Market-Based Instruments of Environmental Policy in Practice: The European Emissions Trading Scheme - Essay Example

? Market-Based Instruments of Environmental Policy in Practice: The European Emissions Trading Scheme Contents Contents 2 Introduction: Market based instruments for environmental policy 3 European Emissions Trading Scheme 4 Application of economic theories and concepts for explaining European Emissions Trading 5 Economic analysis: Market Based Instruments in European Emissions Trading Scheme 7 9 10 Incorporation of aviations industry in the European Emissions Trading Scheme 12 Conclusion 12 References 14 Bibliography 16 Introduction: Market based instruments for environmental policy The environmental pollution and gradual depletion of the natural resources in the global economy could be attributed to one of the major factors, namely inappropriate pricing of goods and services. The hidden costs due to the damages incurred by environmental pollution, loss of soil and species, climate change, heat waves, storms and floods are borne by the people who have not even enjoyed the benefits of the products and services offered in the markets. The utilization of market-based instruments such as taxes, subsidies, charges, permits, helps in the realization of the social, environmental and economic objective of the nations and continents like Europe. The market based instruments influences the cost of production and at the same time protects the health and environment of the consumers and the society respectively by effective management of the resources and the wastes cue to production and consumption. The various ways in which market based instruments prevents the sources of environmental pollution and health degradation includes the following. Due to the implementation of the market based instruments, the producers have shown more responsible behaviour towards switching over to the eco-friendly systems of production, efficient use of natural resources and reduction of wastes. The consumers have also received more transparency on the values of products and services consumed and this resulted in the reduction of excessive consumption with the sense of value for money. The market based instruments like tradable emission permits, fuel taxes have resulted in the reduction of emissions from the transports and aviation industry. The waste disposal taxes, incentives for recycling and taxes on packaging have resulted in changes of behaviour of the households and the business. The incentives for energy efficient heating systems and improved insulation have controlled the heat wave emissions in Europe. The taxes on the pesticides and the fertilizers have also been able to control the pollution due to agricultural activities. European Emissions Trading Scheme The European Emissions Trading Scheme is a policy measure adopted in Europe where the regulatory measure has been taken to fix the level of emission of parameters that emerge from the sources of environmental pollution and degradation of health issues in Europe. The upper limit of the emission level of harmful gases, disposal of wastes has been fixed as compared to certain benchmark or relative to a standard value of the parameter. The European Emissions Trading Scheme works in the following manner. In the initial stages, the emission allowances are first permitted to the sources of emission that causes environmental pollution, depletion of natural resources and other health problems. After initial allocation of the resources, the sources of emission are required to bring down the emission level to the prescribed standard as per the prescribed standard with the help of allowances or permits granted to them within the designated time period of one year (Ellerman, Buchner and Barbara, 2007, p.72). After the designated period of one year, a market for the European Emissions trading would come into action where the sources covered under the scheme would be able to sell or buy the allowances available with them through the process of exchange. The cost or purchase or sell of the allowances for controlling the emissions would be determined by the cost of control of emissions of the seller and the market prices of the allowances. This trading emissions scheme provides flexibility to the emitters in finding ways to reduce the level of pollution from their own operations. Through the emissions trading scheme, the emitters would be able to buy allowances necessary for controlling the pollution level from the other sources who do not consider the ways of controlling emissions to be very expensive (Coase, 1960, p.41). The emitters who buy those allowances would able to reduce the cost of compliance to the standard level of emission which otherwise would be very high for them under the traditional regulatory methods of individual emission control and monitoring. Application of economic theories and concepts for explaining European Emissions Trading The European Emissions Trading Scheme includes the market where the sources of environment pollution and the health problems in Europe participate to buy and sell allowances for controlling the emissions that exceed beyond the prescribed standard level of emission. The fluctuation of the prices in which the allowances are sold and bought by the sources could be explained by the economic theories and