A recent case study of the cost-effectiveness of different policies for controlling air pollution emissions in Poland suggests that the potential benefits of incentive-based (IB) policies, such as emissions fees and emission permit trading, are significant. For example, the study indicates that emissions from large stationary air pollution sources can be controlled at less cost through the use of IB environmental policies than they can be through the use of command-and-control environmental policies. However, the magnitude of the cost savings of IB policies is limited in Poland by several factors. The study also indicates that emission permit trading should be used to complement emissions fees, which are already charged in Poland. However, the legal status of such trading must be clarified.
Like other countries in Central and Eastern Europe, Poland faces the twin challenges of improving its environmental quality while also strengthening its economy during the transition to a market system. One way to reconcile these objectives, as policy analysts have long argued in the West, is to use economic incentives to control pollution. By giving polluters an economic stake in reducing emissions and the flexibility to find least-cost control methods, the argument goes, incentive-based (IB) policies can achieve any specified set of emissions reduction objectives at a minimum total cost to society. To harness economic incentives for pollution control, analysts have advocated the use of emissions fees and the institution of a system of tradable emission permits. A tradable emission permit system establishes a ceiling on total emissions and an initial distribution of allowed emissions among polluters, who can then buy and sell their emission rights. The system thus encourages polluters with the smallest pollution abatement costs to make the greatest pollution reductions.
While the application of such policies in Central and Eastern Europe may seem to be a natural marriage of economic and environmental interests, there are several challenges to consider. Perhaps the biggest challenge is that IB environmental policies are designed to work in countries where polluters actively respond to economic incentives. Even within the context of an established market economy, economic incentives can be distorted by the regulation of product prices and the investment decisions of polluting firms, such as electric utilities. In the emerging market economies of Central and Eastern Europe, the applicability of IB environmental policies is an even more complex issue than in established market economies because the power of economic incentives remains unclear. In particular, continued government intervention in the activities of large state-owned enterprises, which are often the major polluters in a given region, casts a shadow over the use of IB policies.
The application of IB environmental policies poses operational challenges as well. These challenges arise in connection with the monitoring of pollution and the enforcement of pollution standards. Where monitoring is inadequate, even command-and-control (CAC) environmental regulations—in which regulators specify the amounts of pollution individual polluters should cut or the types of pollution control technology to be used—are problematic. By comparison, IB policies require somewhat greater monitoring. To ensure the integrity of emission permit trading, for example, the emissions and permit holdings of individual polluters must be carefully tracked. Legal authority for TB policies must also be clearly established.
The applicability of incentive-based environmental policies is a more complex issue in the emerging market economies of Central and Eastern Europe than in established market economies because the power of economic incentives in the former remains unclear.
In the face of these challenges, two questions arise: First, how large are the potential gains resulting from IB environmental policies compared with those resulting from CAC environmental policies when both types of policies are used to achieve the same environmental goals? If the gains are modest, then efforts devoted to overcoming the economic and institutional obstacles to IB policies might better be spent on addressing other pressing problems. Second, if the gains are worth pursuing, how can these economic and institutional obstacles be overcome in practice?
A study I conducted with Robin Bates of the World Bank and Janusz Cofała of the Polish Academy of Sciences and the International Institute for Applied Systems Analysis in Laxenburg, Austria, attempts to answer these questions. It examines different policies for controlling air pollution emissions in Poland, and it suggests that, in that country, the potential benefits of IB policies appear worth pursuing.
Air pollution control problems and policies in Poland
Our study focused on three main types of primary air pollutants associated with energy use: particulates, nitrogen oxides (NOx), and sulfur dioxide (SO2). Each of these pollutants is believed to cause significant environmental damages, although the precise nature and extent of these damages remain unclear. Particulates are known to be a serious human health threat. Sulfur dioxide and nitrogen oxides in acid rain cause ecological damages. In addition, SO2 converts to atmospheric sulfate particulates that are part of the particulate stream, and NOx combines with volatile hydrocarbons to produce harmful ground-level ozone.
A large percentage of the above pollutants derives from fossil fuel combustion. The magnitude of the problems caused by the pollutants in Poland is related in turn to the energy intensity of the Polish economy and the lack of effective pollution controls. The energy intensity of gross domestic product (GDP) in Poland is much higher than that in the countries of Western Europe. This intensity reflects the legacy of central economic planning, in which physical production of all commodities—including energy—took precedence over environmental concerns; use of Poland's large endowment of coal, particularly low-grade lignite, was extensive; and economic incentives in the command economy for energy efficiency were lacking. Poland's high energy intensity of GDP and lack of effective pollution controls are reflected in the fact that the ratios of particulate, NOx, and SO2 emissions to GDP in Poland are many times greater than those in Western Europe.
