Apr 162014
 

Market Based InstrumentsIn a previous post I explained that the Carbon Price is not a Carbon Tax. That it was an Effluent Charge with a Tax Differential component. Regardless of this, they are all examples of Market Based Instruments. What they are is actually known as Price Based Market Based Instruments or just Price Based Instruments. There are generally three kinds of Market Based Instruments: Price Based Instruments, Quantity Based Instruments (or Rights Based Instruments) and Information Based Instruments.

You may have heard the Minister for the Environment explain that they will replace the “Carbon Tax” with a market based mechanism, insinuating that the Carbon Price is not a market based instrument. He is quite wrong; my master’s thesis was entitled ‘Market Based Instruments for Reducing Pollution Loads Entering Darwin Harbour’ and I will explain in basic terms what these actually are.

Price Based Instruments

Market based instruments that set a price, a charge or a fixed unit cost are known as Price Based Instruments. As previously discussed, Price Based Instruments might include policy mechanisms and instruments such as effluent charges and taxes. But they may also include:

Full Cost Pricing (and include different pricing structures)

Tax Rebates and Tax Differentiation

Insurance Premium Charges

Reverse Deposit Schemes (Container Deposit Schemes)

Subsidies, Rebates and Grants

User Charges

Performance Bonds

Covenants

These are what is known as Pigouvian Taxes. And I think the term Pigouvian Tax is where a lot of the confusion has entered the debate. However, all this term means is that the polluter absorbs the full cost of the production (or consumption) process. How this is done most efficiently and effectively is to be determined by the policy maker, and will be the subject of a later post. How price based instruments act as a market based instrument will also be discussed at a later stage, because it isn’t necessarily intuitively apparent – which is partly the problem that gives rise to comments and purchase in the population that pricing is not a market mechanism.

Quantity and Rights-Based Instruments

Quantity and rights-based Market Based Instruments are what most people think about when they think of ‘Market Based Instruments’. There really only a few types of instruments in this category and it is probably the narrowest policy set for Market Based Instruments. There really are only two types of Market Based Instruments in this category:

Cap and Trade Schemes, Permits and Tradeable Permits

Total Maximum Daily Load Schemes (including accounting and budgeting schemes)

These Market Based Instruments contain a strong regulatory basis as well as frequent market transactions. Offsets can be created and in this sense they operate both as a futures exchange and also a quasi options exchange, with regulatory bodies acting as market-makers. The exchange’s effectiveness is successful or not successful depending on the interaction of these elements.

Theoretically, such Market Based Instruments are most suited to environmental policies where there are a large number of diffuse polluters, and the impacts of pollution are not isolated. That is, a reduction in pollution in one area will benefit the whole, not just the local environment. I will discuss this dynamic at a later date. But in short, it is why Australia’s carbon pollution reduction policies have favoured a cap and trade scheme.

Information-Based Market Based Instruments

Information based Market Based Instruments are also known in the literature as Friction Reduction Schemes, or Friction Reduction Market Based Instruments.

You may ask why these are included as Market Based Instruments. The simple answer is that markets function on the basis of information. There are two things that move a market – noise, and information. Companies listed on stock exchanges are regularly releasing information. It is a legal requirement. There is legal recourse for some buyers when they have been sold something under false pretences in many different kinds of transactions.

These Market Based Instruments are said to reduce friction because they are designed to provide the user or the transacting parties with the available information. Available information is an important component of rational choice making in decision theory in classical economics, and I have some level of qualms with this philosophical position. But for the purposes of policy making, it is at least a worthy aspiring goal for policy.

Information based Market Based Instruments include:

Right to Know legislation

Eco-labelling

Public Information Campaigns

Accreditation

Summary

I hope that I have had some success in helping shed light on what actually Market Based Instruments actually are in environmental policy. There is a broad range of policy options at the hands of decision makers. The pros and cons of each and in what circumstances each market based instrument is likely to be effective will be discussed over time in this blog. But don’t be fooled by politicians and their use of jargon when discussing Market Based Instruments and the underlying philosophy for addressing environmental problems.

If you have any questions or queries, leave a comment, or suggestion. Or if you want me to go over anything in detail, let me know!

  2 Responses to “Carbon Taxing Times: What are Market Based Instruments?”

  1. I like the term Pigouvian Taxes 😉

  2. […] A potential cause of the outbreak and a potential solution fall within what readers of this blog might be familiar with – water quality and market-based instruments. […]

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