Incentives and Environmental Policies: From Theory to Empirical Novelties

The economic protection of the quality of the environment took shape properly in the middle of the 20th Century when various economic instruments were proposed to policymakers. Today, protecting the environment is essential, as evidenced in the rise in temperatures, the melting of the icecaps, the disappearance of animal species, etc. Moreover, with recent advances in other disciplines (notably in psychology), economists are turning more and more towards non-monetary forms of incentive. However, questions concerning the effectiveness of these forms arise.

Incentives and Environmental Policies deals with the role of the economy in protecting the environment by revisiting traditional economic instruments and pursuing an advanced consideration of the role of new forms of incentive. It appears that, in order to strive towards the best possible environmental quality, policymakers will have to take into account the future of many combinations of socially acceptable incentives.

• Language: English
• Publisher: Wiley
• Release date: Mar 7, 2019
• ISBN: 9781119597476

Book preview

Foreword

This book has arrived on the scene at just the right moment, addressing as it does environmental economics illuminated by incentive theory. The Nobel Prize awarded to the economist Richard Thaler in 2017 is an indicator of the major development undergone by incentive theory over the past few decades, symbolizing its relevance to numerous current issues.

For its part, environmental economics has rarely been so topical in its various facets: from global risks such as the greenhouse effect to localized health problems related to air pollution in large cities to the negative consequences for biodiversity of ever more highly industrialized agricultural practices, to cite just a few striking examples.

The contribution of economists to the analysis of individual behaviors is enabling us to assess and reform public policies on these burning issues. Modern theory has overhauled the approach considerably by emphasizing the role of intrinsic incentives (an area long left to psychologists alone) alongside the extrinsic incentives more familiar to economists, such as taxes and subsidies, or market mechanisms if market structures have already been established.

The central question of environmental political economics is, in theoretical terms, the way in which common goods such as non-renewable natural resources (oil, minerals, etc.) as well as renewable ones (arable land, forests, unique ecosystems, renewable resources of all types, etc.)¹ should be managed. Another way of expressing the problem in economist-speak is: How can externalities be internalized? Externality, in the case of exhaustible resources, stems from asymmetrical interaction between generations: oil consumed by current generations is a market object that excludes future generations – which are not present at the negotiation table. Externality in the case of natural resources stems from individual behaviors such as pollution or over-exploitation that are not compensated for by monetary transactions. In both cases, the market prices of goods produced using natural resources (or environmental resources in general) are therefore false, meaning that individual behaviors based on these prices are also inappropriate in terms of the common good.

For an economist, the existing market mechanisms supposed to be spontaneously driving decentralized economic systems toward a socially optimum form are insufficient or even non-existent in the case of uncompensated externalities. This situation must be remedied by causing the socioeconomic system to resume a state of being correctly market-oriented, one way or another. This means correcting market failures, for example, via taxes or public subsidies, or even creating markets, as in the case of greenhouse gas emission rights systems, the first major international application of which was the Kyoto Protocol, which was signed in December 1997 and took effect in 2005.

Applications of incentive theory are paving the way for a new approach to environmental policy, by playing on individual motivations that are not directly economic without being normative in the sense of administrative or legal regulations. Individuals (fortunately) are not the purely individualist, rational actors postulated by standard economic theory; they are able to act while taking into account the common good. They can also be manipulated for a good cause if their various cognitive biases are exploited. It is to all of these questions that this book is devoted, exploring various dimensions throughout its chapters: how can the role of incentives in general and environmental incentives in particular be analyzed and justified? Which incentives (monetary or non-monetary) should be chosen? How do incentives interfere with the spontaneous motivations of actors? Where do these mechanisms, aimed at individuals, fall within the logic of organizations and institutions?

