Environmental Policy

Author: Luis Häcker, March 31, 2025

1     Introduction

Environmental policy can be summarized as the collective choices a society makes with regards to the environment, shaping the interaction between people and their surroundings, regulating the access to vital resources and ensuring their fair allocation. It has the power to ensure the livelihoods of the current and following generations. As the environmental challenges we are facing today are only expected to intensify¹, the goals, strategies, and instruments of environmental policy are increasingly becoming a highly discussed topic not only in scientific circles but also in national and international governmental bodies and mass media outlets. This increasing focus is reasonable, considering the impactful consequences that environmental policies have on all societal levels from national to international, and from private to professional spheres.²

Furthermore, predictions by the IPCC suggest that thus far the combination of announced and implemented environmental policy measures has not been in line with the agreed upon target of limiting greenhouse gas emissions to a level that ensures a global temperature increase of under 2°C.³ These apparent insufficiencies of past and present climate policy measures necessitate the revaluation of environmental policy to ensure that more effective solutions can be found. Hence, understanding where we are today in the vast field of environmental policy research, and knowing of important debates in the scientific community becomes essential for all, as their outcomes might shape the very livelihoods of people across the globe regardless of their socioeconomic status. This thesis is aimed to form a part of this rather large educational task, with the goal of providing a comprehensive and interdisciplinary overview on important instruments and issues. It is not necessarily aimed at furthering the scientific discourse, but rather at making the important aspects and implications of this topic accessible and understandable for non-academic actors like NGO’s, firms, and individuals. To do so, this work is aimed to become part of the sustainable management wiki, thus the selection of specific areas of focus was influenced by which topics already have dedicated articles. Therefore, topics like corporate social responsibility or Carbon border tax alignment were only briefly mentioned as further information can be found in the respective articles.

To achieve these goals, thesis is fusing a literature review of modern research regarding environmental policies with a synopsis of foundational literature. Accordingly, the structure of this paper follows this aspiration and provides the reader with an overview on key concepts, a short introduction into the general policy making process, as well as an impression of important moments in the historical development of environmental policies and emerging trends throughout the last century. The subsequent second part of this thesis is based on a review of contemporary literature. In order to provide a holistic understanding of the complex and multi-level nature of environmental policies the most relevant instruments are critically examined from an economics perspective. The next part of the review focuses on the direct and indirect economic effects these instruments may have, as well as the most important scholarly debates surrounding them. In the last part of this review, the effects of environmental policies are explored from a more management-oriented perspective in order to deliver insights into how companies react to them. Thus, the overview provided is inherently inter-disciplinary and aims to highlight the most important perspectives on environmental policy research to the reader. These insights are further explained and visualized by looking into specific cases and their outcomes to ensure proximity to real-world cases, which is often limited in exclusively theoretical works.

At the end of this paper, these insights are synthesized into practical implications. These are twofold, with the aim to provide sensible suggestions for policymakers to improve the effects of environmental policies, as well as proposing ways in which decisionmakers in firms can react to environmental policies and regulation while creating possible chances and competitive advantages. 

Prior to an examination of the foundational concepts and the historic background of environmental policy, it is important to understand the methodological approach taken to this literature review and the rationale behind the selection process that led to the use of sources. For this reason, the following chapter provides insights into the hybrid literature review approach used in this work. 

2     Basic Concepts of Environmental Policy

A policy can be described as “a relatively stable, purposive course of action followed by an actor or set of actors in dealing with a problem or matter of concern”.^{11, p. 2} Public policy refers to the actions taken by governments in response to societal issues, and the manner in which they address these challenges. These policies can be tangible and directly address the problem they were designed to solve, or they can be of a more symbolic nature. They may be implemented to appease public opposition or to raise awareness for specific issues, addressing public perception and beliefs to implement long-term institutional changes.¹¹

Accordingly, environmental policy refers to all actions taken by governments that either concern/manage environmental issues or are aimed at preventing them.⁸ It manifests itself in a diverse set of laws, statutes and regulations which are shaped by the actions and attitudes of government officials responsible for implementing and enforcing the law. However, environmental policy is not only shaped by the actions of policy makers but also the lack thereof: If a government chooses not to act, it provides room for other actors to shape the environment to their liking. This inaction also constitutes a form of environmental policy in leaving room for other actors to harm the environment.⁸

Furthermore, the expressive nature of environmental policy should not be underestimated. On one hand it can express the seriousness with which a government or international body is handling environmental issues like the climate crisis. For instance, the signing of the Kyoto Protocol sent an important message about the signatories’ serious intention in managing these problems thoroughly, though little direct actions and practices were included. However, this also holds true when governments decide to slacken environmental policy regulations, as in the case of the Trump administrations rollback of environmental policy measures from the previous government.¹² It underscored their stance on environmental issues to supporters and interest groups alike.^8,13 The rollback of significant environmental policy measures should be recognised as the volatile and short-sighted policy decisions that they are. The signalling virtue of this might have caused irreparable damage to the cause of sustainable development. However, before providing closer insights into the general policy making process to understand how different actors might influence the actual policy outcomes, sustainable development in its role as the key objective for environmental policy must first be defined. 

Sustainable Development as a goal for Environmental Policy

The overarching concept of sustainability and sustainable development should be the primary goal of all effective environmental policies.² It should be understood as a guiding principle and benchmark for developing and implementing environmental policy.¹⁴ However, the literature is sometimes misleading in the interpretation of the concepts of sustainability and sustainable development, referring only to certain aspects of it while excluding others. Therefore, it is important to establish a baseline understanding of these terms.¹⁵ As other works have already described the intricacies of sustainable development, a short definition will suffice as a baseline for the context of this paper. 

Sustainable development aims to integrate environmental protection with socio-economic progress. It is defined as development that meets the needs of the present generation without compromising the ability of future generations to meet their own needs. This definition encompasses two key elements: The essential needs of the world’s poor must be prioritized while recognizing the limitations imposed by technology and social organisation on the environment’s capacity to meet present and future needs. Under this definition, sustainable development aims to achieve a balance between ecological sustainability and intra- and intergenerational justice on a global scale. It represents a compromise between competing values, including economic growth, environmental conservation, and equity both within and between generations with the ultimate goal of transitioning society to a sustainable way of living for all people and the planet.^16,17,18

Based on the definition of sustainable development provided by the Brundtland Report, the Triple Bottom Line (TBL) approach has been developed as a framework for measuring the success of organisations and actors against the requirements of sustainable development. The three lines of this framework refer to the economic, social, and environmental dimensions of sustainable development. In general, the TBL approach constitutes the progression of the environmental agenda to a more holistic and comprehensive understanding.^15,19 Under this definition, sustainable development aims to achieve a balance between ecological sustainability and intra- and intergenerational justice on a global scale. It represents a compromise between competing values, including economic growth, environmental conservation, and equity both within and between generations with the ultimate goal of transitioning society to a sustainable way of living for all people and the planet. ^16, 17,18 Based on this understanding, the ideal environmental policy should adhere to the TBL approach and incorporate economic, social, and environmental aspects into the design of instruments and policy goals. Thus, in the progress of this thesis, the effects of individual environmental policy instruments are going to be examined following the three dimensions of the TBL approach. 

The Policymaking Process 

An important aspect of environmental policy besides its overarching objectives is the process under which these factors are formed. Examining the process of policy development also enables perspectives on possible leverage points non-government actors like firms, scientists or the general public have, to affect policies in their interests. The process of shaping the public sphere in general, or environmental policy in particular, is often highly complex and contentious. 

