent or too expensive. Currently, according to the FAO, 70% of the earths land surface
is degraded or subject to heavy degradation. While only 10% of the worlds population lives in
sensitive mountain areas, approximately 40% live in the watersheds they service (IFAD, 2002).
In urban areas of developing countries, among the upper classes, we see concerns similar
to those of the more industrialized world in many places, environmental groups have formed to
advocate for the preservation of rainforests and other sensitive ecosystems. Indeed, much of their
concern focuses on environmental quality issues having to do with pollution from vehicles or
industrial runoff, issues similar to those addressed by many policies in Europe and the United
States. The urban poor, like the rural poor, often suffer most from urban environmental
problems, since it is more likely that polluting firms will locate in poor rather than rich
neighborhoods. In addition, population density and crowding, both of which result in more
intense pollution problems, are likely to be worse in less affluent urban areas. This phenomenon
has led to a growing interest in understanding and demanding environmental justice.
Many of the examples above are of point source pollution, that is, pollution whose source
can be readily identified; it may be a smokestack or a sewer pipe. Point source pollution is
usually much easier to mitigate since the culprit is readily identifiable. Non-point source
pollution, like agricultural runoff or auto emissions, on the other hand, is much more expensive to
control, and the incentives to do so are often weak, given that its effects are often felt on a
regional or global level.
There is a vast literature detailing poverty-environment linkages, some of which are
referenced at the end of this reading. New research has moved away from the simplistic
conclusion that poverty causes environmental degradation towards recognition of the
heterogeneity of poverty and unique solutions found by rural and urban communities to adapt to

resource degradation. However, it remains true that the poor are often forced to overexploit
limited local resources in order to satisfy immediate household necessities.
While earlier studies concluded that economic growth would provide the means to solve
all environmental problems in developing countries, new policy thinking has moved towards
solutions that seek poverty alleviation jointly with environmental preservation. This philosophy
coincides with the vision of natural resources as providers of amenities or services which may or
may not have a market value. A useful extension includes the loss or lack of title to
environmental assets as an additional component of poverty, leading to the conclusion that
environmental conservation is actually a necessary fundamental to poverty alleviation. This
reversal of causality allows us to recognize that degradation of the resource base often leads
directly to increased poverty and hunger through the loss of agricultural production. The overall
conclusion is that the poor are both victims and agents of environmental destruction, and that
policies addressing either issue must consciously consider both.

Global vs. Local

Scope and location are key considerations in the design of any policy. While pesticide
contamination, industrial pollution, or soil erosion might be dealt with on a local or regional level,
issues like the preservation of biodiversity or management of fish stocks require cooperation
among many countries. Environmental problems also move from local to regional to global when
the resources in question are either so large that everyone must share them like air,
transboundary rivers, and the ozone layer or so mobile that they cross national borders during
their normal lifecycle. Examples of these are migrating birds and straddling fish stocks.
At a global level, efforts have already been made to address increasing scarcity of
particular sets of natural resources. Indeed, more concerted attention has been given to
formulating policy guidelines at a global level than at a local one. Policy frameworks exist to
guide international decision making regarding the management of climate change (the Kyoto
Protocol), endangered species (the Convention on the International Trade of Endangered
Species), toxic chemicals (the Basel Convention on the Control of Transboundary Movement of
Hazardous Waste), desertification (United Nations Convention to Combat Desertification and
Drought), the ozone layer (Montreal Protocol), and persistent organic pollutants (POPs) among
others. These conventions are often non-binding in the sense that there are few incentives and
requirements to comply with them, however, they do present useful guidelines for policymaking
and global responsibility. Enormous efforts have been made to facilitate international
cooperation for the preservation of the environment, including the Rio Declaration (1992) and the

upcoming World Sustainable Development Summit in Johannesburg (2002). To date, these

conferences have resulted in more planning than implementation, and the next challenge is to
enforce national compliance plans drawn up in accordance with Agenda 21.

Causes
Environmental problems take on a vast array of forms, and will certainly increase in variety
as we continue to change the technologies and goods that we consume. Fortunately for
policymakers, we find that their root causes are often quite similar. The following is one possible
categorization of them:

1. Externalities in production process. In many cases, the nature of the technology and the
structure of governance institutions result in a situation where an activity might damage the
environment while not hurting the person who undertakes the activity. A manufacturing firm
whose production process creates toxins that then flow into a river is one example of this type
of market failure. In this case, the manufacturer is unhurt by his toxins, but the residents
downstream may become ill or die from them. If the manufacturers production process
affects air quality, then the problem immediately becomes one of a regional or global nature.
The source of the problem is the same, but the policy responses must be quite different.

We illustrate this problem on a graph that we will use repeatedly t o

help us understand failures and possible policy responses.
couch this discussion in the manufacturer
below, the cost to the manufacturer

example.

We will

In the figure

to produce the good in question is

represented by the curve MPC, for marginal private cost.

The

horizontal axis is the quantity produced and the vertical is m o n e t a r y

units. Each point on the MPC curve tells how m a ny monetary units a r e
required to produce Q numbers of the good. MEC is the m a r g i n a l
externality cost. In this case, it is the pollution cost to society f o r
producing a given amount of goods.
different burdens on society.

This cost could reflect m a n y

For example, it might be the cost o f

cleaning up the pollution plus the cost of medical treatment for t h o s e

who become sick from it. The sum of these two curves is the MSC, t h e

marginal social cost.

This represents the true cost to society o f

manufacturing a good whose process is destructive to the e n v i r o n m e n t .

In the absence of a policy intervention, the price charged for the g o o d
will be Pc, and the quantity purchased will be Qc. The best solution f o r
society is at point B, with price P* and quantity Q*. This p o i n t
represents the level of production where the cost of the pollution t o
society is taken into account (note that the optimal solution implies a
reduction in quantity and an increase in price, moving society t o w a r d
an environmental sustainable level of c o n s u m p t i o n ) .

Production Externalities and the Failure of Competitive Markets

The determination of the MEC curve requires a foundation in science; that is, it reflects a
defined relationship between the level of production and the level of pollution. The cost is
then determined by the relationship between the pollution output and the negative effects on
society (health, cleanup, ecosystem damage, etc.).

2. The tragedy of the commons. Popularized by Hardin (1974), the tragedy of the commons
results when groups of people are responsible for the management of a resource for which
none of them holds exclusive rights. The resource in question is one from which nobody is
excluded, but for which consumption by one participant reduces the stock available to all
other participants. Originally developed to describe the degradation of commonly held
pastures, examples of this sort abound: groundwater, pesticide resistance, communal forests
and fisheries are but four of them. The over-use of the resource in question might occur
because participants are unaware of the effect of their activity on the long-run quality of the
resource. It is more likely, however, that overexploitation occurs because users are in a race
to capture the benefits provided by the resource. For example, each fisherman recognizes
that if he doesnt remove as many fish as possible from the existing stock, someone else will.
A participant gains nothing from restricting his catch; in fact, he only loses profits (at least, in
the short-run).
Worldwide, statistics regarding fish stocks reflect this tension. According to the FAO, in
most regions of the world, at least 70% of the fish stocks are fished beyond their maximum
sustainable yield. The range for over-fishing ranges from 41% in the East Central Pacific to
100% in the Southwest Pacific and Western Indian Ocean.