Chapter 1 written by Nathalie Berta addresses the history of incentives in environmental economic thought. It is fascinating to note while reading this chapter how the issues invoked have been present at least since the early 20th Century, and to observe the extent to which the issues have remained fresh. On the other hand, analytical tools have advanced considerably, as have concrete applications in terms of public policy (and organizational strategy). On a personal note, as a doctoral student and then a young researcher in the 1970s and 1980s, I studied highly theoretical models of rights markets (to exploit or pollute) with little idea that, some years later, a whole section of the international community would be attempting to implement a global emissions rights market. Chapter 1 neatly summarizes the entire evolution of economic thought in interaction with its applications, from the first theoretical contributions by great authors such as Marshall, Pigou and Coase to new approaches based on the recognition of the cognitive biases that affect decisions impacting the environment. Chapter 2, written by Nguyen-Van and Pham, revisits this history of theoretical forms of environmental regulation by discussing the respective causes of the ineffectiveness of the policies corresponding to them. Included are a discussion of Pigovian taxes, the externality market introduced by Coase, regulation and the taking into account of behavioral biases.

Chapter 3 by Ouvrard and Stenger on regulation through nudges directly addresses the new literature on regulation taken from research in psychology and experimental economics to discuss the implementation of new regulatory instruments. Unlike traditional instruments, a nudge is a simple, cost-effective and non-restrictive action. The objective remains the same: guiding individuals so that they make decisions that will improve their own well-being or that of society as a whole. This raises two types of questions:

– If individuals can improve their behavior, does this mean that they are not naturally rational, for example, when they do not have all the information necessary to make a decision, or when they display any cognitive bias. We must understand, then, which types of cognitive limits are precisely targeted by policies utilizing nudges.

– If individual actions are guided, this raises an ethical question. Does a nudge respect individual autonomy? Is there a risk of manipulation in the negative sense? Because nudging is based on the existence of a cognitive bias, does it not then reinforce this bias?

Two types of experiments could help to assess the interest of green nudges (that is, nudges applied to environmental policies) and to determine whether or not they are superior to monetary instruments, confirm their social acceptability, and possibly aid reflection on their ethical risks: full-scale experiments (for example, on water or electricity consumption), and laboratory tests on subjects (experimental economics). Real-life experiments certainly have the advantage of realism, but experimental economics enables us to compare the effectiveness of various instruments and to correlate these experiments with psychological profiles tested in the same laboratory. Thanks to this research, economists can help regulators to implement nudges with the benefit of anticipating their relative effectiveness, and even to avoid certain problems, such as the boomerang effect (for example, in the case of a plan that acts on individual information and competition, when the more virtuous subjects may slacken their spontaneous effort upon comparing themselves to less virtuous subjects).

Here, readers will find a complete introduction to all the ways of influencing behavior based on the psychological characteristics of individuals: ego and self-image, comparison to others, preference for simple information, preference for the status quo while being attracted by anything that appears new, playfulness, etc. Understanding the characterology of the target helps in choosing the correct instrument. For example, information on their contribution to the greenhouse effect is a priori ineffective with a climate-change skeptic. We may therefore try other nudges, or fall back on the use of monetary instruments.

Chapter 4 by Bazart and Romaniuc focuses on the question of motivation. Pro-environmental behaviors must be examined in all their complexity in order to avoid the negative effects of certain policies. Here, current waste-prevention policies are evaluated in light of an understanding of the complexity of individual motivations.

The standard economic tool on which many policies are based is the principal–agent theory. The incentive system constructed by the principal (the government or insurance company) must change the agent’s (citizen, civil servant, insurance policyholder) perception of the task delegated to them. This type of instrument is usually monetary, playing on the cost or benefit to the agent. For example, the motivational pricing of the weight of waste produced (measurement has been mandatory in France since 2014) is meant to send a price signal to households to encourage them to engage in pro-social (pro-environmental) behavior. The problem becomes more complicated if there is an existing incentive that predates monetary motivation. Understanding people’s real cognitive and behavioral systems makes it possible to broaden the range of tools aimed at guiding their behaviors by changing their perception of their actions. This understanding of the complexity of motivations is also useful in avoiding the pitfalls of potential conflict between intrinsic motivation (personal ethics or social pressure) and extrinsic motivation (economics). The fact that one type of incentive can degrade another explains the fact that some traditional (monetary) policies fail completely to attain their objectives. In reality, monetary incentive changes the agent’s perspective and runs the risk of weakening their ethical motivation rather than adding to it.

