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Environmental Incentives:
Australian Experience with Economic Instruments for Environmental Management

Environmental Economics Research Paper No.5
Consultancy report prepared by: Dr David James, Ecoservices Pty Ltd
Commissioned by Environment Australia
© Commonwealth of Australia, 1997
ISBN 0 642 26850 9

1. Introduction

1.1 Purpose and scope of paper

This report is an updated and expanded version of Using Economic Instruments for Meeting Environmental Objectives: Australia's Experience (James 1993), an earlier environmental economics research paper prepared by the author for the Department of the Environment, Sport and Territories (DEST). It focuses on the practical application of economic instruments rather than on theoretical appraisals. It aims to improve general knowledge about the use of economic instruments, identify their advantages and limitations in practice, and promote discussion on their potential for wider application in Australia.

The research paper published by DEST in 1993 was based on responses to an Organisation for Economic Cooperation and Development (OECD) questionnaire distributed to governments throughout Australia in 1992, and supplemented by information obtained directly from a desktop survey. A wide range of government agencies within Australia involved in environmental and natural resource management took a considerable interest in the paper. It listed a range of possible instruments, discussed their relative merits and limitations, and documented some of the practical experiences of government agencies in applying them to various kinds of environmental management problems in an Australian context.

In the last few years there has been greater support for using economic instruments to manage the environment. In part, this has been the result of broader policy initiatives based on international and national commitments, as well as an increasing realisation that economic instruments offer scope for achieving environmental objectives in more cost-effective ways than traditional command-and-control or regulatory mechanisms. Thus the use of economic instruments for environmental management may be seen as one way to achieve more efficient government, and to encourage environmental good practice while improving economic performance and international competitiveness.

Although many environmental management schemes have been proposed over the last few years and have received close attention from researchers and policy-makers, this report covers only those that have actually been applied in Australia or are due to be implemented shortly. The report thus omits a number of interesting schemes, such as emission charges and tradeable permits for greenhouse gases, trading schemes for non-point sources of pollution and economic instruments for effluent reuse.

An important development has been the increased use of economic instruments in managing natural resources that have significant environmental connections, for example, in areas such as forestry, fisheries, land conservation, water quality, river flows and the maintenance of biodiversity. The present report covers many of these applications.

The early sections of the report outline the various economic instruments, discuss their strengths and weaknesses, and consider them in the context of general environmental policy initiatives and regulatory frameworks. Subsequent sections provide detailed discussions of each kind of instrument, documenting, where possible, general applications in Australia and elaborating on selected applications as case studies. The report concludes with a general evaluation of the main findings. A comprehensive reference list covers the theoretical literature, overseas experience and specific applications in Australia.

1.2 International context

World Commission on Environment and Development

The World Commission on Environment and Development (WCED) was established in 1983 at the request of the General Assembly of the United Nations. Its report, commonly referred to as the Brundtland report, was a document of international significance (WCED 1987). The commission emphasised the need for environmental and economic policies to be mutually reinforcing to ensure sustainable economic and social development. The Brundtland report had an important effect on environmental policy in Australia.

United Nations Conference on Environment and Development

The United Nations Conference on Environment and Development (UNCED) held in Rio de Janeiro in 1992 resulted in further commitment by the Australian Government to the principles of sustainable development. An outcome of the conference was Agenda 21, a blueprint for environmental action for the next century. Chapter 8 of Agenda 21, which deals with the integration of social, economic and environmental factors to achieve sustainable development, identified the need for making effective use of economic instruments and other incentives (Johnson 1993).

Organisation for Economic Cooperation and Development

Australia's involvement with the OECD has also helped to shape Australian environmental policies and practices. The OECD has been a strong supporter of the polluter pays principle and has for many years advocated the use of economic instruments for environmental management. It released publications on pollution charges in the 1970s and 1980s (OECD 1976, 1980).