While it is commonly believed that environmental degradation is ubiquitous in Poland and other Central and Eastern European countries, in actuality environmental conditions vary considerably across and within these countries. Air pollution in the region of Upper Silesia in southern Poland—and particularly in the areas around the cities of Katowice and Krakow—has been truly dreadful, although it has diminished somewhat as a result of the sharp economic contraction Poland has experienced in recent years. With the exception of areas immediately downwind of particularly dirty pollution emitters, air pollution appears to be at least somewhat less serious in other regions of Poland.
It is also commonly believed that pollution control policies were nonexistent in Central and Eastern Europe until recently. However, Poland charged emissions fees before the political transitions that began in 1989. In 1990, Poland's Ministry of the Environment passed the Ordinance on the Protection of the Air Against Pollution. Under the ordinance environmental standards govern both overall air quality (ambient standards) and the discharges of large factories, power plants, and other large polluters (source standards). Because these standards do not specify the types of technologies that must be used to abate pollution, polluters in Poland enjoy a degree of flexibility in mitigating their air pollution. This flexibility increases the cost-effectiveness of Poland's pollution control system, at least in principle. Since 1989, Poland has also raised its emissions fees (and fines set at a multiple of the regular fees). The increase, which more than offsets inflation, suggests that the fees make some contribution to improving Poland's air quality. Poland's system for monitoring compliance with air quality standards, while far from perfect, is improving.
These observations notwithstanding, there are several problems with Poland's air pollution control policies. First, emissions fees remain low in many cases, indicating that they are more effective in raising revenue (which can be used to ameliorate the effects of past pollution damage or to address other problems) than in inducing polluters to reduce emissions. Second, emissions fees and fines are not enforced in numerous instances because of the practical difficulty of imposing additional costs on enterprises already struggling with economic restructuring. Third, legal issues cloud the application of IB air pollution control policies. Specifically, the Ordinance on the Protection of the Air Against Pollution does not clearly establish the legal basis for emission permit trading among polluting firms. As currently interpreted, the ordinance allows trading among pollution sources within enterprises—among boilers within a power plant, for example. However, it leaves unsettled the scope of trading among polluters. While it has been interpreted as allowing trading among polluters in close proximity to each other, such trading does not appear to be occurring.
Calculating the relative costs of IB policies and CAC policies
In our investigation of the cost-saving potential of IB air pollution control policies, we used a dynamic simulation model that calculates energy use and emissions of air pollution in Poland over five-year intervals from 1990 to 2015 under a variety of emissions control policies. The model, developed at the Polish Academy of Sciences, starts with a scenario reflecting the predictions of experts in Poland concerning economic development and changes in the efficiency of end uses of energy over the period. These predictions give rise to projections of final energy demand—that is, the demand for energy by households, businesses, and other end users of energy—over time. Given these energy demand projections and a specified set of environmental constraints, the model then calculates the least-cost energy supply and energy conversion activities that would be needed to satisfy final energy demand.
The social costs of air pollution control include the reduction in consumer surplus that would result from an increase in energy prices and a decrease in final energy demand caused by pollution control policies.
Implicit in the use of a model of least-cost final energy supply is the assumption that Poland is moving toward a well-functioning energy market in which producers and consumers will pay the full economic costs of energy (plus any applicable excise taxes). Given the pace and direction of economic restructuring in Poland, this assumption seems reasonable. While the baseline energy demand scenario in the model is fixed, the model does allow for variations in energy demand relative to the baseline scenario. Such variations would reflect the effects of emissions taxes or the cost of emission permits in meeting energy demand.
The model includes a highly disaggregated representation of energy supply and conversion technologies as well as options for air pollution control. With respect to the former, for example, it distinguishes among the various energy production technologies used by power plants. With respect to the latter, it distinguishes among emissions control technologies (such as SO2 scrubbing) as well as among emissions reduction strategies (such as replacing coal use with natural gas use and constructing power plants that have increased energy efficiency and decreased emissions per unit of fuel use).
Because the model is designed to calculate energy use and air pollution emissions at a national level, and because it does not specify the location of specific polluters or how the emissions generated by these polluters affect ambient environmental conditions, it cannot show the effect on ambient air quality of different environmental policies. Nevertheless, we believe that our comparisons of such policies give some indication of the potential benefits garnered by IB policies.
In order to measure the cost-saving potential of IB policies, we established a command-and-control regulation baseline. This CAC regulatory scenario includes emissions standards for large stationary pollution sources that are based on the source standards established by the Ordinance on the Protection of Air Against Pollution. It also includes some controls on coal burning by households (namely, the gradual elimination of this activity in urban areas) and on emissions from the transport sector (most prominently, the installation of catalytic converters in motor vehicles) that are not stipulated in the ordinance.