Examples of common resources abound.

In Mexico, the majority o f

the forest left in the country is held in common by small villages

throughout the countryside.

In Africa, pastures are often managed at a

community rather than a household level. Regionally, shoreline fish

stocks constitute a common resource often exploited by several
different countries.

3. Public Goods. Public goods are similar to common property resources in the sense that they
are goods that are shared and consumed by many people. However, in this case consumption
of the good by one person does not limit or reduce its use by another. Biological diversity
presents a prime example of this sort of good. Even if some people pay for biodiversity,
other consumers are able to free ride on this purchase. Because everyone else thinks that
other people will pay for it, there is little incentive to contribute to its preservation.
Agricultural production and cattle-raising are the biggest causes of worldwide loss in
plant and animal biodiversity. The evidence shows that these resources are typically depleted
in order to produce subsistence crops or low-quality cattle. Some conservation-oriented

groups and individuals are willing to pay a high price for the preservation of tropical
rainforests and their biodiversity through land acquisitions and establishment of nature
reserves. The optimal solution might be for those with a concern for biodiversity to pay the
ranchers and farmers to be good stewards of the forest, that is, to compensate them for
providing highly desirable environmental services; however, these types of arrangements for
dealing with market failures are still uncommon.

4. Myopic Behavior. Short-sighted or myopic behavior can also result in the misuse of a
resource even if property rights are well-defined. It may occur because of a lack of
knowledge regarding the consequences of resource use. More often than not, however,
behavior labeled myopic is the result of an agent discounting the future at a high rate. This
may happen among the extremely poor, whose immediate needs force them to sacrifice
longer-term planning for present-day survival.
A higher discount rate can also result from high-risk activities. This does not necessarily
imply that the activity itself is risky (although farming is a good example of this). It could
also mean that owners of property are uncertain of the nature of their property rights. A
farmer who rents a property has the incentive to extract everything he can during the duration
of his rental contract. In some countries, property owners fearing expropriation will also tend
to exploit resources more quickly than would be socially desirable. The biggest source of
uncertainty in many countries, particularly in Africa, is civil unrest. War and political
instability play a major role in undermining property rights, discouraging investment in
sustainable resource management and encouraging rapid extraction of resources. The
environmental devastation wrought during times of war often takes much longer to recover
from than the destruction of infrastructure. Deforestation that occurred at a rapid rate during
the Salvadoran civil war remains one of the most pressing issues in the country, long after
roads have been rebuilt and services re-established.

5. Failures of governance. The above categories are very much rooted in a missing markets
approach to explaining environmental problems. However, it is often the case that poorly
planned or inappropriately applied government policies result in environmental disasters.
Interest groups often determine government decisions. For example, it is often the urban elite
whose agenda dominates government policy-making. For this reason, we often see protection
of polluting industries owned by influential families, and a preference towards investment in
urban infrastructure rather than rural development.

At the root of these characteristics is b a d governance.

Clearly, if

politicians do not adequately represent the populations interests,

institutions are riddled with corruption, and resources do not exist t o
consistently monitor and enforce regulations, policies cannot b e
effectively designed nor implemented.

A large part of a governments

responsibility is to clearly explain rules to a regulated population a n d

enforce them without preference to particular groups.

If the r e g u l a t e d

population does not understand the limitations placed on them by t h e

responsible institution, or if they do not believe that the policy will
actually be enforced, it is highly unlikely that new regulations o r
projects can be effectively put into action.
most advanced environmental

Mexico has some of t h e

legislation in the world; in spite of this,

their capital also has some of the most severe air pollution and t h e i r
deforestation rates rival those of Brazil.
In their analysis of over 150 countries, Kaufmann et al ( 1 9 9 9 ) ,
found good governance to be highly correlated with s u p e r i o r
development indicators, including literacy, economic growth, a n d
infant mortality.

Clearly, these characteristics are also fundamental f o r

local management of natural resources.

Good governance m e a n s

putting control and funding in a p p r o p r i a t e hands.

While s o m e

problems require national, centralized management, decisions

regarding resources such as water and pests need to be made at s t a t e
or local levels.

Mis-specification of the appropriate level o f

management can have disastrous results.

Towards policy interventions

The above examples illustrate the variety of forms that natural resource and
environmental issues can take - rural or urban, local, national or global. These categories are far
from mutually exclusive, but they give us a starting point for thinking about the instruments and
policies we might want to use to address them. In the following section, we first discuss the

larger objectives of policymaking, then move on to the range of outcomes sought by

policymakers, and finally, introduce the tools used to achieve these goals. The final sections offer
a discussion of the constraints under which policies must be designed and implemented.

Policy Objectives
Economists and decision scientists view policymaking as a way to solve the problem of
making a target population as well off as possible subject to the limitations imposed by the policy
environment. Generally, policymakers have several policy instruments at their disposal, and their
freedom to implement a particular policy strategy is restricted by budgetary informational and
institutional constraints. There is a large literature discussing policy objectives, and we present
the most common ones below:
1.

Efficiency
In his 1906 work the Manual of Political Economy, economist and engineer Vilfredo Pareto

first proposed the Pareto criterion. This criterion suggests that a project or policy should be
accepted if its implementation would make at least one member of society better off without
making others worse off. This idea is the basis of a concept of much importance in the literature
regarding human welfare- Pareto efficiency. Pareto efficiency defines situations where one
cannot improve the lot of one individual (by changing resource allocation) without hurting
someone else. To obtain Pareto efficient outcomes, policymakers seek to maximize the wellbeing of an individual or group in society without pushing the welfare of other members of
society below a certain level. This level represents the best that they can do given the available
resources. In theory this is nice, however, in practice it is quite difficult to achieve. For this
reason, most policy exercises use weaker efficiency criteria. Sometimes they aim to maximize
aggregate well-being of members of society (measured by monetary or utility units). Many
applied policy analysts aim to maximize the sum of economic surplus that accrue to various
groups in society, namely, producers and consumers in different markets.
Surplus is a concept that will allow us to evaluate the impacts of policy on different affected
groups. Surplus for consumers is defined as the difference between the price charged for a good
and how much a particular consumer is willing to pay. For producers, surplus is the difference
between the cost of production and the price received. For example, if a consumer is willing to
pay $10 for bread, but it only costs $5, then her surplus is $5. Similarly, if it only costs a baker
$2 to make the bread, then producer surplus is $3. Efficiency in this case is the maximization of
consumer plus producer surpluses, or $8. This sum of surpluses of all the involved parties is
referred to as social surplus. On an aggregate level, if we were to line up all the consumers
willingness to pay for particular quantities, we would end up with a demand curve. The

