l The Economics of Pollution Control at the Local and Global Levels
Jump to: [1. Environmental Economics and the Economics of Pollution Control] [2. Mechanisms to achieve pollution reduction] [3. Reducing Pollution at the Global level] [4. Definitions][Suggested Readings

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1.  Environmental Economics and the Economics of Pollution Control

Environmental economics views the real economy in which we all live and work as an open system. This means that in order to function, the economy must extract resources (raw material and fuel) from the environment, process these resources, and dispose of large amounts of dissipated and/or chemically transformed resources back into the environment. The process starts with the extraction of resources, which can be exhaustible (fixed in overall quantity) or renewable ( resource grows through time). The process ends with the disposal of transformed resources which could pollute the environment. Pollution is waste that has been disposed off in the air, in water or on land, and that reduces the value of those resources in alternative uses. Resource depletion and environmental pollution are key factors in determining the natural capital of a nation and achieving sustainable development. 

Resource depletion and pollution reduction can be viewed as an economic problem. Environmental economics uses cost-benefit thinking to deal with environmental problems and issues. Benefits and damage assessments are used to integrate the un-priced but valuable functions of natural environments into cost-benefit analysis of real world projects, and to illustrate the kinds of economic damage done to national economics by resource depletions and pollution. 

In an ideal world all wastes that cannot be recycled would be outlawed. The costs of a pollution free society would be very high. The other extreme is to live in a society where there is no pollution control. The real world is somewhere in between these two extremes, i.e., it is necessary to achieve a balance between the social costs and social benefits of reducing pollution. 

Empirical evidence indicates that after substantial amount of polluting emissions have been reduced, extra waste reduction is much more costly than previous reductions. There is a point beyond which the costs of further reducing pollution by far exceeds the increase in social benefits and what people are willing to pay. The benefits of pollution control are measured by the reduction in damages caused by pollution to human health, and to material, natural and agricultural resources.

2.  Mechanisms to achieve pollution reduction

Production or consumption of goods and services often results in costs or benefits to people other than the buyers and sellers. For example, if an industry disposes of wastes in a stream, it imposes costs to people who want to use the stream for other purposes, such as drinking water. People who live in that municipality will have to pay to clean up the water if they want to drink it. The cost of cleaning the stream is a hidden cost of the production of goods by the industry. This hidden cost, which will be assumed by taxpayers, is referred to in economic terms as a negative externality1

Free market transactions are usually unregulated in the sense that there is no mechanism for charging polluters a fee to correct for the damage done by their emissions. Once society has decided on an acceptable level of environmental quality, it is necessary to adopt measures that will change the behavior of producers and consumers. This could be achieved through government intervention, by setting command and control regulations and market-based incentives. 

For example, air pollution episodes in major cities across the United States, led to the United States government to the establishment of strong emission standards for industry and automobiles. The Clean Air Act of 1970, empowered the federal government to set emission standards that each state was required to enforce. The Clean Air Act was revised in 1977 and in 1990 to include incentives to encourage companies to lower emissions of chemicals responsible for the production of acid rain. The Act today identifies 189 pollutants for regulation. 

Similarly, by early 1970s water pollution had reached crisis proportions in the United States. Congress responded in 1972 by passing the Clean Water Act, whose main objective was "to restore and maintain the chemical, physical and biological integrity of the Nation’s waters." "In order to achieve this objective it is hereby declared that, consistent with the provisions of this Act —

(1) it is the national goal that the discharge of pollutants into the navigable waters be eliminated by 1985;

(2) it is the national goal that wherever attainable, an interim goal of water quality which provides for the protection and propagation of fish, shellfish, and wildlife, and provides for recreation in and on the water be achieved by July 1, 1983;

(3) it is the national policy that the discharge of toxic pollutants in toxic amounts be prohibited." 2

It should be noted that in the case of air and water pollution, the damage is done because they are open access resources, i.e., no-one owns them, and there is no individual incentive to restrict pollution. This is why the phenomenon of global climate change has come about, which has motivated governments to act.

Regulatory and Incentive-based Policies

The techniques used by regulatory agencies, such as the Environmental Protection Agency (EPA), to control pollution range from charges for the right to pollute to regulations that impose limits to the amount of a pollutant. Among these are the following:

Emission Charges

Emission Charges are prices established for the right to emit a unit of a pollutant.

Example: In the United Sates industrial polluters pay effluent fees for the right to dump waste in municipal water treatment plants.

Advantage: Directly internalizes a negative externality by pricing the use of the environment to dispose of waste.