To explain the intricacies of this process, political scientists have developed several models and theories. Elite theory, for instance, emphasises the influential role of corporate or political leaders who might hold substantially different values compared to the public, to explain why fossil fuel producers have influenced important international agreements to incorporate their interests.²⁰ Other theories, like group theory, explain the outcomes of public policy as a continued tug of war between different interest groups. Here the organizational degree and effectiveness of interest groups is understood as the deciding factor for influencing policy decisions.²¹ Institutional theory on the other hand highlights the importance of formal and legal factors in the policy making process. According to this theory the structure and legal framework of government institutions decides the degree to which interest groups have access to the policy making process.^8,22These approaches represent useful models to explain individual aspects of the policy making process. A comprehensive description of the policy making process in general however is not possible when relying only relying on these frameworks.⁸

The policy process model (also known as the policy cycle) delivers such a general framework. It is able to clarify and categorise the necessary steps in the policy making process in an understandable way, and thus sufficient for explaining the foundational processes of policy making for this paper, even though it may lack some detail compared to other frameworks. The policy process model separates the development of public policy into six distinct phases, as illustrated in Figure 1. The initial step in a government’s response to a public or environmental issue is agenda setting. In this phase, the specific issue is brought to a government’s attention through various channels, such as interest groups, the media, grassroots activism, or other independent actors. An example for this would be the ongoing protest movement in Germany between 2022 and 2024, which can be seen as a push to refocus the government’s agenda on stricter environmental policy.²³ This initial step marks the beginning of formulating a policy response to the identified issue; however, it does not ensure the subsequent implementation of policy measures.^11,24

After a public issue has gained enough political momentum and was identified as prompting a policy response, the government initiates the policy formulation step of the policy cycle. Here the policy goals are set and plans to reach these are made. In this phase, governments often rely on scientific research as a foundation for their decision-making process, allowing contemporary scientific discourses to shape the formulation of policies. Furthermore, the economic, environmental, social administrative, and ethical consequences of the proposed policy measure are considered. To do so, many different actors from the public and commercial domain are involved in this process, which makes this step especially relevant for interest groups and lobby organisations to influence the policy making process.⁸

Following the formulation of policy goals and the necessary measures, a government needs to legitimise them through the legislature. Further actions need to be authorized by the parliament and the legislative process. It is also possible that further adjustments to the policy are necessary to reach a compromise, for the legitimation process to succeed.^8,11Following the formulation of policy goals and the necessary measures a government needs to legitimise them through the legislature. Further actions need to be authorized by the parliament and the legislative process. If no clear majority exist, this step involves the garnering of support of other elected officials or through increased public pressure to secure a favourable vote. It is also possible that further adjustments to the policy are necessary to reach a compromise.^8,11

With the successful legitimation of the policy, the government is able to implement the agreed upon measures. The policy implementation encompasses all activities that are aimed at operationalising policy goals. It usually involves the assignment of responsibilities and the allocation of government resources to the involved agencies, as well as the interpretation of statutory language. Depending on the policies objective and the political system the implementation process can take place on a national, state, or local level. The implementation of environmental policies in the US for instance lies in the responsibility of the individual states. It is important to note that the inner bureaucratic workings shape the ultimate policy outcome in the implementation phase.⁸

Once a policy has been implemented, its progress and performance are evaluated on a regular basis. This evaluation is typically informed by the policy’s initial objectives, although it may also encompass additional criteria such as its distributional impacts and the fairness of its implications across various income brackets. Judicial bodies and the media frequently assume an instrumental role in this evaluation process, providing the government with insights regarding potential policy deficiencies. As with the other phases of the policy cycle, political pressure determines if and to what extent policymakers react to these evaluations and adjust the policy. Such revisions may consist of minor adjustments to specific administrative details, or significant changes to policy goals and instruments. In extreme cases, governments might even decide to terminate the policy and start from the ground up.^8,11

It has become clear that if firms, NGOs or public actors are to influence environmental and public policy, they need to garner enough political momentum. This is particularly true for actors without powerful advocacy, such as grassroots movements or small firms. The most promising step in the policy cycle to influence policymakers and encourage them to act on important issues is to set the agenda for policies. More powerful actors can also influence the policymaking process in its later stages, as they might have more direct access to policymakers. This allows them to influence specific details of policy measures according to their own interests. 

Having established the general objective and process of developing environmental policies, it is important to understand the different contexts in which they are applied. The most pressing of these is the fight against the climate crisis, forming the most significant aspect of environmental policy and the purpose for which many instruments are employed. Consequently, the real-world use cases examined in this paper are predominantly framed by the aim of reducing greenhouse gas emissions. However, it should be noted that environmental policies are applicable to a wide range of issues, including natural resource use, energy politics and biodiversity protection, to name but a few.²Providing a detailed overview on all possible use cases of environmental policy exceeds the scope of this overview. For this reason, a more general approach to environmental policy is taken to explain the basic ideas of environmental policy instruments and effects while exemplifying these with prominent use cases for greenhouse gas emission reduction. The next section is going to provide the foundation for understanding these concepts and their context as it delves into the historic development environmental policy, its research and trends. 

3     Historic Development

Tracing the historical progression of environmental policy development over the past several decades appears crucial for understanding the current status quo. International and national political achievements of the past and present allow the formation of invaluable insights for contemporary policymakers, while observation of historical environmental policy development illustrates the essential role of environmental movements, policymakers, and the scientific community in shaping and implementing effective environmental policies. This chapter aims to provide a comprehensive overview of the historical evolution of environmental policy, highlighting central developments and crucial decisions which have shaped global environmental policy. This progression of environmental policy has been underlined by pivotal milestones reflecting contemporary evolving societal values, scientific understanding, and political priorities. 

3.1 General and Political Development

The early foundations of regulation of natural resource exploitation have been tied to governance. Through property laws, access to natural resources such as land, water, minerals, and wildlife was controlled by governments. Their economic and military activities have significantly impacted the environment in one way or another.^25,26 With the rise of technological advancement, related economic activity, and the environmental quality impacted by it, environmental management and policy became more and more present in the public discourse.¹⁰ First efforts in regulating pollution were seen in 1863, when the first major air pollution law was passed in Great Britain, aimed at controlling chemical emissions from alkali works.²⁷ The turn of the 20th century witnessed the emergence of grassroots environmental organizations in the US such as the Sierra Club (1892) and Audubon Society (1905), blending preservation advocacy with policy influence.^28,29 These organizations played a crucial role in shaping public opinion and influencing environmental legislation, fuelling the emerging interest in environmental protection. The concept of modern environmental policy thus emerged more distinctly in the 19^th century, when governments began taking deliberate actions to safeguard specific natural assets, such as the early conservation efforts in the establishment of Yellowstone National Park in 1872.³⁰ This period also saw the emergence of influential figures such as John Muir and Gifford Pinchot, who advocated for wilderness preservation and sustainable resource management, respectively.²⁵

These early efforts laid the groundwork for future environmental policies by establishing the principle that natural resources and landscapes warranted protection. The unprecedented economic growth and industrialization of the post-World War II era led to improved living standards on one hand, and increased pollution and environmental degradation on the other. This period saw the publication of Aldo Leopold’s “A Sand County Almanac” in 1949, which introduced the concept of a “land ethic” and emphasised the interconnectedness of humans and nature. Leopold’s work would prove influential in shaping environmental thought in the decades to come.⁸