10

analogous relationship for a producer is the extra cost expended to produce each additional unit.
The following figure gives a visual interpretation of producer and consumer surplus.
Consumer and Producer Surplus

25

20

15

A
S
D

10

B
5

0
1

10

Quantity

11
of

12

13

14

15

16

17

18

19

20

21

Bread

The supply curve, S, shows the amount that producers are willing to put on the market at
a given price. The demand curve illustrates the amount that consumers are willing to buy at a
given price. Where these two lines intersect, we find that price that would be charged in a
competitive market, P = 10. The area between what buyers are willing to pay and the price they
actually pay is A. This is the surplus for all the consumers in the society. The area above the
supply curve and below the price, B, shows what sellers of the good are gaining above and
beyond their production costs. It follows that the sum of these two areas, A+B, is the social
surplus.
While consumer and producer are the most commonly discussed types of surplus, the
concept can be generalized. Surplus can be calculated for various sub-groups of society,
including workers, providers of environmental amenities, those who suffer from pollution, etc. In
the case of pollution, if we truly take into account the costs paid by those whose health or living
situation is affected, then that actual sum of all the surpluses is less than it would be if we were
just considering plain old producer and consumer benefits. Net surplus, therefore, must be
adjusted to account for government expenditures as well as cost of environmental damages. If we
consider the optimal subsidy aimed to reduce use of pesticides, for instance, the optimization

11

criterion is the sum of consumer welfare, producer welfare, and environmental quality minus
government expenditure.
When the decision problem relates to situations that entail long-term decisions, we must
include a time component into our measure of efficiency. In this case, benefits of different
periods are discounted to represent decision-makers or societies time preference. There is a
continuous debate about the appropriate discount rate to use for various projects. But in most
cases, there is an agreement that a dollar earned next year will be worth less than a dollar earned
at present (if everything else is the same). Given that policymakers almost always operate under
conditions of uncertainty, they must base decisions upon expected net benefits discounted to the
present period. This is the foundation of cost-benefit analysis.
2. Cost Effectiveness
Sometimes political or other pressures predetermine policy objectives, and in such situations
policymakers may aim to minimize the cost to attain certain policy targets. For example,
governments may decide to improve water quality to meet specified health standards, and the
challenge to policymakers is to design policy instruments that reach this goal at the lowest cost.
Because of difficulties in assessing the monetary value of environmental objectives, a reasonable
criterion for assessing the preferred policy would be the maximization of market surplus (the sum
of the well-being of consumers and producers minus government costs associated with meeting an
environmental objective). These policies can be interpreted as cost effective in the sense that they
minimize the social cost that is required to meet an environmental policy objective.
2. Distributional Objectives
Pareto-efficient outcomes are optimal given the initial distribution of resources. This implies
that equity is not considered in the efficiency concept. In other words, it is possible to have an
efficient resource allocation where 90 percent of societys resources are controlled by 5 percent of
its population. It is for this reason that equity is an important policy criterion in itself. One
extreme policy objective for the achievement of equity was advocated by the philosopher John
Rawls, author of A Theory of Justice, who said that the only fair policy criterion was to maximize
the well being of lowest-income groups. An alternative approach is to aim to achieve poverty
alleviation. In this case, the policy objective is not to maximize the welfare of the lowest-income
groups, but rather to help them achieve a given level of income or well-being.
There are various mechanisms to measure income distribution and equity, of which the Gini
coefficient is one example. The visual representation of the Gini coefficient is the Lorenz curve.

12

Lorenz curves consist of lining up each member of the population on the horizontal axis in order
of increasing wealth. On the vertical axis is the cumulative percentage of the total wealth of the
country possessed by each person. Perfect equality is represented by a straight line from the
lower left corner to the upper right. The more curved is the Lorenz curve, the greater the
inequality. The Gini coefficient can be calculated by dividing the area A by the area A+B in the
picture below. Therefore, higher Gini coefficients indicate greater inequality. Gini coefficients
are quite useful for doing policy impact analysis. In the graph below, the dotted line represents
perfect equality. The curve below it is the Lorenz curve.

Lorenz Curves

1
0.9

Cumulative Percentage of Wealth

0.8
0.7
0.6

0.5
0.4
0.3

0.2
0.1
0
0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

Cumulative Percentage of the Population

Another measure of inequality is variance in income. The choice of which measure to use
depends both on the type of policy being evaluated and the ease of calculation. Often, but not
always, there are tradeoffs to be made between efficiency and equity. For example, although
many Eastern European countries had low Gini coefficients in the late eighties, implying a
relatively equitable distribution of wealth, policies and projects were notoriously inefficient.
Bulgaria, whose economic growth was impressive during the 90s, saw its Gini coefficient rise
from .22 in 1989 to .34 in 1997. These statistics, of course, are to be taken only as loose
approximations of the real dynamics of society. Distribution of income, environmental benefits,
and economic efficiency, can vary greatly within a country, and although tools like variance,
Lorenz curves and Gini coefficients can be broken down regionally, they remain imperfect
measures.

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4. Variability reduction
Reduction of uncertainty and fluctuation is also a common policy objective. Weather
conditions, for example, may cause variation in yields that will affect prices. Inventory control
policies may then be introduced to smooth supply and stabilize prices. Similarly, variation in
weather may result in acute environmental conditions that endanger environmental amenities and
necessitate intervention. The policy objectives in these cases may be expressed in terms of
variance or fluctuation reduction or intervention in cases where key indicators are below
threshold levels based on a statistical distribution. For example, flood control projects are
designed to reduce damage in the case of ten years maximum rainfall, i.e., the maximum amount
of rain to fall in a 24 hour period within a ten year span.
Indeed, many examples of variance reducing policy interventions come from agricultural
and natural resource management. Marketing boards for non-perishable agricultural goods,
coffee, for example, have the stated objective of helping to reduce price uncertainty for farmers.
They often do this by setting guaranteed prices and then controlling the supply of the product
released into the market. In Uganda (and throughout much of Africa), marketing boards existed
for many years for all of the countrys main commodities: coffee, cacao, cotton, and major food
items like groundnuts, beans and maize.
5.

Environmental and health quality parameters

Policymakers may be guided by specific indicators on environmental and human health

conditions. In some cases, environmental indicators serve as an objective to be maximized

subject to a budget constraint. While in other cases a policymaker may take a cost-minimization
approach and design policies to achieve a target level of environmental or health conditions.
Costa Rica, for example, has recently implemented a policy of payment for environmental
amenities/services. The program targets small and medium farmers and its objective is to
maintain or restore forests on designated fragile lands. In order to do so, the government pays
farmers different rates for reforestation or soil maintenance. This policy achieves multiple
objectives by enhancing farmer incomes while protecting forest cover and biodiversity. Another
example is payment for immunization programs aimed to eliminate or minimize the incidence of
a particular disease.

