Foreign aid in the form of technical assistance might be useful in helping the newly independent states of the former Soviet Union deal with past and current pollution. But such aid probably will not have a lasting, positive impact in the absence of reforms in the countries' basic social institutions. Without development of the institutions of a market economy, environmental measures are unlikely to be successful. Obstacles to investments that promote economic and environmental improvements must be removed if these improvements are to be achieved.
Technical and regulatory efforts to improve the management of environmental quality in the former Soviet Union are a focus of programs to provide foreign assistance to the newly independent states that once made up that country. To assess the prospects for the success of these assistance programs, policymakers in the United States and other Western countries must address many basic questions about the new states' environmental policies and their transitions from planned economies to market economies. These questions fall into three categories.
First, what can we expect regarding the investment incentives of firms in these countries? How many low-cost investments that improve both the environment and the economy will the firms undertake, and why are these investments not already being undertaken?
Second, how will the restructuring of enterprises and institutions alter the responses of polluters to environmental policy instruments? Conversely, how do the challenges of restructuring that face enterprises affect the design of environmental policy?
Third, how will environmental policies and fiscal policies interact? How will environmental policies interact with industrial and overall social security policies? For example, where enterprises that are not viable in the long run are being temporarily maintained on social grounds, what investments should be pursued to reduce enterprise losses and environmental damages?
Based on our observations in Russia and Ukraine, and on extensive discussions with experts in those countries, we believe that real progress on environmental problems in the countries of the former Soviet Union will lag until there are substantial and far-ranging reforms in basic economic, legal, and social institutions. We do not deny that some targeted technical assistance could produce substantial improvements in environmental quality and quality of life for individuals affected by the assistance. Without basic institutional reforms, however, it is doubtful that these countries will have the capacity to continue the progress made possible by foreign assistance and to generate substantial environmental improvement on their own.
Our justification for this conclusion goes beyond the observation that the states of the former Soviet Union remain poor and that their resources available for environmental investment remain limited. It also goes beyond the observation that, in the absence of development assistance, excessively strict environmental regulation likely will be politically unpalatable.
Given these countries' current social institutions, it will be costly, if not impossible, to succeed in translating a public demand for environmental improvement into concrete action. The necessary political, legal, and economic accountability needed to do this effectively does not yet exist. Moreover, even if there were agreement on the need for change, institutional failures in the economy would likely raise the cost of enforcing environmental standards well above even the levels experienced under inefficient command-and-control programs in otherwise functional market economies.
These observations in turn raise doubts about the cost-effectiveness of major environmental assistance programs in the former Soviet Union without significant institutional reform there. Evidence is growing that improvement of environmental quality is a highly valued objective in the countries in question. However, environmental quality, as well as economic performance, might be better served first by assistance that helps the countries of the former Soviet Union to develop the institutions of a market economy, including the associated legal institutions of property, liability, and contract law.
Environmental policies in Russia and Ukraine
Environmental policies in Russia and Ukraine illustrate both the disarray in the environmental policies of the countries of the former Soviet Union and the difficulties in improving these policies without progress toward the development of market economies. Environmental policies in these countries consist of a hybrid of standards for emissions and fees on emissions in excess of the standards. Environmental regulators tax pollution at two rates: all emissions are subject to a low tax rate, but emissions in excess of standards set for each source are subject to a higher rate. In principle, environmental regulators also have the power to order polluters to reduce emissions or to cease operations if the emissions pose a serious threat to public health or ecological integrity.
Emissions standards are based on essentially arbitrary distinctions among hundreds of pollutants. Far more standards exist than regulators can monitor or enforce. Standards also are set rigidly for individual sources of emissions, without regard for differences among the emissions reduction costs for each source or for differences among the impacts of each polluter on actual pollution concentrations. Regulators express concern that flexibility in the ways polluters are allowed to comply with emission standards, as with emission permit trading, would expand the opportunities of firms to exceed their emissions allowances—although current rules already require that emissions sources be monitored. This concern is ironic (even surrealistic), given the current scale of pollution violations.
