Economic Prescriptions for Environmental Problems: How the Patient Followed the Doctor's Orders

O ne of the dangers with ivory tower theorizing is that it is easy to lose sight of the actual set of problems which need to be solved, and the range of potential solutions. As one who frequently engages in this exercise, I can attest to this fact. In my view, this loss of sight has become increasingly evident in the theoretical structure underlying environmental economics, which often emphasizes elegance at the expense of realism. In this paper, I will argue that both normative and positive theorizing could greatly benefit from a careful examination of the results of recent innovative approaches to environmental management. The particular set of policies examined here involves two tools which have received widespread support from the economics community: marketable permits and emission charges (Pigou, 1932; Dales, 1968; Kneese and Schultze, 1975). Both tools represent ways to induce businesses to search for lower cost methods of achieving environmental standards. They stand in stark contrast to the predominant "command-and-control" approach in which a regulator specifies the technology a firm must use to comply with regulations. Under highly restrictive conditions, it can be shown that both of the economic approaches share the desirable feature that any gains in environmental quality will be obtained at the lowest possible cost (Baumol and Oates, 1975). Until the 1960s, these tools only existed on blackboards and in academic journals, as products of the fertile imaginations of academics. However, some countries have recently begun to explore using these tools as part of a broader strategy for managing environmental problems.