concepts. In order to explain the role played by the market based instruments for controlling the emission levels, cost of emission control and the purchase and sell of allowances in the emissions trading scheme in Europe at market based prices, the economic theories of price elasticity of demand, marginal rate of substitution and the indifference curve concepts could be applied in this field (Mankiw, 2011, p.62). In case of the European Emissions Trading Scheme, the emission limits prescribed by the regulatory agencies and the allowances allocated to the suppliers are the quantity instruments. These quantity instruments are referred by the emitters in order to meet the prescribed norms of emission. The prices of these quantities or the allowances provided to the emitters vary in the European Emissions Trading Scheme based on the supply and demand of the allowances after the designated period of operation of the emitters in the industry. The volatility of the prices of the allowances which is borne by the industry and not by the regulators could be explained by the economic theory of price elasticity of demand (Marshall, 2006, p.58). The economic theory of price elasticity of demand explains the response of the demand of the quantity due to change in unit price of the quantity. This could be explained by the following curve as shown below. A rise in the level of demand for the quantity or the emissions would lead to the change in the price level of the quantity which in this case is the allowance sold in the European Emission Trade Scheme. The emitters who have higher demand for the allowances would be able to obtain it at a relatively lower price from the emitters who are not so much in need of those allowances as a result of meeting with the prescribed norms of the regulatory agencies. This is resembled by the price demand curve as given below (Stonier, 1984, p.25). Figure 1: Price versus Demand Curve In the transfer of the allowances at a price in the European Emissions Trading Scheme, the exchange of allowance for controlling the emissions at a comparatively lower cost, the economic theory of marginal rate of substitution could be applied. The theory of marginal rate of substitution explains that the emitters would be ready to sell the allowances to other players while maintaining the same level of utility or the emission control level. The neo-classical theory of economics support the fact that the consumption of the good and services which are the allowances in this case is continuously divisible and the marginal rate of substitution of the allowances would continue till the point of indifference in the utility of the allowances are restored in the market (Schotter, 2008, p.57). The market based instruments enforced by the regulatory agencies are the taxes, charges, permits which are price based instruments. These price instruments have led to the variation of the emission control by emitters due to which the cost of control of the emission has varied which in turn has decided the prices of the allowance sold in the emission trading scheme (Hepburn, 2006, p.239). Economic analysis: Market Based Instruments in European Emissions Trading Scheme The signing of the Kyoto Protocol was the platform where the proposal of the Emission Trading Scheme in the market was first mentioned as a market based instrument which could be use the policy makers in order to control the level of environmental pollution and health problems by controlling the production and consumption of goods which gives rise to the emission of harmful gases, disposal of wastes and causes depletion of the natural resources. The European Emission Trading Scheme highlights the use of market based instruments like allowances, permits, etc. that have played a significant role in controlling the level of emission and the related pollution of the environment and health problems. There are several evidences that support the implementation of market based instruments as a part of the European Emissions Trading Scheme (Ellerman and Buchner, 2008, p.276). The tradable renewable energy certificates have been implemented by the European countries like UK, Italy, Netherlands and Sweden. The tradable renewable energy certificate is a market based instrument that poses obligation on the emitter to produce renewable energy as a certain percentage of the total energy production (Lu, Zhu and Cui, 2012, p.262). The tradable energy certificates have not only allowed the European countries to develop renewable energy reserves but also provide the way of producing the renewable energy in the cheapest method (Caney and Hepburn, 2011, p.225). Thus, it could be observed that the cost of compliance to control of environmental pollution is reduced by the role of market based instrument (Stavins, 1995, p.144). In order to control the damages to the environment by complying with the prescribed limits of emission, the allocation of allowances to various countries of Europe is given below in Table 1. The allowances have been expressed in terms of million tons of carbon-di-oxide per year (European Environment Agency, 2005, p.32). Table 1: Allocation of allowances to European nations in June, 2005 The prices of the allowance sold and purchased by the emitters in the European Emissions Trading Scheme are determined by the supply and demand for