Pollution fees are too low to achieve much environmental improvement. In any case, at current rates of inflation, increases in the fees are shortly rendered negligible.
In principle, these problems could be lessened by overhauling environmental regulations. However, other shortcomings in environmental regulation reflect economic and social concerns, as well as environmental concerns, and thus are harder to address.
The administration of pollution fees in Russia and Ukraine is problematic in several respects. Because expenditures for environmental protection are financed mostly by fees on polluters rather than from general revenues, environmental regulators are faced with a fundamental contradiction: to address environmental concerns arising from one set of activities, they must tax pollution from other, quite possibly unrelated, activities. If regulators were to charge pollution fees high enough to encourage substantial reductions of pollution, they would risk undercutting the tax base.
Revenue raising largely motivates the setting of emissions standards. To maintain tax revenues, the government often sets emissions standards a few percentage points below prevailing emissions levels. If the system worked to reduce emissions, it would require a ratcheting upward of standards to raise revenues, compromising firms' incentives to make long-term investments in environmental improvement. However, pollution fees simply are too low to achieve much environmental improvement, especially for state enterprises that do not face the normal budget constraints of a market economy. Moreover, at current rates of inflation, increases in pollution fees are rendered negligible shortly after they are announced.
With fees having little impact on pollution, the only other line of defense is legal sanctions against egregious violators of pollution standards. In practice, however, the problems of economic and political transition render this option largely ineffectual as well. Because so much of the economy in the former Soviet Union remains under state control, attempts to enforce environmental sanctions become intramural conflicts among government ministries. In this situation, the rule of law with regard to the environment often is quite weak, especially in light of the strong vested interests in maintaining enterprise operations that we discuss below.
Aside from problems related to the administration of emissions standards and pollution fees, the allocation of funds for pollution cleanup and reduction projects leaves something to be desired. The determination of priorities for environmental expenditures is not necessarily linked to environmental benefits. Some effort to identify such benefits is made when different expenditure proposals are considered. However, an important criterion for allocating funds appears to be the financial need of the local government or enterprise proposing a pollution cleanup or reduction project. Thus funds are often made available for projects that local governments or firms cannot finance on their own, with little regard for the benefits the projects generate by reducing serious health or environmental risks arising from pollution.
Obstacles to making win-win investments
In the long run, the industrial pollution problems of the former Soviet Union can only be overcome by major investments in more efficient and cleaner production processes and equipment. Many such investments probably could be undertaken at very low cost and result in both substantial environmental benefits and lower production costs.
Many investments in more efficient and cleaner production processes and equipment probably could be undertaken at very low cost and result in both substantial environmental benefits and lower production costs.
The existence of such "win-win" investments begs an important question, however: If such options are available, why have they not been pursued? Some of the reasons that these possibilities continue to be unexploited may be traced to the Soviet legacy, others to the difficulties of the transitional period, and still others to problems of information and oversight common, to greater or lesser degrees, in all economies.
One impediment to win-win investments is the morass of regulation and licensing requirements left over from central planning. These requirements make starting new businesses and instituting substantial reforms in existing ones extremely difficult. As a result, they discourage the establishment or retooling of firms that are both more profitable and less polluting.
A second part of the Soviet legacy that impedes win-win investments is the tradition of propping up faltering firms with public funds. This tradition undermines incentives for both increased efficiency and pollution reduction. If enterprise managers know that they will be bailed out with public funds, regardless of the performance of their firms, they have little incentive to seek cost-saving production innovations. Moreover, they may have little incentive to adopt even low-cost solutions to their environmental problems if they believe that these solutions will sooner or later be financed out of public funds.
One ongoing impediment to win-win investments is obstacles to both foreign and domestic private investment. Such investment is limited by several factors. First, the process of privatization has just begun in Russia and is even less advanced in many other states of the former Soviet Union. Second, the institutions that characterize capital markets and the banking system in Western economies are just now coming into being in these countries. For example, corporate law is very incomplete, and accounting procedures that would enable outside investors to determine the value of potential investments have not yet been adopted. Third, taxes on the profits of firms in the countries of the former Soviet Union are substantial. These taxes, along with exchange controls and high inflation (which triggers high interest rates), limit the attractiveness of new investment.