However, it was not until the 1960s, with the rise of environmental consciousness and the establishment of comprehensive environmental laws, ministries, and agencies, that contemporary environmental policy truly took shape. The decades ranging from 1960 to 1980 formed a noteworthy time for wide-ranging regulatory improvement fuelled by overall ecological comprehension, as seen by Rachel Carson’s highly influential 1962 publication, “Silent Spring,” universally acclaimed for initiating the present-day ecological movement via its unveiling of many perils of pesticides. This publication was indeed used in the European parliament seven years later to advocate for the expansion of the Commission’s task to additionally include information on air, water and noise pollution in the future. Until 1969, discussions and debates around pollution were rarely observed, for example, in the European parliament. One of the pivotal events of the 1960s which further spurred public discourse around the need for environmental policy was the Rhine fish kill in the summer of 1969, with parliamentary members demanding a focus not only on increased research, but actual environmental policies in the European Parliament. ³¹

The first Earth Day in 1970 further mobilized public opinion and helped push environmental issues onto the political agenda. This heightened awareness led to the enactment of landmark legislation in the United States, including the National Environmental Policy Act (1969), the Clean Air Act (1970), and the Clean Water Act (1972). These laws established a comprehensive framework for addressing environmental issues and set a precedent for similar legislation in other countries.⁸ On the international stage, the 1972 United Nations Conference on the Human Environment in Stockholm marked a significant milestone. This first global environmental conference led to the creation of the United Nations Environment Programme (UNEP) and signalled a growing recognition of the need for international cooperation on environmental issues.³² In Europe, the formal publication of the Environmental Action Programme (EAP) in November 1973 was the result of the Paris Summit meeting of heads of state of the European Economic Community (EEC) in October 1972 and its subsequent tasking of the European Commission with designing an action program for environmental protection. By the mid-20th century, environmental policy gained significant momentum across member states of the Organization for Economic Cooperation and Development (OECD): Within a few years, nearly all OECD countries had established national environmental agencies or ministries, impacting legislative activity. Data indicates that the average number of major environment-related laws enacted annually in OECD countries increased from 0.8 between 1956 and 1960 to 2 per year from 1961 to 1965, then to 3.6 per year from 1965 to 1970, and finally to 6.2 per year during the period from 1971 to 1975.

The 1980s and 1990s saw the emergence of global environmental governance structures. The United Nations signed the Montreal Protocol in 1987 to address ozone depletion which became a framework for international environmental agreements. In 1988, the Intergovernmental Panel on Climate Change (IPCC) was established with the intention of forming a scientific basis for understanding and addressing climate change. The 1992 Earth Summit in Rio de Janeiro further advanced global environmental governance, producing key agreements such as the United Nations Framework Convention on Climate Change (UNFCCC) and the Convention on Biological Diversity.^32,33 With the 20th century drawing to a close, climate change thus became an increasingly central focus of environmental policy, reflected by The Kyoto Protocol, adopted in 1997, which set binding emission reduction targets for developed countries, marking a significant step in global climate policy. The early 2000s saw further developments, such as the launch of the European Union Emissions Trading System (EU ETS) in 2005, which created the world’s first major carbon market.⁸ Recent years have shown the development of environmental policy in response to a growing state of scientific knowledge, methodology, and instruments, as well as changing global dynamics. The Paris Agreement, adopted in 2015, represented a global commitment to limit temperature increase to well below 2°C above pre-industrial levels, marking a shift towards a more inclusive approach to climate policy and involving commitments from both developed and developing countries. The same year saw the adoption of the United Nations Sustainable Development Goals (SDGs) by all member states, which integrated environmental sustainability with broader development objectives, recognizing the interconnected nature of environmental, social, and economic challenges.⁸

Trends in Political Development

Meadowcroft gives a detailed description of the political trends in environmental policy, which is summarized in the following section. Since the late 1980s, environmental management has evolved into a central component of state governance, driven by shifts in policy approaches and expanding environmental challenges. Initially, environmental policies focused on regulating emissions separately across media such as air, water, and land. However, this fragmented approach gave way to integrated pollution control systems that assess the overall environmental impact of industrial facilities and sectors. Governments transitioned from reactive measures like end-of-pipe treatments to proactive strategies emphasizing pollution prevention and the greening of production processes. Furthermore, traditional “command-and-control” regulations were supplemented or replaced by market-based mechanisms and negotiated agreements, fostering greater involvement from businesses and civil society.²⁵

Another significant development was the integration of environmental considerations into broader governmental activities. Instead of being confined to one ministry, environmental concerns began influencing decision-making across sectors such as energy, agriculture, and transportation. This shift acknowledged the interconnected nature of environmental issues with economic and social practices. For example, habitat protection became linked to forestry policies, and climate change mitigation was embedded within energy strategies.²⁵

Over time, governments deepened their engagement with environmental issues by adopting more sophisticated frameworks that account for ecological constraints. Concepts like ecosystem-based management, life cycle analysis, and ecological fiscal reform gained traction in official programs. Examples include the focus on ecosystem protection over individual species conservation and catchment-based water management under the EU Water Directive. These approaches reflect a growing recognition that addressing environmental problems requires systemic adjustments to production and consumption patterns.²⁵

The internationalization of environmental policy further reinforced its importance within state functions. Global agreements such as the Stockholm Conference (1972) and the Long-Range Transboundary Air Pollution agreement (LRTAP) necessitated national commitments and implementation efforts, elevating environmental governance on political agendas. Additionally, public debate and media interest have ensured that environmental issues remain central to political discourse. This ongoing engagement has strengthened the legitimacy of governments by linking their credibility to their ability to meet environmental commitments.²⁵

Contemporary environmental policy is increasingly focusing on concepts such as the circular economy and nature-based solutions, reflecting a more holistic approach to environmental management. However, as Kraft (2018) notes, the implementation and enforcement of environmental policies remains an ongoing challenge, particularly in the face of competing economic interests and political ideologies.⁸ The history of environmental policy development reflects a growing recognition of the complex, interconnected nature of environmental challenges and the need for coordinated, global action. From early conservation efforts to contemporary climate agreements, this evolution demonstrates the dynamic interplay between scientific understanding, public awareness, and political will in shaping our approach to environmental stewardship. 

3.2     Developments in the Scientific Community

The existing scholarly literature on environmental policy reflects an evolution from niche academic discussions and solitary research interests to a central field influencing global governance frameworks. In essence, the development of the scientific discourse regarding environmental policy reflects the evolution of public interest as well as growing political awareness of its importance, related to technological advancements which were on one hand causing environmental issues, while others were developed with the intention to find solutions for these problems. The earliest scientific publication related to environmental policy appears to be rooted in the works of Marquis de Condorcet at the end of the 18^th century, which discussed government intervention to address environmental harm, such as air pollution caused by industrial activities, and advocated for policies to restore environmental quality and promote cleaner technologies. His ideas, though unpublished for a long time, represent early recognition of the links between economic activity and environmental quality.³⁴ In terms of modern academic contributions, Arthur C. Pigou’s The Economics of Welfare (1920) laid foundational principles for environmental economics by addressing externalities and proposing taxes as policy tools to mitigate environmental damage; principles which are still relevant today in the application of environmental policy instruments.³⁵

Moving beyond early influential publications into the 1960s, the connection between environmental policy research and its political development become especially apparent when looking at publication numbers in scientific databases such as Google Scholar or Elsevier for the search term “environmental policy” per decade. These numbers are mainly used to visualize the increase in scientific interest and may include spurious findings or re-publications of earlier work in later decades. The 1960s produced foundational works by Rachel Carson (1962), catalysing public and policy interest in ecological impacts of industrialization, and by Garrett Hardin (1968) who framed resource management debates.^32,33 In general, fewer than 100 publications relating to environmental policy could be found on Google Scholar, with the titles frequently  reflecting the initial emergence of environmental topics in relation to policymaking, such as “Environment: a new focus for public policy?”.³⁴ Results on Elsevier number around 1,600, although an initial screening of the literature revealed results relating largely to “environment” and “policy” in separation but not as a combined entity. 

