Assessing the Dragon's Choice: the Use of Market-Based Instruments in Chinese Environmental Policy

Georgetown International Environmental Law Review, Summer 2004 by Shuwen, Jolene Lin

A. THE THEORETICAL ADVANTAGES OF EI POLICIES OVER CAC REGULATION

1. Cost-Efficiency at Stake

Command and control policies are often not cost-efficient. This is because holding all firms to the same pollution abatement target through CAC regulation can be very costly and, as a result, counter-productive. For example, although technology standards, by stipulating the actual equipment or methods that must be adopted by firms to comply with the regulations, are attractive from an administrative perspective, they tend to be the most capital-intensive - a serious drawback in a developing economy. Further, as the costs of reducing pollution vary greatly amongst firms, the appropriate technology for one firm may not be so for another. Thus, one of the advantages that EI instruments offer over CAC instruments is cost efficiency.56 On the other hand, EI instruments create incentives for individual firms to choose abatement levels that minimize the aggregate costs of attaining a particular level of environmental quality. Thus, economic instruments allow pollution control to be realized at the lowest overall cost to society as those firms which can reduce pollution most cheaply are incentivized to produce the greatest reductions in pollution.57

2. Chilling Effect on Social Innovation

A key criticism of traditional CAC regulation is that it hampers social innovation.58 Social innovation refers to the development and adoption of environmentally superior technologies. It includes the development of clean fuel cars, less polluting industries, and greener production methods.59 From a long-term perspective, such innovation is vital to combat further environmental degradation. As economic growth continues, pollution will also increase unless society continually develops and adopts less polluting technologies. Unfortunately, CAC regulation tends to freeze innovation as there is no financial incentive for businesses to exceed their control targets and both technology-based and performance-based standards discourage the adoption of new technologies. Any incentive to innovate is often offset by the enforcement risks associated with using a non-approved technology and the risk that a superior new technology will serve as the new standard in another round of CAC standard-setting - the so-called "regulatory ratchet." 60

In contrast, economic instruments potentially provide powerful incentives for firms to develop and adopt better pollution control technologies. This is because with economic instruments, particularly emissions fees, it always pays for firms to clean up a little bit more if a sufficiently cost effective method for doing so is available. second, the absence of rigid technical and design specifications in EI policies removes the enforcement risk of using non-approved technologies. This is important as firms will hesitate to adopt environmentally superior technologies as long as the fear of violating regulatory standards for doing so exists. It would also be easier to involve firms in the testing of new technologies if they are not bound by technology-specific standards. This will help speed up the development of new pollution control methods. Finally, EI policies encourage innovation to the extent that a business that has adopted a new technology need not fear that it will be rewarded by being held to a higher regulatory standard and not being able to reap the financial benefits of its investment, except to the degree that its competitors may face even greater difficulties reaching the new standard.