We then compared four IB policies with this CAC scenario. The first three of these policies have the same total emissions targets as the policies in the CAC scenario; the fourth does not. The first IB policy retains the CAC scenario's controls on coal burning by households and on emissions from the transport sector, but requires large stationary pollution sources to pay fees on emissions of particulates, NOx, and SO2 in order to achieve the total emissions reductions that would be attained under the CAC scenario. The second IB policy relaxes all the CAC scenario's fixed controls on pollutant emissions, including those on coal burning by households and on emissions from the transport sector, and relies on emissions fees paid by large stationary pollution sources and on energy taxes paid by mobile air pollution sources (such as cars) and small air pollution sources (such as homes) to achieve the total emissions reductions that would be attained under the CAC scenario. In order to make the energy taxes equivalent to the emissions fees, the taxes are based on the average volume of pollutant discharges per unit of fuel use. The third IB policy allows large stationary pollution sources to engage in SO2 emission permit trading at the national level but maintains the CAC scenario's restrictions on particulate and NOx discharges from these sources. It also maintains the CAC scenario's controls on coal burning by households and on emissions from the transport sector. The fourth IB policy relies on a 100 percent tax on coal use to achieve emissions reductions. In selecting this policy for our analysis, we were interested in exploring the effects of a narrowly targeted tax rather than in attempting to equate the total emissions reductions that would be achieved by the policy with those that would be attained by the CAC scenario.
We compared these four IB policies with the CAC scenario on the basis of social costs (see table, p. 21). These costs include the costs of abating emissions from large stationary pollution sources and the costs of controls on coal burning by households and on emissions from the transport sector. They also include the reduction in consumer surplus that would result from an increase in energy prices and a decrease in final energy demand caused by the pollution control policies.
Results of cost comparisons
Simulations of our model reveal that the application of IB policies to large stationary pollution sources will garner cost savings, but that the magnitude of the savings is limited by two factors that reflect—at least in part—efficiencies already embodied in the CAC scenario. First, as noted above, the CAC scenario's emissions control standards for such sources are based on source standards that do not prescribe the use of particular pollution control technologies. Thus polluters can realize some cost savings under the CAC scenario by choosing the technologies that are least expensive for them. Second, an implicit assumption of our model is that individual firms are free to choose how to distribute pollution abatement efforts among the pollution sources they control—for example, among boilers within a power plant. This assumption reflects a broad interpretation of the possibilities for intrafirm emission permit trading under the Ordinance on the Protection of Air Against Pollution. Given a narrow interpretation of the ordinance's source standards, firms' flexibility to choose pollution control strategies is limited, and the cost-saving potential of IB policies is increased.
Another implicit assumption of our model leads to an understatement of the cost-saving advantages of IB policies. This assumption is that all the technologies that could be used to abate pollution have already been developed. It does not reflect the fact that IB policies provide dynamic incentives for the development of technologies that would abate pollution at less cost than existing pollution control technologies.
While simulations of our model reveal that the cost savings garnered by the application of IB policies to large stationary pollution sources are limited, they indicate that substantial cost savings can be attained through the use of emissions fees and fuel taxes on all pollution sources and the relaxation of rigid controls on coal burning by households and on emissions from the transport sector. Compared with increased controls on emissions from large stationary pollution sources, the controls on emissions from the transport sector are an expensive means for achieving emissions reductions. Relying only on fuel taxes makes it possible to find a relatively low-cost combination of pollution abatement efforts—most likely, less such efforts by the transport sector and more such efforts by large stationary pollution sources. However, controls on small air pollution sources and mobile air pollution sources in urban areas might still be necessary to satisfy local ambient air quality standards, even if they are expensive.
Two other outcomes of the model simulations are noteworthy. First, the emissions fees that are required under the first and second IB policies in order to achieve the emissions reductions attained under the CAC scenario are more than an order of magnitude larger than the emissions fees currently used in Poland. Second, the coal tax (the fourth IB policy) is almost as costly as, but far less effective in reducing emissions than, the other three IB policies and the CAC pollution control strategy. This finding highlights the importance of a comparatively more broad-based emissions reduction strategy.
Social Costs of Pollution Control in Poland under Command-and-Control and Incentive-Based (IB) Environmental Policies, 1991–2015
Implementing incentive-based environmental policies
Our case study of air pollution control strategies in Poland indicates that IB policies can generate cost savings that are, at minimum, nontrivial and possibly substantial; but how can these savings be achieved in practice? Which IB policies are likely to be most effective under the economic circumstances encountered in the transition to a market-based economy?