For the 1970s, approximately 5,000 articles and reviews could be found on Elsevier, with topics ranging from pollution control and the impact of international conferences. Notable publications of this decade include the Stockholm Conference Report (1972), which established the link between development and environmental protection, leading to the creation of UNEP.⁸ The 1970s framed technological advancements such as the increasing use of automobiles and associated air pollution, as well as the growth of industries that generated significant waste and pollution. These developments then prompted the first the rise of environmental regulations during this period.¹⁰ The 1980s saw a further increase in publicized literature and studies (approximately 18,378 articles and book chapters found on Elsevier), with literature expanding to include comparative policy studies and sustainable development, such as the Brundtland Report (1987), which introduced sustainable development as a global policy goal and is cited extensively in academic literature.¹⁷ In the 1990s, a marked increase in publications can be observed, with approximately 36,000 articles being listed under “environmental policy” for this decade on Elsevier. The scientific focus during this time shifted towards global environmental governance, market-based instruments, and integration of environmental concerns into broader policy domains. The time period from the 1980s onwards also saw the development of computer-based information processing, which facilitated the distribution of environmental information to the public, increasing transparency and holding polluters accountable. On the other hand, environmental monitoring and assessment was significantly enhanced by these developments, leading to an improvement in the information base which enabled policymakers to better understand environmental problems, track progress, and design more effective policies.¹⁰

In the first decade of the new century, the scientific discourse revolved increasingly around climate change instead of toxic pollution control, with the Kyoto Protocol (1997) spurring research on emissions trading schemes, carbon pricing, and mitigation strategies, as well as a notable peak in climate policy production after it came into force in 2005.³⁹Approximately 66,588 articles and book chapters found on Elsevier revolve around these and related topics in this decade. With environmental policy increasing making use of market-based and technology-support policies, the discourse in the scientific community reflected these developments.⁴⁰ Quantitative metrics such as the Environmental Performance Index (EPI) became widely used to measure policy effectiveness and stringency, enabling cross-country comparisons and informed global negotiations. Building on trends from the 1990s, the 2000s emphasized integrating environmental concerns into energy, agriculture, urban planning, and transportation policies. This reflected a systemic approach to addressing ecological challenges, while international agreements like the Kyoto Protocol and EU directives influenced national policies worldwide, giving rise to global databases such as CPDB and EEA which facilitate comparative research on policy adoption trends. Further, there was a growing attention to biodiversity conservation, ecosystem-based management, and land-use change as critical components of environmental governance.⁴¹ Regarding the technological side of the scientific discourse, this period saw significant advancements in solar, wind, and other renewable energy technologies, making them more cost-competitive and spurring policies to promote the adoption of renewable energy sources, including subsidies and tax incentives (like feed-in tariffs), with the aim to reduce reliance on fossil fuels and mitigate climate change.¹⁰ In summary, this decade marked a shift in the scientific discourse towards addressing global-scale environmental challenges with quantitative tools, interdisciplinary approaches, and a stronger emphasis on climate change mitigation compared to previous decades.

Finally, the time period from 2010 until 2024 provided approximately 420,786 search results on Elsevier for the term “environmental policy”, showcasing the high degree of scientific interest for this research field, reflected in another peak in adaptation of environmental policies in the early 2020s.³⁹ The scientific discourse in the post-2010 period emphasizes innovation-driven solutions rather than purely regulatory approaches, while climate adaptation gained prominence alongside mitigation efforts. Current publications increasingly explore the role of narratives and discourses in shaping environmental governance, examining how framing affects policy implementation and public acceptance.⁴²Furthermore, carbon removal technologies gained prominence as essential tools for achieving net-zero emissions, recognizing the necessity to remove existing atmospheric CO₂ alongside reducing emissions.⁴³ In line with this, the role of innovation in driving environmental policy has become central, with studies examining how policies stimulate environmentally friendly technologies.⁴⁴ Finally, noteworthy technological advancements of this period, such as the application of artificial intelligence to environmental monitoring, forecasting and modelling, now facilitate evidence-based policymaking, improved resource management, and the development of targeted environmental regulations, as well as optimizing energy consumption and reducing emissions. An increase in electric vehicles (EVs) based on advancements in battery technology reduced emissions from the transportation sector, being promoted by the adaption of policies promoting EVs included subsidies, tax credits, charging infrastructure development, and stricter emission standards for conventional vehicles. Finally, the development of smart grids improved the efficiency and reliability of electricity distribution, facilitating the integration of renewable energy sources.¹⁰

In summary, environmental policy has expanded in scope and complexity over recent decades, with an increasing number of policies being adapted since 1990 – a development reflected in an increase in the extant scientific literature and discourse, as well as public discourse focusing increasingly on environmental issues.³⁹ Environmental policy thus serves as the bridge between scientific understanding, societal values, and actionable strategies for ecological stewardship. Its relationship with environmental management, public opinion, and research forms a dynamic ecosystem that shapes how societies address ecological challenges. It now encompasses a vast array of issues, forming a topic of active exploration and research in the scientific community while integrating deeply into state structures. This evolution reflects not only the growing urgency of ecological challenges but also the increasing recognition of their interdependence with economic development, public welfare, and global security. As we face increasingly urgent environmental challenges, the continued development and effective implementation of environmental policies will be crucial in ensuring a sustainable future for our planet.

4        Economic Perspectives on Environmental Policy

The environmental challenges currently being experienced on a global scale have prompted a wide range of policy reactions on all levels of government. These responses have materialized in a plethora of proposed solutions, models and instruments, each with its own set of advantages and disadvantages. The effectiveness of these measures in addressing the environmental problems they are designed to tackle can vary based on a variety of influencing factors. A similar variability is observed in their economic consequences. While most policy decisions have economic ramifications, environmental policies and their instruments exhibit a particularly intricate relationship with the economy.² The reason for this lies in the dependence of all economic activities on a healthy environment, as the economy at large is nested inside the environment relying on its resources to function. Therefore, environmental health should not be seen as another factor of production but a prerequisite for all economic activities.^45,46 Nevertheless, the way in which these issues are addressed from a policy perspective depends on the prevailing views of policy makers, economist, and researchers in the different discussions surrounding environmental policy and its economic effects. These perspectives may influence the choice of environmental policy instruments and approaches policymakers decide on. Therefore, it is essential to understand the most important arguments in these influential debates.²

This chapter aims to provide an overview of some of these discourses. However, this section should not be mistaken for a complete and comprehensive list of all important discussions on the economics of environmental policy. Rather, it should be seen as providing insights into certain important topics, chosen for their general implications for environmental policy and their relevance for future policy decisions. The topics discussed are the different perspectives on economic growth in the context of environmental policy, the debate on demand and supply side instruments, the integration of environmental policies, and the effects environmental policy can have on innovation. These issues should provide a sufficient basis to formulate some practical implications for policy makers at the end of this paper. Before exploring these discourses in more detail, it is essential to understand the economic perspective on environmental problems, its core concepts and the options available to policymakers to address environmental issues. 

