Environmental economics: making the money, saving the planetNovember 19, 2012
By Alexander Wood and Dana Krechowicz
But when it comes to finding ways to capture the value inherent in that capital, and to promote the simultaneous economic and environmental benefits that can come from it, we simply haven’t measured up. It is, in this context, not surprising that the belief persists in Canada that there is an inherent trade-off between economic growth and environmental sustainability.
By relying on policies and practices that are all about saying ‘no’ through regulation, we force trade-offs between environmental protection and economic gain that should not be necessary.
The theory and practice of environmental economics have evolved greatly over the past twenty years. Economists have understood for some time now that laws and regulations can breed a “compliance mentality” which ensures that a firm or individual will change behaviour right up to the level required, but not beyond. Such a mentality not only stifles innovation — because there is no incentive to go beyond compliance — it also ties changes in corporate behaviour to a limited set of options and so increases the cost of improving a firm’s environmental performance.
The great innovation in environmental policy of the last twenty years, in fact, has been the creation of market-based approaches that allow societies to achieve their environmental objectives at lesser cost. Examples like the U.S. midwest’s famous experience with fighting acid rain with cap-and-trade have demonstrated in real terms the substantial economic advantages of such policies.
With that as background, a recent survey undertaken by us at Sustainable Prosperity, an Ottawa-based green economy think tank, provides some hope: environmental markets are thriving in Canada. Sustainable Prosperity’s estimate, based on an assessment of current air, water and biodiversity markets in Canada, found that the 57 markets are worth $462-$752 million annually.
This is a good start, but environmental markets still are not meeting their full potential in Canada.
The challenge is twofold: developing the right structure and regulatory framework for each environmental market and maximizing investment.
Right now, the structure of many Canadian environmental markets prohibits or hampers trading. For some, this is due to practicalities involving the interchangeability of credits. In other markets, there is clearly scope to enhance market liquidity and/or the availability of pricing information. An interesting development in this regard is Quebec’s decision to link its forthcoming cap-and-trade system with California’s. The gains from trade for Quebec, in terms of lower cost from the broader availability of credits and the opportunity to sell Quebec credits into the California market, could be substantial.
Right now, in more than 50 per cent of Canadian environmental markets, especially in water and biodiversity markets, government is the main buyer. There is an opportunity to increase private sector involvement in these markets to help them grow, but this requires policies that enable their involvement while providing the appropriate regulatory oversight.
Investors should identify opportunities to participate in existing and emerging markets as lenders, financers, and insurers, and lend their expertise to helping build market infrastructure. The key role for the financial sector is as a “market-maker” — facilitating the purchases and sales of credits — and as an advisor for clients.
For financial service providers to get more involved in these markets, their clients need to get more involved. More companies need to think more deeply about environmental risks, dependencies and opportunities, and how involvement in environmental markets can help them secure access to ecosystem goods and services.
Policy-makers set the frameworks in which investment decisions are made, but the financial sector is the only part of the economy capable of providing the kind of capital needed to scale up existing investments beyond their current small scale. Further, investors need to develop models to understand the new revenue streams that market-based environmental instruments can create.
Policy-makers have a role to play in identifying opportunities to scale-up and modify the structure of existing markets for increased efficiency and better governance. They, together with researchers, can also identify necessary data for good market functioning and ensure that it is collected and shared.
Researchers have a vital role here: by understanding the functioning and sensitivities of ecosystems, we can ensure that environmental markets are soundly designed to protect the ecosystems we all depend upon. Better baseline data on environmental conditions and policy performance is a necessity.
Environmental markets are just one of many tools that can be used to protect the environment. They are a tool that — when well-designed, with the appropriate institutional and regulatory structure — can produce good outcomes for both the environment and the economy.
Due to the unique nature of ecosystem goods and services, there may be limits to the expansion or use of these markets. However, the opportunity to secure or restore the quality of our environment can also make financial sense, and the right policy incentives can help to make it happen.
Investors, policy-makers and researchers all have a role to play in maximising the benefit that Canada can get out of environmental markets. If we do it right, our environment — and our wallets — will thank us.
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