Emission Standards

Limits established by government on the annual amounts and kinds of pollutants that can be emitted into the air or water by producers or users of certain products.


EPA places limits on the number of grams/mile of hydrocarbons, nitrogen dioxide and carbon monoxide emitted per automobile. The automobile industry satisfies these standards by equipping cars with catalytic converters. In turn, this device raises the cost of cars. 


- Allow emission of less than the standard free of charge;
- Firms are restricted in the method of compliance; 
- Does not take into account differences among firms;
- Does not take into account differences among regions.

Command and Control Regulation 

A system or rule that requires the use of specific pollution control devices on certain sources of pollution or applies strict emission standards to specific emitters.

Example: All newly produced automobiles are required to have catalytic converters to meet EPA emission standards. 


- All emitters are treated equal.
- Provides no incentive for emitters to seek less expensive ways of reducing emissions.
- Provides no incentive to reduce emissions more than the required amount.

Pollution Rights

A government-issued permit allowing a firm to emit a specified quantity of polluting waste.

Example: Michigan's Air Emissions Trading Program.


- Pollution permits are tradable at free market prices.
- Regulatory authorities can control the amount of pollution by limiting the number of certificates.
- Provides a choice: purchase permits and pollute or reduce pollution and save the cost of permits.
- Provides an incentive to reduce emissions in order to sell previously purchased pollution rights.


- A firm in a very polluted region is allowed to buy emission permits from a firm in a region where there is no pollution.

Emission Offsets

EPA policy which allows a new firm to be established in an area where additional polluting emissions resulting from the firm's operations normally would prevent the firm from being approved by EPA. Under this policy the new firm, before it is approved, most induce other firms in the area to reduce emissions usually through a cash payment. 

The Bubble

EPA policy which allows a firm to exceed the amount of emission of a pollutant, if it reduces another pollutant by more than the current standard. This policy has been named the bubble because it places a virtual enclosure over the firm to monitor various types of emissions. 

Banking of Emissions

A firm that emits less than the specified level of a pollutant is given a credit that allows them to emit more than the standard at some time in the future. The firm is also allowed to sell these credits for cash to other firms who want to exceed the standards. 

Failure of Government Intervention and alternatives

Although there are good reasons for government to intervene, they are often no better at managing natural resources than the free market. Some of the reasons for this are:

  1. They may favor the interests of some part of the community rather than the community as a whole. If government acts to please some particular pressure group, it may not act to protect the environment, especially if environmental protection would impose costs on members of a particularly powerful pressure group. 
  2. Governments are not very good at obtaining the right information about the full consequences of a particular action. This is mostly true because of the tendency of governments to compartmentalize issues.
  3. They may have problems translating good intentions into practice because of lack of competence among the government bureaucracy. 
An alternative to government intervention is proposed by Coase 3(1960), who argues in favor of market bargaining underpinned by appropriate property rights in order to achieve the social optimum of pollution. Given the existence of an appropriate property rights system (guaranteed ownership of resources via the force of law), Coase argued that polluter and those affected by pollution should be left to bargain in an unregulated situation. The Coase theorem states that regardless of who holds the property rights, there is an automatic tendency to approach the social optimum via bargaining. If this analysis is correct, then government regulation of externalities is redundant, the market will take care of itself, with bargaining representing an efficient process. Coase’s approach also has its disadvantages and limitations. In reality, a combination of a property right system, regulations and economic incentives may be the best approach to protect the environment. 

3.  Reducing Pollution at the Global level

We have addressed techniques to control environmental pollution at the national level. In some instances, however, pollution is the result of activities at the global level and nations may be required to implement international agreements that address current pollution practices. As environmental problems become global in scope, international cooperation is needed to solve them. International and regional organizations may play a key role in developing a consensus on what types of collective action should be pursued. Although the role of international organizations is extremely important, one should not forget that environmental problems require action at the national and local levels.

An example of a global environmental issue is the depletion of the stratospheric ozone layer, which will increase exposure to solar UV radiation, thereby increasing the incidence of cancer and cataracts. The Montreal Protocol [sedac.ciesin.org/entri] (The Protocol on Substances that Deplete the Ozone Layer), signed in 1987, established a timetable for diminishing CFC emissions and the use of bromine compounds, both of which destroy ozone. In November, 1992, representatives from half the nations of the world met in Copenhagen to revise the treaty. Provisions of the meeting called for a quicker phase-out of the previously targeted ozone-destroying chemicals. 