When breaking down general societal issues, economists tend to explain them as a discrepancy between the actual and the societal optimal outcome in the market allocation process. If there is a difference between these two, a market imbalance or market failure is in place and the application of correcting measures should be considered. The reasons that cause this imbalance are numerous and hard to pinpoint. One economic explanation for market failures are external effects with environmental problems being the most prominent example.⁴⁵

External effects, or externalities, are described as the dependence of one individual’s utility-situation onto another individual’s actions. In the context of environmental problems external effects refer to negative impacts on the environment due to the economic activities of market actors. Economists identify the core of this problem as the absence of a market mechanism which allocates the costs of the negative effects back to its perpetrator so that the costs of removing the negative environmental effect are reflected in the costs of production. In other words, a market failure takes place. If a mechanism is brought into place to address this market failure, ensuring the realignment of societal costs and costs of production, it is understood to achieve the internalisation of external effects.^45,47

Deliberations on such measures have been at the centre of environmental economic research. A key theory for the internalisation of external effects is the Coase Theorem. It postulates that externalities can be resolved through private bargaining between affected actors if property rights have been assigned and the cost of negotiating is low. If these conditions apply, parties will negotiate a mutually beneficial solution and thus resolve the external effect through extending market mechanisms to include the environment. However, this theory has very limited potential for real-world application, as negotiation costs are usually high, and property rights are difficult to assign in the context of environmental externalities.⁴⁵ Economists understand the intervention of governments through the implementation of environmental policy measures as a more realistic solution to internalise or prevent external effects. Furthermore, from the economic perspective the dimension of total cost is used to determine the most desirable policy measure. Thus, a policy instrument that reaches an established objective at the lowest possible cost to society should be preferred above all other options.^45,47

The following sections on environmental policy instruments will show that this theoretical ideal is seldomly achieved in practice, as many other factors also influence policy instrument choice.

4.1 Environmental Policy Instruments

Environmental policy relies on a diverse set of economic instruments designed to regulate, incentivize, or guide behaviour toward sustainable outcomes. These policy instruments can generally be categorized along two dimensions as shown in Figure 2. This classification proposed by Russell and Powell (1996) and later expanded by Jordan et al. (2003) arranges environmental policy instruments according to the specific environmental goals they aim to achieve and the methods they utilize to achieve these goals.^48,49 The framework provides a structured way to classify these tools according to their methods and goals, highlighting the stark differences between market-based instruments and regulatory methods often referred to as command-and-control policies. These approaches occupy opposing roles in contemporary debates on environmental policies.²

This framework can provide a general idea on the differences between certain forms of environmental policy instruments and thus is applied to provide structure in this overview to categorize and describe the different instruments. However, such a generalizing framework also has its drawbacks as some instruments like cap-and-trade systems, generally seen as a form of market-based instrument (MBI, see section 5.1.2), do not have the characteristics associated with MBIs according to this framework, as they usually have a specific target for environmental harm reduction. For these reasons, the application of such frameworks should always be approached with a degree of scepticism.

In the scientific literature there seems to be no general agreement on which policy instrument should be regarded as the best or most useful one for policymakers. The reason for this ongoing debate lies in the individual strength and weaknesses of each instrument type as well as the context in which they are applied. More contemporary research has shown that there may not be a “one fits all” type solution for environmental policy instruments. It has become clear that only a combination of several instruments into a policy mix adjusted to a specific socio-economic context can achieve the best environmental and economic outcomes.⁵⁰

Before diving deeper into the topic of policy mixes, a closer look into the most prominent instruments seems sensible to understand their individual characteristics. Therefore, the next sections explore these instruments, their individual effects, as well as their strength and weaknesses. They were selected for further assessment due to them being the most discussed in the contemporary research as well as their practical implementation in national and international environmental policy efforts. It is important to note that the instruments outlined in this work do not represent the full range of available options for policymakers. However, a more comprehensive presentation of environmental policy instruments is not possible within the limited capacity of this work. The order in which the instruments are examined should not be seen as a way of prioritization as their practicality depends on the specific policy contexts. 

The first set of instruments identified for this work are regulatory approaches. These include command-and-control measures and set minimum performance standards, either in the form of absolute environmental targets or specific limits on emissions and pollutants. However, regulatory measures are often subject to industry influence, with large polluters lobbying for exemptions, such as “grandfather clauses” that protect existing firms from compliance.²

The second type of instruments are the so-called market-based instruments (MBI). These focus on achieving the internalization of external effects. Thus, they are aimed at assigning prices to environmental damages to allow market mechanisms to adjust and minimize environmental harm These goals can be achieved through different approaches, and they can differ significantly. Therefore, the most prominent forms are going to be examined further.²

Environmental taxation as a form of MBI aims at raising the cost of environmentally harmful activities such as energy consumption and transportation through a tax. It is suggested that they form an effective tool against rising emissions however it is challenging to rally public support for rising tax levels.⁵¹ Furthermore, they are often faced with the same challenges as regulatory approaches. Especially interference by industry actors pose a threat to their effectiveness.²

Cap-and-trade systems on the other hand do not have a predetermined price for environmentally harmful activities. They aim at achieving the pricing through a trading scheme. A prominent example is the EU´s emissions trading scheme which was implemented in 2005.⁵². Schemes like these can allow for cost efficient reductions in environmentally harmful emissions. However, they are highly dependent on well-established institutions and administrative structures as well as on carefully setting the emission prices to avoid overallocation of permits.²

Beyond regulatory and market-based instruments information-based measures have emerged as an easy to implement way for changing the behaviour of firms.⁵³ Technology-push instruments on the other hand refer to policy methods that incentivise desired behaviour usually through subsidies for research and development (R&D) or in the case of renewable energy through predetermined feed-in tariffs.² Though feed-in-tariffs incorporate some market-oriented mechanisms they are generally not considered to be pure MBI. They are usually used in the context of energy production and provide energy electricity producers with a fixed tariff for each produced unit.⁵⁴

Apart from their individual strengths and weaknesses the effectiveness of environmental policy is most often determined by a combination of different instruments in a policy mix. Given the complexity of environmental challenges, it has become clear that no single policy instrument can effectively address all issues across different contexts. Thus, successful policy implementation typically requires a combination of instruments on different levels. A “one fits all” solution appears to be an unrealistic to target the complex problems addressed by environmental policy.²

Moreover, it is essential that policymakers acknowledge the barriers that can hinder policy effectiveness, including economic constraints, cultural resistance, stakeholder opposition, and legal limitations. Addressing these challenges requires a careful approach that balances regulatory oversight with economic incentives, ensuring that environmental policies are both effective and adaptable to diverse political and economic landscapes.⁴⁹ The following sections aim at critically examining these instruments and their individual challenges in more detail.

4.1.1      Regulatory Approaches

Regulatory approaches, also referred to as command-and-control instruments, are fundamental tools in the metaphorical toolbox of policymakers. These approaches involve direct regulation by governmental bodies, specifying standards, targets, or methods that firms, plants, or citizens must adhere to in order to control pollution and protect the environment. They are aimed at restricting or even prohibiting the production, use, or disposal of harmful emissions and substances and form the mainstay of governmental reactions to environmental problems. Through their direct effects they have shaped the public perception of environmental policy in the last decades.^24,55

A common approach for command-and-control instruments is the specification of permitted pollution levels for individual polluters. This is typically achieved through the issuance of licences or permits that stipulate the allowable level of pollution and the conditions under which polluters are allowed to pollute. The allowable pollution level is typically defined in terms of a source level emission rate, meaning the aggregate emission level is not directly controlled. This can result in rising aggregate emissions if production increases or if more polluters enter a market, as aggregate emissions are dependent on the total number of polluters.⁵⁶

Command-and-control instruments are usually applied in the same manner to all polluters of a given regulated industry. If the costs of abatement for each polluter are similar this approach can be considered cost-effective. However, in the case of differing abatement costs between polluters, these regulatory approaches can lead to outcomes that are not cost effective, as these policy measures usually do not allow for the reallocation of abatement measures if individual polluters face high abatement costs.⁵⁶

In addition to directly limiting or prohibiting the emission of harmful substances into the environment, regulatory approaches may also incorporate technology standards and performance-based standards. Technology or design standards stipulate specific technological specifications, applicable to either the production process or the end product. In this case, policymakers define the reduction of pollution, ensuring a high degree of certainty in achieving environmental improvements. This can be beneficial in situations where monitoring emissions incurs significant costs, but the control of the applied technology standard is relatively straightforward. In this case, the method of compliance for polluters is specified, offering little to no flexibility or cost-effectiveness in reducing emissions. Consequently, polluters may be reluctant to explore more effective or innovative abatement measures, as they may face technological lock-in effects over time. Examples for technology standards are the mandatory installation of filters in waste disposal plants or the mandate for catalytic converters on cars in order to limit harmful emissions.