In 1987 the OECD undertook a major survey of the use of economic instruments for environmental protection and published the results two years later (OECD 1989). The survey results revealed that the use of economic instruments had increased significantly over a period of 15 years. Within the 14 countries surveyed, there were more than 150 examples of the use of economic instruments.

This OECD publication was followed shortly by a set of guidelines on how to apply economic instruments in environmental policy (OECD 1991). In 1992 the OECD conducted an update of its 1987 survey by circulating a standard questionnaire among all member countries. The Australian results were incorporated in the 1993 research paper prepared for DEST (James 1993). The present report on economic instruments is based on the classification of instruments established by the OECD.

1.3 National context

Ecologically Sustainable Development Working Groups

The concept of ecologically sustainable development (ESD) has its origins in the 1972 United Nations Stockholm Conference. The principles were applied in an important policy document, the World Conservation Strategy, published in 1980 by the International Union for the Conservation of Nature and Natural Resources (IUCN 1980), the United Nations Environment Programme (UNEP) and the then World Wildlife Fund (WWF). The strategy provided the basis for the National Conservation Strategy for Australia (Commonwealth of Australia 1984). The Brundtland report and UNCED carried the concepts of sustainability further.

In 1990, the Commonwealth initiated a national program on ESD, with the release of a public discussion paper. Subsequently, nine ESD Working Groups were established to consider the implementation of ESD principles in sectors of the Australian economy, together with industry, government, conservation groups, research institutions and the general public. The ESD Working Groups were required to examine issues of sustainability, providing advice on future ESD policy directions and developing practical proposals for implementing them in Australia. During 1991 and 1992 the ESD Working Groups produced reports on agriculture, forestry, energy production, energy use, fisheries, manufacturing, mining, tourism and transport (Commonwealth of Australia 1991a), as well as reports on intersectoral issues, the greenhouse effect, economic modelling, and a compendium of ESD recommendations. Each of the reports considered economic incentives as a means of facilitating environmental and natural resource management.

In 1993, the ESD Steering Committee reviewed progress in implementing the National Strategy for ESD (Commonwealth of Australia 1994). The committee commented that there was still a lack of practical techniques and experience with economic instruments to achieve environmental objectives through these means rather than through regulation, and emphasised the need to develop economic instruments quickly to keep pace with the process of deregulation, privatisation and other market mechanisms. The committee noted that work had commenced on the development of economic instruments in a number of jurisdictions. The present report describes these and other subsequent developments.

National Strategy for Ecologically Sustainable Development

The National Strategy for ESD provided a comprehensive blueprint for achieving sustainable development in Australia (Commonwealth of Australia 1992a). Chapter 20 of the strategy, 'Pricing and Taxation', calls on governments to continue to develop practical experience in the use of pricing and economic instruments such as tradeable rights in managing resources. It also suggests that governments establish pilot programs within a number of specific natural resource sectors to test the practicability and effectiveness of different mixes of market and regulatory mechanisms. The strategy also advises governments to ensure that taxation regimes foster sound environmental practices.

Intergovernmental Agreement on the Environment

The Intergovernmental Agreement on the Environment (IGAE) was signed in 1992 by the Commonwealth of Australia, all States and Territories and the Australian Local Government Association. It achieved agreement by all governments in Australia to take a cooperative national approach to the environment (Commonwealth of Australia 1992b).

Section 3 of the IGAE calls for the effective integration of economic and environmental considerations in decision-making processes, in order to improve community well-being and to benefit future generations. It identifies the need for the nation's international competitiveness to be maintained and enhanced in an environmentally sound manner; and it requires that the measures adopted be cost-effective and not disproportionate to the significance of the environmental problems being addressed.

On the matters of valuation, pricing and incentive mechanisms, the IGAE requires that:

The National Commission of Audit (1996) investigated the IGAE and concluded that, to date, it has not been an effective mechanism for encouraging action on environmental issues from a national and bilateral perspective. It considers that environmental protection is primarily a State responsibility. The commission noted that:

'there is a lack of progress in pursuing more cost effective ways of achieving environmental objectives such as improved valuation and pricing of resources and other incentive mechanisms. States have a vital role in the introduction and implementation of such mechanisms.' (p. 76).