Policy Outcomes
Once a problem has been identified, appropriate policy outcomes need to be specified in
the context of the policy objectives discussed above. Different policy tools can then be applied.

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The choice of tools depends not only on the nature of the problem, but also on the resources
available to the policymaker, both in terms of human and financial capital. The following
represents the range of outcomes that policymakers commonly seek to achieve. Often several of
these outcomes are needed to remedy the problems discussed in the first section.
1. Behavior Modification
Behavior modification, invasive as it sounds, is the goal behind a large number of
policies. Mandatory schooling, soil conservation programs and food subsidies all include
behavior-modifying elements. It is important to distinguish between short- and long-run behavior
modification. In the short run, behavior modification consists of changes in existing production
and consumption patterns, while longer-term change may involve adoption of new practices. In
the case of externalities, policies may aim to reduce pollution-generating activities or introduce
pollution-abatement activities that protect individuals from negative side effects. In some cases,
the intervention seeks to reduce the use of inputs, say, pesticides, that cause negative
environmental side effects. In other cases, they may induce individuals to change behaviors that
put them at risk, such as applying pesticides without protection, or even something as simple as
washing hands before eating. Another example might be an inefficient food preparation
technology that either causes pollution or depletion of resources (say, deforestation to use wood
for cooking). In this case, incentives, education, and access to alternatives may induce people to
adopt solar, gas heating or more efficient wood-burning stoves.
In the long run, behavior modification results in innovation and the introduction and
adoption of new technologies. This innovation may be both technological and institutional. For
example, stricter pesticide regulations may lead individuals to invest in alternative chemicals or
different approaches to pest control. Government policies restricting pollution may induce
concerned civil society groups to form organizations that manage and monitor pollutioncontrolling activities. These organizations may also lobby for penalties for polluters or trades in
pollution rights that aim to reduce total pollution.
2. Resource Reallocation
A major outcome of many policies is a change in income distribution. For example,
welfare policies result in a transfer of income to poor or disadvantaged groups. Policies may also
result in changes in land allocation and other resources. For example, a policy like Costa Ricas,
mentioned above, may lead to reduction in agricultural land and increase the land used for

15

environmental services. In other cases, a policy may divert water from low-value to high-value
crops, as has been the case in many water-scarce countries like Israel and Jordan. Three Gorges
dam in China is a striking example of reallocation. In an effort to control the Yangtze River,
whose dangerous floods kill hundreds of people every year, and with an eye on hydroelectric
power - a predicted supply of 1/9 of the countrys power - the Chinese government has
undertaken the construction of this multi-billion dollar water project. The trade-off, however is
the largest relocation project in history; nearly 2 million people will be resettled in different
villages while their land will become part of the dams basin. The other exchange to be made is
with the environment, the damage to which is hotly debated but essentially unknown.
It is important to distinguish between intended and unintended consequences of policies.
Bad policy designs may result in outcomes that are not foreseen or are contradictory to the initial
objectives of the policy design. For example, the Endangered Species Act of the United States
aims to save endangered species by restricting exploitation of land and water resources that
support endangered species. However, owners of these resources may destroy endangered
species to avoid the restriction before the authorities become aware of the situation. On a global
scale, the implementation of CITES resulted in extraordinarily high ivory prices that are difficult
for residents of poor countries to resist. Poaching of elephants in countries across Africa has
resulted in a policy conundrum that costs governments substantially in both domestic
expenditures to control it and international negotiations to soften the zero sale clause.
3. Resource and Capital Augmentation
Finally, government policies may result in expansion of economic activities. This occurs when
government spending or tax relief are used during periods of recession. Governments may also
subsidize certain economic activities such as cleanup of contaminated sites. These policies
typically result in the expansion of different types of capital: physical, human, social and natural
capital. Physical capital is essentially infrastructure. In the case of the environment, this might
include damns to modify water movement and use, or repairs of irrigation canals to reduce
seepage, or water body restoration projects Human capital expansion refers to the transfer of
knowledge and skills. Clearly, education, both formal and informal is fundamental to human
capital expansion. Public health workers may promote educational efforts to improve water use
efficiency quality, both of which increase human capital . Finally, environmental policies that
reduce pollution or protect biodiversity, for example, improve environmental quality and thus
enhance natural capital.

16

Policy Tools
1. Incentives
Incentives may include carrots such as subsidies and sticks such as taxes and penalties. The key
to the design of incentives is understanding the factors that affect decision-makers choices as
well as how these choices are aggregated and affected by market outcomes. Well-designed
policies are incentive-compatible in the sense that they provide individuals the incentives that
result in outcomes that are consistent with social objectives. To establish effective policies,
information about individual objectives, preferences, economic situations, and other variables that
affect behavior is essential. It is also important to be able to observe individual choices or
responses to assess performance of policies and effectiveness of incentives.
Under quite reasonable conditions, different incentives may result in the same desirable
outcomes, but may have different distributional effects. For example, a tax on pollution and a
subsidy to reduce pollution may result in the same final pollution level, but polluters will be
better off with the subsidy and may lose from the tax. Lets consider the following table
describing the benefits of using coal for energy production:
Lbs of Coal
1
2
6
10

Value of Energy
15
30
66
100

Damage from Pollution

10
20
30
50

The damage from pollution is measured in the same way as the value of energy, for example, in
dollars, and quantifies the impact on human and environmental health from using the
corresponding amount of coal for home heating. The policymaker wishes to maximize the
benefit per pound of coal consumption minus the pollution damage per unit of coal. This occurs
when 6 pounds of coal are consumed. In this case, the social surplus is 6, which is greater than
the surplus from consumption of any other amount of coal. Left to their own devices, consumers
will want 10 lbs. of coal, since that gives them the most benefit if they ignore the pollution
damage.
In order to encourage the consumption of 6 units of coal, the government can set a per
pound tax that equals the average damage from pollution. i.e., the tax would be 5 per pound for
10 pounds, 5 for 6 pounds, 10 for 2 pounds, and 10 for 1 pound. This forces consumers to pay for
the cost of the pollution that their consumption produces. The tax revenue for this case, where
consumers will choose to consume 6 units, is 30.