Emissions fees might be favored in Poland because they already are well established in Polish law and because they generate revenues that can be used to ameliorate pollution or to attain other social goals. However, there are several well-known disadvantages to their use. First, such fees lead to the transfer of substantial revenues from polluters to the government, and polluters therefore oppose raising them. In simulations of our model, emissions fees increased the private cost of compliance with environmental standards by about 75 percent. Second, emissions fees may not have the desired effects in a setting in which enterprises receive budget subsidies from the government and in which the state will either indirectly subsidize emissions fees or not enforce them.
Given these disadvantages, tradable emission permits may be an important complement to the emissions fees currently charged in Poland. A program of nationwide emission permit trading, like the SO2 emission control program enacted in the United States under the Clean Air Act Amendments of 1990, requires relatively careful monitoring of individual firms' emissions and permit holdings, as noted above, as well as a substantial number of well-informed market participants who are capable of making sophisticated trade-offs.
However, less ambitious programs based on a system of bilateral emissions trading also have substantial promise in an economic setting such as Poland's. Under such a system, individual polluters can seek out trading partners in ad hoc fashion (without a formal market mechanism or formal tradable emission rights issued by regulators) in order to find mutually advantageous arrangements. Such arrangements are those wherein a polluter with low pollution abatement costs makes emissions reductions greater than those required by law in exchange for financial compensation from a polluter with high pollution abatement costs. Such arrangements can be conditioned on a requirement that a total emissions reduction goal is attained and that overall air quality in any one area is improved.
In Poland, bilateral emissions trading may be an important complement to emissions fees in controlling air pollution; under such a trading system, a polluter with low pollution abatement costs makes emissions reductions greater than those required by law in exchange for financial compensation from a polluter with high pollution abatement costs.
Bilateral emissions trading will not result in the exploitation of all possible cost-effective reallocations of responsibility for pollution control. Nevertheless, analyses of comparable trading opportunities in the United States generally indicate that such trading can lead to significant cost savings in pollution abatement efforts. However, these analyses also suggest that the cost-saving potential of bilateral emissions trading tends to be diminished when government restrictions encumber exchanges of permits. Thus the cost-effectiveness of such trading would be enhanced if the legal status of emissions trading were clarified and if government restrictions on exchanges were limited.
There are several potential obstacles to emissions trading in Poland. One obstacle, as noted above, is that the legal status of such trading in Poland is unclear. Another is that incentives to engage in emissions trading would be limited if the government fails to enforce air quality standards or interferes with the economy in ways that weaken firms' interest in minimizing pollution control costs. Under such circumstances, however, any pollution control policy—including emissions fees and CAC regulation—is doomed to failure.
Policy recommendations
Despite the potential obstacles to its success, emissions trading appears to be an important complement to emissions fees in controlling air pollution in Poland. Although such fees stimulate some pollution abatement activities and provide a source of revenue for mitigating environmental damages generated in the past, it is doubtful that they can be raised to the level necessary for Poland to attain its current air quality standards. This point is underscored by the fact that no country in the West has yet managed to raise its emissions fees high enough to rely on the fees to achieve its environmental goals. Thus it seems vital to develop the legal and economic institutions needed to support increased emissions trading. Such trading could start with informal bilateral exchanges, as discussed above, and progress to more formal and multilateral exchanges as Poland's economic and regulatory institutions develop.
It should be noted that the cost-saving potential of emissions trading in Poland might be greater or smaller than our case study indicates. In the study we focused only on how alternative air pollution control policies will affect total air pollutant emissions in Poland. However, the effectiveness of such policies needs to be gauged by how the policies affect actual air quality—that is, ambient pollution concentrations in different locations—as pollution damages depend on ambient conditions. Thus, to improve our understanding of the cost-effectiveness of IB environmental policies in Poland and in other Central and Eastern European countries whose economies are in transition, it is necessary to extend our analysis to an examination of emissions trading in light of local ambient standards and the way pollutants are dispersed as a result of meteorological phenomena. Such an examination will allow us to quantify more accurately the gains from emissions trading under trading rules that reflect how emissions from different pollutant sources affect ambient conditions at different locations. An analysis of this kind by the World Bank has already begun in the Polish city of Krakow.
Michael A. Toman is a senior fellow in the Energy and Natural Resources (ENR) Division at Resources for the Future. A more detailed account of the issues addressed in this article can be found in discussion paper ENR93-16, "Alternative Standards and Instruments for Air Pollution Control in Poland," by Toman, Robin Bates, and Janusz Cofała.
A version of this article appeared in print in the October 1993 issue of Resources magazine.
A version of this article appeared in print in the October 1993 issue of Resources magazine.