These observations concerning the psychology of economic actors are surprising only to economists; to psychologists, they are classic. However, since more interdisciplinary research was undertaken by researchers including Kahneman and Tversky beginning in the 1990s, a school of economists has been working to make decision-making theory more realistic and develop methods of experimental economics that contrast sharply with the traditional normative approach. Taking people for what they are (humans) and not what they should be (homo oeconomicus) constitutes significant epistemological progress. One application of the concept of motivational policy is as follows: monetary compensation offered by the principal is sometimes ineffective, as it diminishes the agent’s perception of his/her own personal value; the resulting loss of self-esteem has a negative effect on the altruistic capacity of the agents, which guides their behavior in the wrong direction.

In addition to pure psychology, there is also a social dimension here. Interactions such as reciprocity mechanisms further complexify the principal–agent pattern, making projections based on standard economic models more and more unrealistic. As in the case of game theory, in which evolution must be prompted by introducing irrational motivations, it is important to understand that individuals take positions that exceed basic utilitarianism. The hypothesis of methodological individualism key to standard theory is found wanting when actors reason according to collective or moral challenges or social representations. Altruism and the desire to punish are both deep-seated motivations for real behaviors.

In the case of waste reduction policies, studies make the decision-making patterns of users quite clear. If we wish to modify behaviors using pricing measures, it must be done on a massive scale, as weak monetary incentives have proven to be counterproductive.

In the final chapter of the book, Magali Jaoul-Grammare further explores the social psychology dimension of pro-environmental behaviors through the introduction of educational bodies. Education for Sustainable Development (ESD) as extolled internationally by UNESCO is an interesting example of the taking into account of the cultural dimension in environmental policies. It is clear that financial incentives are not enough – even when accompanied by the effects of political announcements and technological solutions – to meet the challenges of sustainable development. Education has a vital role to play in shaping future generations; it is a veritable catalyst for pro-environmental behavior. We must analyze with precision these attitude-shaping mechanisms, which come prior to acting and kick off processes of imitation and learning (engagement theory, which shows the interest of a preparatory act, which costs the individual little effort, but serves as a sort of primer or initiation). If education is done well, it gives the individual not only knowledge, but actor status via preparatory acts that will lead to spontaneous future actions. The chapter lays out this issue, using as an illustration the evolution of French educational policy, specifically the passage of education from being about the environment to being for the environment.

Jean-Alain HÉRAUD

2019

1 We have chosen here to adopt the terminology used by a great economist who contributed to a reworking of the economic approach to natural factors in the 1970s (and who spent several years in Strasbourg during that period), Nicholas Georgescu-Roegen.

Introduction

In its simplest sense, motivating an individual means pushing them to act in a given direction. If we raise the question in the context of environmental protection, it is because we do not put enough thought into the impact of our actions (purchasing of goods, consumption of energy and natural resources, transportation, etc.) on environmental quality and its degradation. Given the various manifestations of climate change (increased temperatures, melting of glaciers, etc.), it appears necessary to change our behaviors.

In France, the importance of the environmental question is shown by the fact that it is no longer possible for presidential candidates not to have an environmental component on their political agenda (Bontemps and Rotillon, 2013). This observation is also true at the global level, with the withdrawal of the United States from the 2015 Paris Agreement, which provoked strong reactions from other signatory countries.

To fight against climate change, governments have implemented various types of measures to improve environmental quality over the past several decades: environmental laws, subsidies, emission permit trading systems, etc.

The goal of this book is to provide an accessible introduction to the group of economic instruments that have implemented in recent years as part of environmental regulation. We have tried to take an original approach by beginning with the history of environmental regulation in economics, and then moving on to more recent forms of incentivization (non-monetary incentives; the role of motivation and education).

This book has been designed so that readers can peruse it, however, they choose. The chapters can be read in order so as to appreciate the historic dimension of the implementation of various economic incentives up to the present day, but the reader can also dip into it as desired, depending on the type of instrument he or she wishes to examine – however, Chapters 1 and 2 should be read together, as they constitute two sides of the same coin: the historic aspect of monetary incentives in environmental economics is introduced in Chapter 1, and the applications of these incentives in Chapter 2.

What are the incentives for environmental regulation?

Before discussing