17

A subsidy can be used to achieve this same effect. In this case, the government could
subsidize producers to make it worth their while to provide 6, instead of 10 pounds of coal. In
this case, they have to pay the producers enough to make it worth their while to not provide 10
pounds of coal. We are assuming here that there are no costs to providing coal, so what the
producer receives is simply the value of the product. In this case, then, the government will have
to transfer 34 dollars (show calculation) to producers in order that they will provide 6 pounds of
coal. The distributional effects are obvious; in the producer subsidy, coal companies are happier.
The government loses revenue. In the tax case, the government gains revenue, though consumers
are hurt. The environmental damage is the same in either case, although one might imagine a
situation where tax revenues could be used to pay to eliminate or lesson the damages.
These concepts can also be illustrated on a graph. Here, the policymaker wishes to
achieve a pollution level associated with the production of an amount, Q* of output. Determining
the appropriate level of Q requires the participation of scientists, who must both establish the
relationship between the level of production and the level of pollution, in addition to deciding the
appropriate level of damage tolerated from the polluting compound. Once the target level of
output is decided upon, there are three strategies which can be used to achieve it: 1. A tax. 2. A
subsidy, and 3. Direct control. We will compare the outcomes of the first two here:
In the case of the tax, the government may charge producers a per unit tax which makes it
more expensive for them to produce their goods. They will decrease production and the
government will earn tax revenues. Equivalently, the tax could be levied on the consumption of
the polluting good in order to achieve the same outcome. This situation is depicted graphically as
follows: A tax on consumption raises the price paid by buyers of the good. If all things are held
equal, consumers will buy less. If the pre-tax demand for the good is illustrated by the curve
labeled D=MB. After the imposition of the tax, the demand perceived by the firm is reduced;
i.e., the curve representing the amount consumers purchase at each price (NMB) is shifted
downward in a parallel fashion by the amount of the tax.

18

As in the production tax case, output is reduced to the desired level, Q*.
consumers is Pc* and the amount received by producers is Ps*

The price paid by

= Pc* - t, where t represents the

cost of the externality to society.

Another possibility to achieve the same outcome Q is to pay producers a per unit price
NOT to produce a certain amount of output. This policy can be designed to produce the same
outcome as the tax, but the distribution of the benefits is different. In the case of the subsidy, the
producers experience a windfall.
In the case of either strategy, there may be unintended and undesirable outcomes. The
tax may generate revenues for which government officials may eventually compete in order to
redistribute them to interest groups. The subsidy may actually end up costing the government far
more that originally anticipated, since such a payment may attract more firms to the industry.
2. Direct Controls
Policymakers may order members of society to conduct certain activities. They may
establish target levels that have to be met and dictate how certain activities should be performed.
They may also establish, for example, threshold levels of allowed pollution and constrain firms to
abide by these upper levels. While these two policy levers can be designed to have the same
effect on pollution, their institutional requirements, efficiency and equity effects are entirely
different.
Returning to the example above, we can illustrate in the following graph that a direct control
can achieve the same outcome as either the tax or the subsidy. Government regulators will
simply tell the polluting manufacturer that they must produce Q* amount of output, which is the
level that scientists have determined is the socially optimal quantity. This approach is quite

19

common and in the case at hand is known as a production quota. In the coal production case
above, the government would give the producer a quota of 30 pollution units. The difference
between a standard and a tax are the distributional outcomes; in the case of a tax, the government
earns revenues, while in the case of a standard, the producer receives the same amount as extra
profit.
If pollution taxes are so efficient, why does most environmental legislation use direct
controls? The answer lies in the other two issues alluded to above - equity and institutional
strength. Our simple analysis showed that producers prefer direct controls because they make
more profit; essentially, they are given a market advantage by the government mandate to reduce
production and prices can increase. It has been suggested that laborers might also favor
standards/production quotas, since the rise in production costs caused by taxes may reduce
employment. In addition, there are several cases, namely when risk or uncertainty affects the
industry in question, when a mixture of taxes and controls may be preferable (a good review of
these concepts is given by Helfand, 1999). Finally, and most importantly for developing
countries, it is often easier to legislate and monitor a standard than to impose and collect a tax.
This is due both to lower resistance to the imposition of standards for the reasons just mentioned,
as well as to the fact that taxes are a strong government policy. They require considerably
more infrastructure both in terms of human capital and institutions. The monitoring aspects are
especially difficult.
3. Establishment of Property Rights and Trading
A major cause of many environmental and other misallocation problems is missing
markets. This lack of markets may be the result of poorly defined property rights that prevent
individuals from investing and trading. Therefore, policymakers may redress these failures by
establishing property rights legislation, enforcing these rights, and allowing trading, which may
result in improved resource use efficiency. (Trading can occur on a global, regional, or local
level, depending upon the scope of the problem. Water trading occurs in the state of California.
Globally, it has been proposed, though not yet implemented, that countries trade their allocations
of rights to carbon emissions. This would be of particular benefit to developing countries, who
have higher allocations than their actual production of emissions. Locally, policymakers may
establish overall policy targets for pollution and distribute firms pollution rights that are
proportional to their historical share in aggregate pollution. Then the firms could be allowed to
trade.

20

Trading in pollution rights may result in the same overall pollution level as a tax or
subsidy, but the distributional effect will be quite different. In particular, polluters will lose less
under transferable rights, but will not gain as much as with subsidies. On the other hand, a
tradable pollution right will not cost taxpayers, one reason why this solution may be politically
acceptable.
3. Education, Information, and Communication
Many behavior patterns result from lack of information. People who are aware of the
consequences of activities such as smoking or unprotected sex are likely to modify their behavior,
and education can serve to inform the agents of consequences of their activities. For example,
farmers may modify waste management practices if they discover that these practices may
contaminate a lake they use for recreational activities. They might change soil conservation or
pest management activities if extension programs promote more effective and inexpensive
alternatives.
Education, however, can also serve to modify preferences and, thus, leads to change in
behavior. The right educational program may induce people to appreciate the environment, value
the preservation of natural resources, and thus behave in a more environmentally friendly way.
Policymakers or environmental groups may provide information about activities of certain groups
in society to generate negative publicity that will lead to a change in behavior. Publishing a list
or establishing a website with the names of the firms that generate the most pollution may induce
some of these firms to change their practices because this information may reduce the demand for
their product. Indeed, this sort of behavior by advocates is an integral part of good governance,
which will be discussed below.
4. Improvements in governance
As discussed previously, weak governance is often at the root of environmental problems.
Breaking the hold of interest groups on the legislative process involves the participation of civil
society. Much of the most forward-looking laws implemented in Europe and the United States
began not within parliamentary walls but rather in outside non-governmental activists and
organizations. One of the elements most important to a governments efficiency is the ability to
develop mechanisms and institutions to address problems as they are discovered. Responsiveness
requires all the components of good governance: transparency, representativeness, and efficiency.
The role of civil society in encouraging responsiveness cannot be underestimated. Pesticide
policy did not exist in the United States until the publication of Rachel Carsons Silent Spring,