Performance-based standards, on the other hand, refer to regulations that mandate a specific level of emission, providing polluters with some degree of flexibility for achieving set targets. These emission targets may be absolute for a specific polluter or refer to emissions per unit produced. When designing performance-based standards, policymakers base their emission reduction goals on what is technologically feasible, as opposed to mandating the use of a single technology. This approach enables firms to achieve emission targets at a lower cost compared to technology standards. However, they may not offer significant incentives for firms to innovate and enhance their production processes in order to further reduce emissions.^56,57

The social, economic and environmental effects of command-and-control approaches are multi-faceted and have been the subject of extensive research. From an environmental standpoint, these instruments have been recognised for their substantial contributions to effective emission control. However, the effectiveness of these instruments in affecting emission levels is contingent on their design and implementation regardless of the type of standards employed. Furthermore, policymakers must ensure the effective functioning of enforcement mechanisms to successfully reduce environmental harm through regulatory approaches. To this end, public officials must be granted the necessary jurisdictions and resources. Furthermore, the determination of strict penalties in the case of non-compliance is necessary to effectively deter polluters from infringing against emission targets.²⁴ A good example for the environmental effectiveness of emission standards are the Clean Air Act Amendments (CAAA) of 1970 in the US. Studies have shown that the CAAA led to a substantial reduction in air pollution, particularly in areas designated as non-attainment zones underscoring the potential impact of command-and-control efforts.⁵⁸

On the other hand, the EU´s passenger car emission regulation provides a recent example for a command-and-control measure that failed to reach its objective due to manufactures exploiting vague formulations and inadequate enforcement measures. Especially the case of Volkswagen´s (VW) diesel emission scandal has shown the need for strict control and enforcement of performance standards. In 2014 a research team from West Virgina University revealed that the actual running emissions of VW diesel vehicles were significantly higher than the declared test values. This prompted international outrage and further investigation proved that VW had used a software that recognized if a vehicle was running in a testing environment and in that case adjusted the emission of nitrous oxide (NO_x) levels according to the regulation threshold.^59,60 Further research showed that millions of vehicles were equipped with such software globally. However, it also made clear that the regulations on these “defeat devices” were much vaguer in the EU compared to the US. This left original equipment manufacturers (OEM) in the EU with wider possibilities to bend the set standards to their advantage. These revelations compelled EU policymakers to reevaluate the established policy control, enforcement mechanisms and introduce stricter and more representative forms of emission testing for personal vehicles.⁶¹ The failure of EU performance-based standards for NO_x emissions has shown that it is essential for the environmental effectiveness of regulatory approaches to implement clear and comprehensive standards. Furthermore, this example highlights the importance of working control and enforcement mechanisms in the context of regulatory environmental policy instruments.⁵⁹

Economically, the impacts of regulatory approaches are complex which is reflected in the scientific discourse that has provided diverging assessments of their outcomes. The limited flexibility to reach cost effective abatement solutions for polluters and subsequent negative effects on productivity and economic growth are partially supported by different empirical studies. In the context of US manufacturing, Greenstone, List, and Syverson (2012) found that total factor productivity declined by 4.8% for polluting plants in strictly regulated counties relative to weakly or unregulated counties following the implementation of the 1970 CAAA. However, it’s important to note that these effects are often short-term and can be offset by other factors and policy adjustment.^58,62

Interestingly, some studies have observed positive economic effects in the longer term. Berman and Bui (2001) discovered that refineries in the Los Angeles Air Basin, despite facing stringent air pollution regulations between 1979 and 1992 and a short-term productivity decrease, eventually experienced significantly higher productivity compared to other US refineries. This suggests that regulatory approaches can also drive innovation and efficiency improvements in the long run. Generally, the economic effects seem to depend on the specific context and design of the command-and-control instrument.^58,63

The research regarding social and distributional effects of regulatory environmental policy has found that these instruments have had mixed effects. While they have contributed to improved public health through reduced pollution levels and improved air quality, there have been concerns about potential job losses in heavily regulated industries. Job losses were especially attributed to early emission standards when no regulation was previously in place forcing especially barely profitable plants into closing down. However, these job losses could be partially attributed to a general slowdown of the economy. On the scale of sector-specific employment, the research shows only marginal or no effects of regulation implementation on weakening work place security.⁶⁴

However, it is important to note that employment decrease can be a direct consequence of command-and-control instruments, and research has shown that specially manufacturing jobs in carbon intensive industries may be at risk, leading to public outrage and a rise of perceived economic injustices. Therefore, the careful design of regulatory environmental policy instruments with regard to environmental, economic, and social factors is essential.⁶⁴

The extant literature shows the way in which command-and-control instruments can provide an effective option for policymakers to combat environmental issues with their direct and aimed efforts to stop and prevent undesired behaviour. They also comply with the “polluter pays principle”, ensuring that those who cause environmental damage are also responsible for complying with the set regulation. However, as they are usually aimed at regulating the individual pollution levels of firms and actors, their effects on aggregate emission levels can be difficult to anticipate.⁵⁷

The absence of adequate incentives for polluting industries to reduce emissions beyond the defined target has also led to increased criticism of command-and-control measures. The experience of the EU’s car emissions standards has demonstrated the necessity of regular and comprehensive regulatory oversight to achieve the desired policy outcomes. It has also highlighted the need for policymakers to specify the exact aspects of regulatory instruments in detail, thus increasing the necessary information requirements significantly. This can prolong the time and effort needed to implement such policy instruments. Economists argue that command-and-control instruments require large amounts of government resources, reducing their general cost effectiveness in comparison to other environmental policy options.²⁴In conclusion, while regulatory approaches have been effective in achieving environmental goals, their economic and social impacts are complex and highly dependent on the context in which they are employed. Their limited flexibility and lack of economic incentives have led to suggestions that alternative instruments might be more effective in addressing environmental challenges.

4.1.2      Market Based Instruments

MBIs as instruments of environmental policy aim at internalizing external environmental effects, thus they have the goal of reflecting the costs of environmental damages on the costs economic activity. MBIs incentivize polluters to adopt pollution reduction methods at low costs as polluters can freely choose pollution abatement measures. For this reason, they are often seen as theoretically the most cost effective way to enhance environmental protection.⁶⁵ MBIs can be categorized into policy instruments aimed at price regulation or quantity regulation. Price instruments set a specific price for a unit of pollution, or a unit of renewable energy produced, while letting the quantity adjust itself through market mechanisms. Quantity instruments on the other hand set a desired quantity, for example a specific reduction in emissions, while regulatory markets set the price.⁵⁴

Historically, European policymakers have shown a tendency towards price regulation with environmental taxes, while regulators in the US preferred quantity regulations through cap-and-trade systems and renewable portfolio standards. The reason for this lies in the different strands of liberalism preferred on each side of the Atlantic, ordoliberalism in Europe and neoliberalism in the US.⁵⁴ This division has changed in the last 20 years, however, as hybrid approaches have become the dominant choice in transatlantic policy spaces as exemplified by the coexistence of the EU´s cap-and-trade system with carbon taxes in various member states.⁵⁴ To gain a more in-depth perspective on the similarities and differences between the two main MBI approaches, both are described in more detail below, including an overview of benefits and downsides of each. This may facilitate an understanding of their combinative application in a policy mix. 