Although both stratospheric ozone depletion and global climate change have been induced by human actions, there are basic differences between these two problems, which have led to very different policy scenarios. The ozone issue was simpler and more immediate, its causes were understood, and its principal dangers could be foreseen with greater confidence. Most important, the ozone depletion could be stopped with relatively little impact on economies and lifestyles. All these factors made it feasible for governments to move into action. 

On the other hand, the circumstances around the global climate change issue have been different. The causes of global climate change are less well understood, and there are a lot of uncertainties and discrepancies about its principal dangers. Mitigation and adaptation responses imply far-reaching, costly and controversial changes in economic, technological and political behavior implying personal and national present-day sacrifices on behalf of an uncertain future. Another obstacle has been the inviolability of sovereignity that occurs in action plans adopted by the United Nations. Because of the magnitude and uncertainty of these issues, delaying and avoiding action has been an attractive option for many policy makers. The international response to the global climate change issue is still in progress. 

When the 20th United Nations Conference on the Environment and Development convened in Rio de Janeiro on June, 1992, Global Climate Change was the most important issue at hand. This conference, known as the Earth Summit, adopted the detailed Agenda 21, a plan of action to confront and overcome the economic and ecological problems of the late 20th century, and to guide the development of the Earth in a sustainable manner. Two other documents resulted from the Earth Summit in Rio: a convention on biodiversity and a convention on climate change. These agreements were signed by 154 countries. Here the latter of the two documents will be considered. 

The United Nations Framework Convention on Climate Change

The United Nations Framework Convention on Climate Change entered into force on 21st March 1994, after ratified by 50 states. The Convention's general objective is the "stabilization of greenhouse gas concentrations in the atmosphere at a level that would prevent dangerous anthropogenic interference with the climate system" (Article 3). To achieve this the Convention elaborates legally binding commitments in three categories: (1) those to be undertaken by all Parties; (2) those that apply to OECD countries, except Mexico, the EEC and eleven countries that are undergoing transition to a market economy; and (3) those to be undertaken by OECD countries except Mexico and the EEC. Commitments that apply to all Parties are:

- preparation and communication to the Conference of Parties of national inventories of greenhouse gas emissions caused by human activity using comparable methodologies;

- development and communication to the COP of programs to mitigate effects if greenhouse gases and measures of adaptation to climate change;

- cooperation on technology related to greenhouse gas emissions for all relevant sectors;

- sustainable management of greenhouse has sinks and reservoirs;

- cooperation in preparing for adaptation to the impacts of climate change;

- integration of climate change consideration with other policies;

- research to reduce uncertainties concerning scientific knowledge of climate change, the effects of phenomenon and the effectiveness of responses to it; and exchange of information, on matters such as technology and the economic consequences of actions covered by the Convention.

Through the negotiations leading to the adoption of the Convention, there was support among OECD Member countries to establish national emission targets. 

Institutions created under the Convention are the Conference of the Parties (COP) and two subsidiary bodies. One of the primary functions of the COP is periodic examination of the obligations of the Parties (commitments) and the institutional arrangements under the Convention. If the commitments established during the Convention are found to be inadequate, the COP could adopt amendments or one or more protocols to the Convention that would dictate additional commitments. The COP met in Kyoto in December 1997 with this goal. The Kyoto Protocol on Climate Change is the product of this conference.

The Kyoto Protocol on Climate Change and the CoP-4 

[ Key aspects of the Kyoto Protocol on Climate Change and the CoP-4 are presented by the U.S. State Department at: www.state.gov/www/global/global_issues/climate/index.html

A summary of the material at this site is presented here]

The Conference of the Parties (COP) of the United Nations Framework Convention on Climate Change held a conference in Kyoto, Japan on December 1-11, 1997 to agree on a plan to reduce greenhouse gas emissions. The agreed to plan makes use of global free market forces to protect the environment. The Kyoto Protocol will be open for signature in March 1998. To enter into force, it must be ratified by at least 55 countries, accounting for at least 55% of the total 1990 carbon dioxide emissions of developed countries. 

Key Aspects of the Kyoto Protocol :

- A set of binding emissions targets for developed nations. The specific limits vary from country to country. Examples of specific limits: 8% below 1990 emission levels for the European Union countries, 7% for the United States and 6% for Japan. 

- Emission targets are to be reached over a five-year budget period, the first budget period being 2008-2012.

- The emission targets include of major greenhouse gases: carbon dioxide, methane, nitrous oxide, and synthetic substitutes for ozone-depleting CFCs.

- Activities that absorb carbon (sinks), such as planting trees, will be offset against emissions targets.