21

which detailed the dangers of chemical exposure. Organizations like the Nature Conservancy and
Rainforest Action Network are important players both in pressuring government and in providing
funding to finance the purchase of environmental services in many countries. To fulfill the
responsibilities associated with the latter role, they must be allowed to operate in cooperation, not
against, national governments. The repression or under-funding of many of these groups in
developing countries often removes this source of pressure. Support for such activities is
beneficial not only for the environment but also for government accountability in many sectors.
Increased involvement of communities, an integral component of good governance, is
particularly important for the poor, who often find no outlet for their voice in government affairs.
Indeed, UNDP documents on governance include components fundamental to good management
of natural resources: educating young people, indigenous peoples and their communities,
strengthening the role of non-governmental organizations, educating farmers and providing them
with incentives to conserve the environment, and regulating business and industry. In addition,
developing reasonable monitoring and enforcement schemes requires institutions that are trusted
by the population. If officials are suspected of corruption or payment schemes are unclear,
policies may have detrimental and unexpected consequences. The role of civil society returns
again in the context of forcing government accountability. There is often a great discrepancy
between laws passed in parliament and those actually enforced on the ground. Non-governmental
organizations often take on the responsibility of pointing out government corruption or
inconsistencies in the application of policies.
A fascinating case study of successful use of local communities and information
dissemination in controlling firm and government activities is Indonesias PROPER PAKASIH
public disclosure program. The system continuously monitors and makes public environmental
ratings of manufacturers, and by doing so educates both employees and neighbors of the firms
regarding pollution standards. The program has been quite successful in moving firms towards
compliance, with some even seeking to reach abatement goals lower than those legally mandated
(see Afsah, S., et al). Bangladesh also provides a useful example of community involvement in
pollution abatement. Although environmental regulations are non-existent or unenforced in
Bangladesh, community complaints to polluting companies resulted in impressively effective
clean-up efforts and monetary compensation for lost crops and other food sources (see Wheeler).
Taking account of the architecture of a government is also essential to designing effective
policies. Policymakers must work within existing structures, and often choices need to be made
regarding whether to create new institutions for policy implementation or make use of existing
ones. One of the best examples of this is water allocation. While some countries, such as India

22

take advantage of existing centralized systems, other allow for the development of regional water
management authorities. At a local level, institutions may be developed to manage village and
regional level problems. Water users associations, sewage districts, and community cooperation
for mosquito and pest management are examples of local solutions to environmental adversities.
National level umbrella organizations might be public health, environment, and the national park
service. These management systems require different tradeoffs between efficiency and equity,
and optimal arrangements will vary given the context of different countries.

5. A few words on public goods

As we established above, public goods have two defining properties:
nonrivalry, i.e., it can be utilized by many people simultaneously, a n d
nonexcludability, i.e., there are no barriers to utilizing these public goods.
Like many other goods, production of public goods may be costly.
Markets left on their own tend to underinvest in public goods b e c a u s e
each individual has a tendency to free ride, i.e., he expects others to p a y
for the public good so he can benefit from it for free.
At the national level, the national defense is used as an example of a public good. Within
a city, environmental quality (clean air) is a public good. However, even this simple example
illustrates the problematic features of this notion, since some neighborhoods have cleaner air than
others. In the case of the ozone layer, the holes seem to occur in isolated areas around the globe,
for example, over Maine in the United States and La Paz in Bolivia. Global climate, biodiversity
of resources, and human knowledge are all goods with public goods properties. All of mankind
benefits from the ozone layer and from moderate climate. However, some groups can benefit or
be harmed more than others; furthermore, the cost of providing this public good may vary across
groups. The debate on policies that deal with climate change, ozone depletion or biodiversity
addresses these issues. Some northern countries may benefit more from preservation of
biodiversity (e.g. pharmaceuticals, improved crop varieties, ecotourism) than southern countries
that may have to bear much of the cost to maintain global biodiversity while not gaining access to
all of its benefits. For this reason, establishment of compensation schemes (debt for forests, etc.)
is very important.
When there is differentiated access to a good that has nonrivalry of consumption, then
there are differences in private benefits, and people may pay for the access. When the access to a
good with nonrivalry of consumption is blocked, the private sector will have the incentive to
provide this access. In the case of biodiversity, this might take the form of a park where an entry

23

fee is charged to users who wish to enter. The fact that some people can be excluded makes this a
semi-public good. On a local level, when there is heterogeneity in benefits derived from goods
with nonrivalry of consumption, the resource owner who charges an entry fee may underprovide
the good, unless he charges a differentiated price that will reflect an individuals willingness to
pay for access to the good. Without the ability to charge differentiated prices, the owner may
build a smaller facility and charge a higher price to tap the richer members of the community. In
this case, there will be little access to the poor of goods with nonrivalry of consumption. In many
cases there are differentiated prices (e.g., between tourists and locals) to allow access to different
members of society as well as to increase the profit of the owner of the property.
When there is nonrivalry of consumption but ability to control access and heterogeneity
in benefits, private sector control of a good may be suboptimal. In many cases the government
either controls or interferes in management and provision of such goods. . Development of
environmental amenities in many cases follows a similar pattern. A developer obtains the right to
develop a property and part of it will be developed exclusively to capture benefits from rich
people who are able to pay. Another other part of the property may be provided cheaply for
members of the public. In this case, part of the area that is developed (be it parks, beaches, etc.)
may be allocated by queuing with a lower access fee.
In addition to such government subsidy schemes or payment for access strategies,
specialized organizations play an important role in the provision of public goods. One common
method is to provide storehouses for information which is of benefit to the public. This
approach is manifested in the construction of seed and gene banks, public libraries and other
storehouses of information.

CONSTRAINTS ON POLICY MAKING AND IMPLEMENTATION

Rarely are policymakers given free hand to pursue their objectives. One of the most
challenging elements of policymaking is to achieve one of several goals subject to a variety of
constraints. These constraints may include:
1. Budget and resource availability
The budget constraint includes not only an upper bound on spending but it also
limitations of personnel and equipment available for a task. For example untrained staff or a lack
of computers and other equipment may limit the capacity to implement a complex policy. The
current efforts to rebuild the Afghani government epitomize this constraint - new ministers have

24

complained of deficits of elements as simple as paper, pencils, and telephones. Staff limitations
as well as the limitations of the regulated population set a premium on simplicity of policies. It is
easier to implement a uniform taxation scheme or one dependent on clearly observable
parameters than a complex non-linear tax formula that requires difficult to undertake
measurements.
2. Knowledge
Policy design is as good as the information upon which it is based. Policymakers need
two types of information. First, scientific information on relationships between key physical
variables is essential. For example, pesticide control policy needs to be based on knowledge of
the relationship between exposure to toxic material and health situation. It also requires
understanding of the factors that determine the effectiveness of pesticides and their impact on
productivity. In the pollution example given above, the marginal externality cost must be
determined by a combination of scientific and economic information, as the relationship depends
both on the interaction between the production process and the level of pollution, as well as the
correlation between the level of pollution and difficult to quantify costs.
Another set of knowledge, understanding human behavior and responses to incentives,
may even be more important. In many cases, this is even more ambiguous than the knowledge
required to set policy targets. It requires understanding how people might compensate for
limitations in some area of their lives by changing other behaviors. As we mentioned before, the
Endangered Species Act in the United States, which requires the preservation of special habitats
for certain animals and plants, has caused many landowners to exterminate these species when
they discover them on their land in hopes of avoiding the stringent management practices
required by the Act. Mexico Citys No circula policy, which places restrictions on the days
during which cars with certain license plate numbers can be driven, is another example of
miscalculating behavioral responses. The implementation of the policy actually increased the
number of cars in the city, as people purchased second vehicles in order to be able to drive every
day of the week. This reaction clearly undercut the intention of the policy, which was to
ameliorate the severe air quality problems of the city.
3. Ability to enforce and monitor