the allowances and the market prices of those allowances. The fluctuation of the price of these allowances is borne by the industry and not by the regulators. The fluctuation of price of the allowances from 2003 to 2005 has been shown below in Figure 2 (European Environment Agency, 2005, p.33). Figure 2: Price of allowance (July, 2003 to Sep, 2005) The contributions of the European Emission Trading Scheme have helped to address the problems of acid rain precursor in Slovakia and Netherlands. The international obligations have been imposed on Slovakia in the emission of sulphur -dioxide into the atmosphere while the Netherlands faces obligation of reducing the emissions of nitrogen oxides in the environment that causes acid rain precursors in the environment (Stavins, 1998, p.75). The allocations provided to Slovakia and the Netherlands for controlling the environmental pollution have been given above in Table 1. The packaging recovery notes issues in UK is another example of market based instrument that is used in the European Emission Trading Scheme. The packaging recovery notes are issued to the companies which in turn put an obligation on the businesses of the amount of amount of amount of package recycling to be done in order to prevent the disposal of the wastes. The packaging recovery notes are traded in the emissions trading scheme as an evidence of meeting the packaging and recycling obligations (Montgomery, 1972, p.417). The allowances under the European Emissions Trading Scheme also stated that under article 5 of the landfill directives, any member country that is conducting the activities of land-filling more than 75% of the biodegradable wastes or municipal wastes as compared to the 1995 levels are able to take up derogation for a period of four years. UK which has been land-filling its bio-degradable wastes at the rates of 80% as compared to the levels of 1995 are likely to take up the derogation provided in the allowance of the European Emission scheme (Burton and Sanjour, 1970, p.148). The exchange of the allowances between the members in the European Emissions Trading Scheme is largely possible due to the features of the European Emission Trading Scheme that have been analyzed and explained as follows. The members of the European Emission Trading Scheme maintain a computerized registry with a dedicated website where the allowances allocated to the members are maintained. The trading and exchange of allowances between the members occurs through the computerized mode which could be explained by the economic theories of price elasticity of demand, marginal rate of substitution. The price of the allowances fluctuates in response to the level of supply and demand of the allowance, the cost of controlling the emissions (Hepburn, 2006, p.235). The change of unit price of the allowances determine the level of the demand or in other words the market forces adjusts the price level on the basis of demand of the members who could reduce their cost of compliance by the process of transfer from another member for whom the cost of compliance is less. The seller justifies the sale of the allowances through the economic theory of marginal rate of substitution which allows the seller to sell the allowances by maintaining the same level of control over the environmental pollution and hazards created due to economic activities, wastes disposals and others. Incorporation of aviations industry in the European Emissions Trading Scheme Looking at the increasing level of emission from the aviation sector, the European Commission has decided to include the activities and the potential damages of the aviation industry under the purview of the European Emissions Trading Scheme. The incorporation of the aviation industry under the European Emission Trading Scheme is a complicated task as the emissions of the aviation industry not only includes the emission of carbon-dioxide but also includes a comprehensive emission of several radiations from the aircrafts. Looking at the growing priority over controlling the environmental impacts due to aviation, several changes on the use of market based instruments have been considered. The taxation on kerosene as a fuel for aviation is reconsidered as the previous taxation on aviation fuels rarely taxed kerosene as an aviation fuel (Ekins and Barker, 2001, p.338). Thus the lost opportunities for controlling the damages to the environment have been recovered by the incorporation of aviation industry under the purview of the European Emissions Trading Scheme. Conclusion The market based instruments play a significant role in controlling the damages to the environment as it controls the behaviour of producers in the process of production and the volume of consumption by the consumers. The European Emission Trading Scheme was implemented due to the proposals that emerged in the conference of Kyoto Protocol on climate changes and environmental protection. The European Emission Trading Scheme aims to put the burden of environmental protection on the market based factors and releases the pressure from the regulatory changes. The market based instruments are the allowances, permits, incentives and the taxes that are allocated to the member countries for control of the emission within the period of one year. 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