- International emission trading will be allowed. Countries that have met their targets for emission reduction and have room to spare can sell emission permits to companies or countries. Emissions trading can provide a powerful economic incentive to cut emissions while also allowing important flexibility for taking cost-effective actions.

- Countries with emission targets may get credit towards their targets through project-based emission reductions in other such countries. The private sector may participate in these activities. 

- Through the Clean Development Mechanism (CDM) developed countries will be able to use certified emissions reductions from project activities in developing countries to contribute to their compliance with greenhouse gas reduction targets. Certified emissions reductions achieved starting in the year 2000 can count toward compliance with the first budget period. 

- The Protocol identifies various sectors (including transport, energy, agriculture, forestry and waste management) in which actions should be considered in developing countries to combat climate change and provides for more specific reporting on actions taken. 

- The protocol contains several provisions intended to promote compliance. 

At a conference held November 2-13, 1998, in Buenos Aires, Argentina, the Parties to the UN Framework Convention on Climate Change agreed to a two-year action plan for advancing the agenda outlined in the Kyoto Protocol. The Buenos Aires conference (known also as the "Fourth Session of the Conference of the Parties" or "CoP-4") saw a significant breakthrough on the issue of developing country participation in international efforts to address climate change. Argentina became the first developing country to announce its intention to take on a binding emissions target for the 2008-2012 time period. Kazakhstan announced that it intended to do so as well. Greater engagement in Buenos Aires on the part of developing countries was evidenced in other areas as well. One notable example was the growing interest of countries in Latin America and Africa in the Clean Development Mechanism, one of the Protocol's market-based provisions that provides incentives for investment in clean technology projects. 

During the Buenos Aires conference, on November 12, 1998, the United States signed the Kyoto Protocol at the United Nations in New York. Signing does not impose an obligation on the United States to implement the Kyoto Protocol. (The Protocol cannot become binding on the United States without the approval of the United States Senate.) The President will not submit the Protocol to the U.S. Senate for approval without the meaningful participation of key developing countries in efforts to address climate change. 

4.  Definitions

Convention - (a) An agreement between states for regulation of matters affecting all of them (Merriam Webster's Collegiate Dictionary, Tenth Edition); example: The United Nations Framework Convention on Climate Change.

Protocol - A preliminary memorandum often formulated and signed by diplomatic negotiators as a basis for a final convention or treaty (Merriam Webster's Collegiate Dictionary, Tenth Edition); examples: Montreal Protocol, The Kyoto Protocol on Climate Change.

Treaty - An international agreement concluded between states in written form and governed by international law, whether embodied in a single instrument or in two or more related instruments and whatever its particular designation (Vienna Convention on the Law of Treaties 23 May 1969, Article 2, paragraph 1[f]); example: 

party - a state which has consented to be bound by the treaty and for which the treaty is in force (Vienna Convention on the Law of Treaties 23 May 1969, Article 2, paragraph 1[g]); example: 

date of ratification - when a state makes a final formal expression of its consent to be bound by a treaty. This usually occurs after signature. 

date of entry into force - when a treaty becomes binding upon the states which have expressed their willingness to be bound by it. This is usually triggered by a clause in the in the text of the treaty saying something like "this treaty shall enter into force when n states have signed it...". 

date of adoption - when states participating in the negotiation of a treaty agree on its final form and content. This usually occurs before signature.

date of signature- when a state expresses its consent to be bound by a treaty.

5.  Organization for Economic Co-operation and Development

Pursuant to Article 1 of the Convention signed in Paris on 14 December 1960, and which came into force on 30 September, 1961, the Organization for Economic Co-operation and Development (OECD) shall promote policies designed:

To achieve the highest sustainable growth and employment and a rising standard of living in Member countries, while maintaining financial stability, and thus to contribute to the development of the world economy;

To contribute to sound economic expansion in Member as well as non-Member countries in the process of economic development; and

To contribute to the expansion of world trade on a multilateral, non-discriminatory basis in accordance with international obligations. 


Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy, Japan, Luxembourg, New Zealand, The Netherlands, Norway, Mexico, Portugal, Spain, Sweden, Switzerland, Turkey, the United Kingdom, and the United States.

6.  References and Suggested Readings

  • The Clean Water Act 20 Years Later, Robert W. Adler, J. C. Landman, and D. M. Cameron, Island Press, Washington D. C. , 1993.
  • Climate Change Policy Initiatives, Vol. 1, International Energy Agency, OECD, 1994.

  • Environmental Economics: An Elementary Introduction, R. K. Turner, D. Pearce, and I. Bateman, The John Hopkins University Press, Baltimore, 1993.

All materials © 2001 by the University of Michigan.