25

Policy design must recognize to what extent policymakers are able to monitor performance and
enforce regulations. A recent study of East Asian countries, which have been quite fast in
adopting strict pollution standards, describes the following problem:
In several of the countries studied here,[Note 4] the monitoring problem is compounded by weak
enforcement. In short, when violators of standards are detected, if penalised at all they often face only weak
sanctions. (...) polluters are exempted from fines either on grounds of financial hardship or because the
violators wield undue political influence. Perhaps the most pervasive problem is that, even when fines are
levied, they are frequently so low in real terms that they have little if any deterrent value. (OConnor in
Afsah et al, 1997)

In many situations, we encounter asymmetric information, i.e., where the regulated

population has knowledge that is not available to policymakers. Policymakers therefore must
operate based on the information they have or may provide extra incentives that will induce
decision-makers to reveal some of their knowledge. For example, policymakers may not be able
to easily identify the poor populations that they wish to target. Therefore, programs targeting the
poor often include a work or waiting requirement unappealing to the untargeted population.
Control of runoff in storm situations may depend on preventive activities taken by producers, but
not all of this effort is observable. The amount of pollution may be affected both by farmer
efforts and technology. When effort is unobservable, policies may be dependent on choice of
technology.
One element of policy implementation is design of mechanisms to monitor that may
include both procedures and technologies. Monitoring by itself is not sufficient. It is crucial to be
able to enforce a policy and the ability of the regulator to punish determines policy choices. In
many cases, environmental agencies lack political will and power to enforce punishment and may
resort to subsidization and voluntary cooperation to achieve policy objectives.
To some extent, the ability to monitor and enforce depends on the agencys budget. In
some cases, agencies may use fines and penalties to finance their activities. This obviously
creates perverse incentives and penalties will be based both on severity of the offense as well as
ability to pay and resources needed by the agency. Frequently, part of monitoring effort should
be directed at the bureaucracy that enforces the policy. When policies are complex and
ambiguous there is room for error and misinterpretation that may breed corruption. The
advantage of simplicity and transparency is that they reduce opportunities to abuse the system.

Dynamic Considerations
Societies and economies are evolving systems and policy design must take dynamic
processes into account.
1. Adaptive Learning

26

Since some of the key relationships that determine response to policy are uncertain, policy
design should be flexible and contain mechanisms to collect information, learn and adjust. In
some situations in early stages of policy implementation, it may be worthwhile to experiment
with alternative mechanisms in order to increase the information availability to allow for future
adaptations. Policy design entails a trade-off between desire to change policy parameter as
information becomes available and the desire to maintain stable regulatory environment.
Most policy analysis is done prior to the implementation of the project (ex ante), but it is
also essential to analyze project impact ex post. To conduct this ex post analysis, one has to
develop data collection efforts that will record impacts on alternative groups. This analysis
should contrast ex ante conditions and predictions with the actual outcome to identify sources of
deviation from the desired outcome. This type of analysis is fundamental to the adaptive learning
process and therefore to the successful implementation of environmental policy. Policies often
have unexpected consequences that have to be recognized and understood in order to improve
decision-making in the future.
2. Irreversibility
Some projects such as dams and large infrastructure projects may modify the
environment in a way that is either irreversible or very costly to reverse. Design of these projects
requires extra care and learning especially when there is uncertainty regarding future scenarios.
For example, a water project may be less valuable if a new water conserving technology is
introduced. The decision to implement the project may be delayed until more information about
new technologies is available rather than implemented at the moment where the expected benefit
of the project is greater than the expected cost. When assessing projects, it is not sufficient to
determine whether the expected net benefits are positive, its also important to know whether the
timing is right.

Heterogeneity
Theoretical and conceptual analysis frequently simplifies systems by assuming that
agents are similar or homogeneous. Policymakers must make certain simplifications in order that
their strategies be implementable in a transparent and effective fashion, however, assuming that
all members of a regulated part of society or beneficiaries or an educational program are the same
can undermine their success. Homogeneity may lead to uniform treatment that may not take into
account variability in behavior and circumstances of different agents. Appropriate recognition of
sources of heterogeneity is essential for effective policy design and while simplicity in design is a
virtue, adjustment of policy parameters to account for differences in circumstances is also very
valuable.

When firms are heterogeneous and differ in their ability to abate, or cut back,

27

their pollution, it is necessary to determine both the efficient amount of total emissions and the
efficient mix of pollution among alternative sources. The efficient mix of pollution is simply the
combination of controls that generates the efficient amount of total pollution at the lowest cost.
This may require that all polluting firms in a given location cut back pollution to the same level,
or it could mean that only one of many firms should abate.
Heterogeneity can also be caused by differences in location. The potential damage of a
chemical companies located in an isolated rural area is much less than that of a company built
next to a densely populated urban area. A tragic example of this was the chemical company in
Bhopal, where faulty production practices allowed 40 tons of methyl isocynanate to be released
into the environment. Over 4,000 died as they slept. Had this company been farther away from
the city limits and had regulations been effectively enforced, this disaster could have been
averted. When resources for regulation are limited, they should be concentrated in areas where
the potential for damage is greater. In the Bhopal case, regulations should have been more
strictly enforced nearer to urban centers, or, alternatively, a minimum distance between such
plants and local population must be established and enforced.
The market approach, or transferable permit system, is another possible mechanism to
correct negative externalities that may also increase efficiency. It attempts to establish markets
for pollution. The approach utilizes economic incentives found in conventional markets to
allocate pollution abatement between firms in the most cost-effective manner. In this example,
we assume there are 2 polluters whose production affects the quality of an airshed or lake. For
simplicity, we assume that their pollution only hurts the airshed or lake and not any other local
resources.
In the figure below, the curve MSC is the marginal social cost of pollution, referring to
the amount of money the damage caused by the pollution costs society. The two curves labeled
MB1 and MB2 are the benefits that accrue to the two polluters for producing their waste. Polluter
1 benefits more than polluter 2 at a given level of production. This might be because person 1 is
producing a higher value product than person 2, or because person 2 has a more efficient
production process.
Heterogeneity: The Case of Two Polluters