Environmental Taxation 

The origin of environmental taxation lies in the idea of the Pigouvian tax. The English economist Arthur Cecil Pigou was the first to propose that external effects should be internalized by means of government action, coming up with the idea of reducing misallocations that emerge through the divergence between private and social costs by applying governmental actions. Therefore, he was the first to propose that external effects should be internalized by the means of governmental actions. For him, the most obvious instruments applicable to this were taxes and subsidies for either negative or positive external effects. These ideas, even though not committed to any specific field of politics or research, have become most commonly applied in the field of environmental policy.⁶⁶

The basic idea for Pigou´s proposed tax lies in the polluter pays principle. The tax´s basic goal is that the perpetrator of a negative externality is taxed by the rate which equals the external marginal cost in the social optimum. This means that the tax would be as high as the not internalized social costs that arise through the production of one more unit. This brings additional costs to the producers if they do not take corrective action. But because producers usually aim at maximising profits, and thus at minimizing costs as well, they will try to minimize their costs as far as they can. As long as the costs of reducing the environmental impact are smaller than the costs of the environmental tax, the assumption is that producers strive to reduce their impact on the environment. Ideally, this would be the point at which the environmental impact of production is reduced to an ecologically acceptable and therefore socially acceptable level.⁴⁵

Applying this to real-world settings is a complicated task to accomplish, as officials need to gather a wide array of information to define the marginal avoidance costs and marginal environmental impact costs for every company in order to calculate the tax rate a given company is asked to pay. This information gathering can complicate tax law and produces a great bureaucratic effort. Thereby the financial gains achieved by the tax could potentially be partly absorbed by the bureaucratic expenses which are necessary to support it.⁶⁶

To avoid these bureaucratic expenditures, the literature provides three different approaches to minimize the necessary effort to raise the Pigouvian tax. The first approach proposes a tiered tax system that increases the tax according to different classes of polluters. To do this, polluters with similar marginal avoidance costs and marginal environmental damage costs are grouped together in a tax class. In this way, it is only necessary to collect precise information to outline the boundaries of each class. Another method is to increase the tax according to differences in total marginal abatement costs and total marginal environmental damage costs per region. Thus, polluters in a region would be taxed at the same rate. The final idea proposed is that of a coherent tax rate, where each polluter would be taxed at the same rate.⁶⁶

These alternative approaches show a reduction in the amount of information needed to determine the tax rate. But at the same time the original idea of calculating the tax rate mathematically by studying the marginal avoidance costs and marginal environmental damage cost curves of the polluters gives way to a looser determination process that is more influenced by political decisions. Before discussing the difficulties of implementing a Pigouvian tax in the real world, it is useful to take a closer look at the effects of environmental taxation and the distribution of the tax burden.

Assessing the impact of environmental taxation on the economic and environmental situation of a country, requires a thorough understanding of the options available to policymakers for using the tax revenue generated. The net revenue option allows governments to increase the size of the national budget through the tax revenue generated by the environmental tax. Although this could potentially make room for more government spending on sustainable development, policymakers usually reject this option for fear of losing votes and opposition from the commercial sector. A revenue-neutral approach is therefore seen as being more favourable for governments.⁶⁷

Apart from possible political opposition, another argument in favour of the revenue-neutral approach is the so-called double dividend. The idea is that the revenue raised from environmental taxes is used to make room for tax cuts in other pre-existing distortionary taxes, such as the income tax. This could stimulate economic growth by giving consumers more money to spend, thus potentially outweighing the distortionary effects of environmental taxation on the economy. The term double dividend therefore refers to the potential of environmental taxation to increase economic efficiency in two ways, both by raising revenue to cut other taxes and by addressing the market failures through internalizing the external effects of environmental harm.⁶⁸ However, even if the benefits from reductions in other taxes are lower than the costs of the environmental tax so that there is no double dividend effect, the tax revenues still can cover for a majority of the administrative costs and so minimise a nation´s costs of reaching their environmental goals.⁶⁹

The positive environmental effects of the introduction of an environmental tax system are difficult to calculate ex ante, as they are linked to many factors that can affect the environmental effectiveness. The most important factors are the tax rate and the time frame in which the effects are monitored. Some studies of carbon taxes suggest that applying the correct tax rate may be very effective in reducing carbon emissions by 40% in ten years. These studies also concluded that there is no linear relationship between the tax rate and the rate of carbon reduction, i.e. doubling the tax rate would not result in the same level of carbon emission reduction.⁶⁸

Even though these numbers seem promising, real-world examples have shown that it is difficult for governments to evaluate the effects of environmental taxation separately from other taxes and macroeconomic development. Some simulations by Hoerner and Bosquet (2000) even suggest that a revenue neutral environmental tax reform could raise CO₂ emissions due to the stimulating effects of cutting taxes and thus stimulating consumption. The importance of anticipating these rebound effects should therefore not be underestimated.⁶⁹

It is also important to consider the social impact of the introduction of environmental taxes. The impacts on income levels can be split into two distinct groups: use-side and source-side effects. While use-side effects describe the impact of environmental taxes on prices for carbon-intensive goods, like electricity and petrol, source-side effects describe the impact on wages and capital income. While low-income households are disproportionally affected by use-side effects, higher-income households face comparatively higher losses from source-side effects. However, lower income groups face more severe consequences. The increased prices account for a 3-5% welfare loss in this group, while reduced income for higher-income groups leads to a 2-4% welfare loss under model conditions. Furthermore, lower income groups have less financial leeway to offset these welfare losses.⁷⁰

In order to meet the social and equity demands of sustainable development, policy makers therefore should implement a system that shifts the tax burden of environmental taxation away from lower income households. To do so, a progressive adjustment to labour taxes, rather than lump-sum rebates, would yield the best results. Policymakers should also abstain from corporate tax cuts as these would risk to amplify the economic distortions between income groups.⁷⁰

To give this theoretical approach on the effects of environmental taxation a better connection to reality, in the following, an overview of the Swedish carbon tax will be presented as an example. The Swedish carbon tax follows the aforementioned idea of internalizing external effects through market measures and is based upon the notion of the polluter pays principle. It was first introduced in 1991 and resembled a change in the existing tax system towards an orientation of tax rates on pollution.⁷¹

When it was introduced, the Swedish government introduced a tax not only on CO₂ emissions but also on SO₂emissions. It also increased other environmental taxes and reduced taxes on fossil fuels by between 25% and 50%. Nevertheless, the changes in the Swedish tax system resulted in a net increase in energy taxes. At the same time, income taxes were reduced by 30%, resulting in a negative budget balance compared to the budget before these changes. This was done with the idea of the double dividend in mind.^69,72

The proposed tax rate for a tonne of CO₂ emissions in 1991 was SEK 250, or 24€, for both the industrial and commercial sectors. The tax was to be increased annually to provide an increasing incentive for more environmentally friendly behaviour. In 1993, after extensive lobbying, the Swedish government reduced the tax rate for the industrial sector to about 25% compared to the rate for the commercial and domestic sectors. Industry argued that the tax would make Sweden less competitive on the world market, leading to layoffs and a decline in the employment rate. This tax rate reduction changed the effective tax rate on energy to a level below that of 1991.⁶⁹ This change was re-evaluated by policymakers in 1997 and the tax rate for the industrial sector was slowly brought into line with the commercial and residential sector. However, this realignment did not take place until 2018, when the tax rates for the two sectors were once again equalised at a rate of 114€ per tonne of CO₂.⁷²

Regarding the effectiveness of the carbon tax in Sweden, it is notably difficult to generate precise numbers that reflect its effects on CO₂ and other emissions due to many uncertainties and different factors which need to be considered. However, the Swedish CO₂ emissions in 2018 reached a level that was 26% below that of 1990 while generating an increase in GDP of 78% in the same timeframe showing that the combined efforts of the Swedish government seems to have bearded fruit.⁷² The reasons for this cannot solely be traced to the usage of the carbon tax but rather a combination of environmental policy instruments. 