A second ongoing obstacle to win-win investments is the limited capacity of the labor market to adjust to the transition from planned to market economies. Labor mobility remains limited because workers have traditionally obtained all social services (including housing) through the enterprises that employ them and because internal migration is subject to state control. Another circumstance that has made it difficult for the labor market to adapt to the transition is the financial stake employees have in some newly privatized enterprises. Share ownership in such enterprises is largely concentrated among workers and managers, increasing the financial losses that employees would face if these enterprises fail. Because employees realize that they face risks of financial loss and unemployment in emerging market economies and because they distrust the prospects for success with new investment, they are exerting political pressure for their governments to subsidize firms or to take other measures to prevent firms from failing.
Ongoing impediments to win-win investments include obstacles to foreign and domestic private investment and the limited capacity of the labor market to adjust to the transition from planned to market economies.
A seemingly simple solution for overcoming the obstacles to win-win investments would be to allow firms to sink or swim on their own merits. However, this solution may not be feasible under the current circumstances of the transition from planned to market economies. These circumstances may combine to deprive even deserving enterprises of the financing they will need to survive. Thus, in deciding which otherwise failing enterprises receive financial aid and regulatory leniency, decision makers in the countries of the former Soviet Union must distinguish between firms that make obsolete products using archaic production methods and those that are trying to make needed products using newer, cleaner production methods. Moreover, given restrictions on the social "safety net," decision makers need to take into account social factors that may outweigh considerations of narrowly defined economic efficiency in making these decisions.
Thus the limitations on private activity to improve the environment and the economy at the same time also hinder governmental policies for pollution control. While the possibility of publicly funded bailouts exists, polluting firms will be unresponsive to economic sanctions. Moreover, legal or economic sanctions that threaten employment, the viability of enterprises, and the social fabric will be vigorously opposed by enterprise managers, employees, and the branches of government that still oversee polluting industries. As long as public and private decision makers remain unaccountable for their decisions, firms' capacity to change their environmental behavior is very limited.
Institutional reforms
Environmental policies per se probably will have relatively little effect until there is progress toward greater general strengthening of economic and legal institutions. The development and maturation of the institutions of capitalism in the former Soviet Union may be facilitated by increased macroeconomic stability, the establishment of legislation to govern corporate conduct and reduce regulatory barriers to the creation of new businesses, the reform of financial markets, and the revamping of the provision of public goods and social security.
While the transition from planned to market economies proceeds, it is important that environmental policy move in tandem with the general development of economic, legal, and social institutions. For example, while some flexibility in approaches to the enforcement of environmental regulations is called for, it is also important that decision makers be able to predict the effects of these approaches. Actions that would further decrease the confidence of potential investors could be counterproductive, even if they achieved some short-term environmental improvement.
It is also important that the institutions of environmental policy reflect the changing technical capabilities of regulators, the evolution of judicial and other institutions, and the increased stability of firms. Case-by-case reviews of compliance strategies should be replaced by general regulations that incorporate flexibility in compliance. Incentive-based measures, such as limited emissions-permit trading programs, should be established and expanded as opportunities arise. A more concerted effort to set priorities for environmental expenditures and to limit soft enterprise budgets (budgets that are based on the expectation of publicly provided funds to make up losses) would probably improve the efficiency of environmental expenditures while the economy as a whole makes the transition toward greater private financing of environmental improvements. Finally, some simplification of the environmental standards themselves would be beneficial.
Building better economic and political institutions is time consuming and does not offer the immediate and tangible rewards that technical support systems may afford. However, institutional reforms are crucial if the technical support programs for environmental improvement that are now being championed in foreign assistance debates are to be successful.
Michael A. Toman is a senior fellow and R. David Simpson is a fellow in the Energy and Natural Resources Division at Resources for the Future. This article is excerpted from Pollution Abatement Strategies in Central and Eastern Europe, edited by Toman and published by Resources for the Future.
A version of this article appeared in print in the May 1994 issue of Resources magazine.
A version of this article appeared in print in the June 1994 issue of Resources magazine.