28

The line ABC is the sum of the two marginal benefits curves, or the aggregate demand for
pollution by the polluters. The optimal levels of pollution, where the marginal social cost are
equal to the benefits to each polluter, are given by X1* , X *2 , X*. Because there is no charge for
pollution, the initial unregulated levels of pollution are simply X 02 , X10 ,X 0 .
Recall that to achieve X* using a pollution tax, we could set a per unit tax on pollution
equal to the MSC at X* = l. In this case, each individual producer will equate their MB to the
tax and will produce the socially optimal level of pollution
With tradable pollution permits, each polluter is assigned X*/2 pollution coupons. They
are traded at an equilibrium price of l. Polluter 1 buys X1* - X * /2 from polluter 2. These are
gains from trade. Using the concepts of surplus discussed previously, we can see that welfare is
smaller if each polluter is restricted to X*/2 pollution units and trade is disallowed.
Seller Gains from trade = revenue received - total benefits of lost pollution
where:
total benefits of lost pollution = area under MB curve for units traded
Buyer Gains from trade = total benefits of gained pollution - cost of pollution permits
KNT = gains from trade of polluter 1 = KTX1* X*/2 - NTX1* X*/2.
MNL = gains from trade of polluter 2 = NMX2* X*/2 - LMX2* X*/2.

29

Note that the larger the heterogeneity (the larger the difference between MB1 and MB2),
the more likely trade is to occur and the larger the volume of trade in pollution permits.

Political economy
As we have alluded to throughout this reading, policy-making is not conducted in a
vacuum. While analysts may give equal weight to different groups or may emphasize certain
groups like the poor, the political process often results in a different agenda. Policy analysis may
consist of understanding and quantifying the impact of this agenda over time in order to design a
policy that can be feasibly implemented. In other words, design of policy has to take into account
political reality; policymaking is a process of negotiation and interaction with interest groups.
Policy analysis shouldnt only look at total impact, but instead provide estimates of impacts of a
proposal on various groups. The concept of changes in surplus for effected groups can be very
useful in this regard. If this analysis is not undertaken, unforeseen opposition may dilute a
policys effects or prohibit it from being implemented at all.
This brief paper has touched on many facets of environmental policymaking and policymaking in
general. Its intention has not been to be an exhaustive guide to policy analysis, but rather an
introduction that attempts to put some order into the complicated process that is policymaking.
Many of the topics here are complex in their own right and merit more extensive consideration.
To this end, we have complied the following (by no means exhaustive) list of references that you
might find useful in expanding your understanding of the topics discussed here:

Rural Poverty & Poverty in General:

International Fund for Agricultural Development (IFAD) Rural Poverty Report 2000/2001
http://www.ifad.org/media/pack/rpr/overview.htm

Poverty-Environment Linkages:
Arnold, J.E.M. and Bird, P. Forests and the Poverty-Environment Nexus Prepared for the
UNDP/EC Expert Workshop on Poverty and the Environment, Brussels, Belgium, January 20-21
1999 http://www.undp.org/seed/pei/
Dasgupta, P., Folke, C. and Maler, K. (1994) The Environmental Resource Base and Human
Welfare in Population, Economic Development and the Environment eds. K. Lindahl-Kiessling
and Hans Landberg. Oxford University Press, Oxford.
IFAD (2002) Combating Environmental Degradation Conference on Hunger and Poverty.

http://www.ifad.org/events/past/hunger/envir.html

30

Reardon, T. and Vosti, S. (1997) Poverty-Environment Links in Rural Areas of Developing

Countries in Sustainability, Growth, and Poverty Alleviation: A Policy and Agroecological
Perspective eds. S. Vosti and T. Reardon. Johns Hopkins University Press, Baltimore.
Marcoux, Alain (1999) Poverty and Environmental Change: from linkages to policy issues
Sddimensions, Food and Agriculture Organization
http://www.fao.org/sd/WPdirect/WPre0089.htm
**Pillai, P. (2001) Poverty, Environment and Sustainable Development: A Thematic
Bibliography http://www.worldbank.org/wbi/wbien/nrrp/publications/bibliography.pdf
this is a remarkable bibliography.
Scherr, S. Poverty-Environment Interactions in Agriculture: Key Factors and Policy
Implications Paper prepared for the United Nations Development Programme (UNDP) and the
European Commission (EC) expert workshop on Poverty and the Environment, Brussels,
Belgium, January 20-21, 1999 http://www.undp.org/seed/pei/

Externalities:
Dasgupta, S. (1999) Opportunities for Improving Environmental Compliance in Mexico
World Bank Working Paper No. 2245
http://econ.worldbank.org/view.php?topic=11&type=5&id=979
Eskel, G. (2001) Externalities and Production Efficiency World Bank Working Paper No.
2319 http://econ.worldbank.org/view.php?topic=11&type=5&id=1074
Zilberman, D. (2001) Negative Externalities and Policy Notes for ARE 298/PP 290.
Department of Agricultural and Resource Economics, University of California at Berkeley.
http://are.berkeley.edu/~zilber/EEP101/revised2001/Chapter4.pdf

International Treaties:
An excellent source for finding summaries and texts of international treaties is the
Fletcher School Multilaterals project:
http://fletcher.tufts.edu/multilaterals.html
Fish:
FAO The State of the World Fisheries and Aquaculture 2000.
http://www.fao.org/docrep/003/x8002e/x8002e00.htm

Governance:
The World Bank has a useful web site on governance and anti-corruption:
http://www.worldbank.org/wbi/governance/

Kaufmann, D., Kraay, A. and Zoido-Lobaton, P. (1999) Governance Matters World

Bank Policy Research Paper 2196.
http://www.worldbank.org/wbi/governance/pdf/govmatrs.pdf

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UNDP (1997) Governance for Sustainable Human Development

http://magnet.undp.org/policy/default.htm

Good WHO document on environmental health in developing countries:

Bulletin of the World Health Organization, 2000. Special Theme: Environment and
Health: Roundtable. Environmental Health: For the Rich or for all?
http://ehs.sph.berkeley.edu/krsmith/Publications/round_env_health_rich.pdf
Standards vs. Taxes
Helfand, G. (1999) Standards vs Taxes in Pollution Control in Handbook of
Environmental and Resource Economics, ed. J. van den Bergh. Massachusetts: Edward
Elgar Publishing: 223-234.
Governance and Environmental Compliance:
Afsah, S, Laplante, Benoit, and Wheeler, D. (1997) Regulation in the Information Age:
Indonesian Public Information Program for Environmental Compliance World Bank
web Page: Incentives and Behavior. Multiple Actors, Multiple Incentives.
http://www.worldbank.org/nipr/newappr.htm
Wheeler, D. and Huq, M. (1993) Pollution reduction without Formal Regulation:
Evidence from Bangladesh same source as above.

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