Recommendation 4.36 refers specifically to economic instruments and states that:

'Commonwealth and State agencies should pursue greater use of economic instruments, such as appropriate valuation and pricing of resources and increased cost recovery, through purchaser/provider agreements' (p. 77).

The Productivity Commission also reviewed the IGAE and recommended that its implementation be accelerated. In its Stocktake of Progress in Microeconomic Reform, the commission noted that:

'the costs of meeting environmental objectives can frequently be reduced by employing outcome-oriented regulation and economic instruments that provide firms the flexibility to modify their production and/or consumption so that the requirement is met in a least-cost fashionÉTo date, governments in Australia have used economic instruments sparingly. There is scope for them to be used more extensively' (Productivity Commission 1996, p. 141).

The Minister for the Environment, in a recent statement titled Investing in Our National Heritage, indicated the Government's commitment to reviewing, in consultation with the States and local government, the effectiveness of the IGAE to achieve a clearer definition of the respective roles of the Commonwealth and the States in environmental protection (Commonwealth of Australia 1996).

1.4 Range of instruments covered

The economic instruments covered in this report correspond to those identified by the OECD. Not all of these instruments have been applied in Australia, but a full checklist of instruments is covered for the sake of completeness. The main instruments surveyed are:

Subsidies in various forms, such as tax concessions, capital grants, reduced prices and support for research and development, may be another means of managing the environment. However, they tend not to be favoured from the viewpoint of economic efficiency. Indeed, subsidies that are used for other purposes often have unwanted adverse impacts on the environment. For example, underpricing of irrigation water may lead to overuse, resulting in waterlogging and salination.

1.5 Case studies

Where possible, the report uses case studies to illustrate the practical application of economic instruments in Australia. A common framework has been used to help compare instruments. The main features of the framework are as follows.

Problem identification

Instrument selection

Description of instrument

Assessment against criteria for evaluation

Concluding evaluation

1.6 Sources of information

The present report builds on the content of the 1993 research paper and incorporates additional information compiled in 1996. The 1993 report was updated and expanded using telephone discussions and direct consultations with personnel in relevant government agencies, many of whom followed up with useful documentation on topics discussed. Other information was obtained from a desktop survey of reports, research papers, academic texts and public information documents.

1.7 Government agencies covered

A wide range of government agencies are responsible for managing the environment and natural resources. This research report focuses on State, Territory and Commonwealth agencies. However, an important addition to the report is information from local government agencies, which are increasingly looking to economic instruments to support their environmental objectives at the local scale.

1.8 Experience of other countries

Economic instruments for environmental protection were scarcely used 20 years ago, but their use has increased steadily. Some of the first examples were the use of effluent charges in the management of water quality in France, Germany and the Netherlands (Kneese & Bower 1968; OECD 1976; Bower et al. 1981). Economic instruments now used in European countries include effluent charges, input taxes, user fees, noise taxes, product taxes and deposit refunds (OECD 1989, 1991; Opschoor & Turner 1994).

In the United States, the most notable use of economic instruments for environmental protection resulted from the United States Environment Protection Agency's emissions trading policy, which evolved during the 1980s as a consequence of the Clean Air Act 1977. The emissions trading program has achieved significant cost savings and has given firms greater flexibility in meeting emission limits (Tietenberg 1985; Hahn & Hester 1989).

The Clean Air Act 1990 created the scope for using tradeable permits to reduce acid rain, but it has yet to take effect. According to Foster and Hahn (1995), the most vigorous application of the emissions trading program has been in smog control in the Los Angeles area. The analysis undertaken by Foster and Hahn indicates that the market for permits in Los Angeles has been active since the mid-1980s. A more extensive marketable credits program (RECLAIM) is currently being formulated for the Los Angeles area.


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