The tax revenues of the Swedish carbon tax have provided the government with a steady tax income. This is predominantly because the tax base is mostly inelastic to price changes regarding petrol and diesel. As the generated income is added to the general budget of the Swedish government and not earmarked for specific purposes, no specific claims can be made with regards to its usage and distributional effects.⁷¹ However, it has been estimated that approximately half of these revenues have been used to lower other taxes like personal income taxes, which suggests that the Swedish government was considering the use-side effects of their carbon tax system.⁷³

Cap-and-Trade Systems

The general idea of cap-and-trade schemes is deeply rooted in neoliberal theory, explaining the popularity of cap-and-trade systems especially in the US. The concept emerged in the 1980s when the Reagan administration implemented a cap-and-trade system to phase out leaded gasoline, achieving faster results at lower costs than anticipated. The approach gained prominence with the 1990 U.S. Acid Rain Program under the Clean Air Act Amendments, which targeted SO₂ and NOₓ emissions from power plants. This program capped emissions nationally, allocated tradable allowances and was deemed a success by policymakers. This prompted emission trading schemes to become a widespread environmental policy instrument in the US during the 1990s. Multiple emissions trading schemes (ETS) were established on a state level consolidating the dominance of market-based regulation in the US.^74,75

The negotiations of the Kyoto Protocol in the mid-1990s brought ETS into the discussion of environmental policy instruments for combating climate change. Through US pressure ETS were included in the Kyoto Protocol as a tool for achieving emission reduction goals, even though the EU and other countries objected. However, little guidance on the actual application of ETS in the context of greenhouse gas emissions was incorporated in the Kyoto Protocol and the subsequent Marrakesh Accords. This meant that these international treaties only succeeded in giving ETS prominence and space for further development.⁷⁵

During the last 30 years ETS were adapted to different economic contexts and subsequently implemented in different countries and international organisations like the EU. They are primarily used for pollution abatement, however, ETS have been implemented on smaller scales as transferable quota systems for natural resource management like the regulation of fisheries.⁷⁶ However, this section only provides an overview on ETS, thus only their use for pollution abatement is considered.

Generally, cap-and-trade systems have the same goal as environmental taxes. They are aimed at assigning a price to environmental harm which is aimed at encouraging polluters to abate emissions. The difference between these two instruments lies in the way that prices are assigned. Where in the case of environmental taxation a certain price is set, cap and trade systems only set a certain environmental target, the cap, with an uncertain price for environmental harm.⁷⁷ This allows for governments to be freed of the intensive information gathering necessary for environmental taxes as they do not need to find the marginal abatement costs for specific industries. This is because the market price in the equilibrium between supply and demand in an ideal emissions market is equal to the marginal abatement costs of all polluters. Therefore, a cost-effective outcome can not only be obtained through environmental taxation but also with a cap-and-trade system.⁵⁷

There are two distinct forms of cap-and-trade systems which differ in the way in which governments allocate the necessary permits to polluters and thus in their subsequent distributive effects. One option involves the sale of emission permits to polluters, generating additional revenue similar to that generated by environmental taxes. Ideally, this revenue can provide the same benefits through the effects of a double dividend when used to reduce other distorting taxes. However, it should be noted that this is only theoretical, as in the case of cap-and-trade systems, risks of market fluctuation need to be considered under real-world conditions. This makes the level of generated revenues uncertain for governments if permit prices fluctuate too much. Additionally, demand for emission permits is highly dependent on the economic expectations of polluters, as they only purchase more permits if an expected future increase in production justifies the purchase. For these reasons, governments might not be able to budget precisely with cap-and-trade revenues, thus hindering their usage for double dividend effects.⁵⁷

On the other hand, governments can also opt to hand out emissions permits free of charge. Polluters are then able to decide if they want to abate emissions and sell the allocated permits to others or to use them for themselves. The amount of permits a polluter receives can either depend on their historic emission levels in a grandfathering scheme or based on a benchmarking system that incorporates technological standards which polluters should be able to fulfil.⁵⁷Under ideal conditions the way in which permits are allocated only impacts the distributional effects and should not make a difference regarding the actual emissions reduction. However, under real-world conditions, polluters might opt for increasing emissions to receive more permits under a grandfathering allocation scheme. This could hinder efficient market outcomes and go against the intended reduction in emissions.⁵⁷

There are other economic drawbacks and risks to cap-and-trade systems which make their successful application in the real-world dependent on certain premisses. If permits are distributed free of charge to polluters, the government must ensure that there is perfect competition on the supply and demand side of the permit market. The absence of perfect competition in permit markets prevents the minimisation of abatement costs and thus a cost-effective outcome. This means that a large number of polluters must participate in the emissions trading system. If this is not the case, market power may be concentrated with a few market participants.⁷⁸ This could be the case if governments issue free permits to a limited number of polluters on the basis of grandfathering. If more polluters enter the permit market for the first time, they will have to accept the prices set by older polluters, which may not be in line with marginal abatement costs. Such a scenario would prevent the cost-effective outcome.⁵⁷

The auctioning of allowances on an emission permit market may show its own inherent risks. It is theoretically possible for single powerful polluters to buy all permits and outbid their competitors. Thus, they might be able to push competitors out of the market or at least force them to reduce production and enlarge their own market share. Such a strategy might not be feasible in a large national or international cap-and-trade system as the costs would probably outweigh the benefits for single polluters. In a local system however such a strategy can bear fruit if abatement measures are not readily available as a cheap alternative for polluters without permits. To prevent such market manipulation, policymakers have to be aware of risks on small permit markets and act accordingly.⁵⁷

To better understand the challenges and potential of cap-and-trade systems, especially under real-world conditions, it is helpful to examine the EU-ETS as a case study. The EU ETS represents the world´s most extensive carbon pricing mechanism. It operates as a cap-and-trade system for greenhouse gas emissions, mainly CO₂ but also NO_x and perfluorocarbons, and was first adopted in 2003 and implemented in a pilot phase in 2005. It has a comprehensive scope, incorporating all 27 EU member states as well as Iceland, Liechtenstein and Norway, regulating approximately half of the EU’s CO₂ emissions.^57,79,80 This system covers over 11,500 major emitters of greenhouse gasses and includes oil refineries, power plants, coke ovens, cement and metal production facilities, glass and ceramics manufacturing, and the pulp and paper industry. However, it does not cover most emissions from the transport, commercial, agricultural, and residential sectors.⁷⁶

The implementation process of the EU ETS spans over four distinct phases between its first pilot phase in 2005 and its planned completion in 2030. Between 2005 and 2007 emission caps were set independently by each individual member state which led to inconsistencies and strategic behaviour of national governments influenced by lobbying efforts from polluting firms.^57,81 The allocation of allowances was predominantly done free of charge through a grandfathering scheme, which created sizeable profits for large polluters like big power plants. As a result of over-allocation and the inability to transfer permits to the next phase, allowance prices collapsed by 2007 due to oversupply.⁵⁷

In the second phase, the free allocation of allowances based on grandfathering continued, but emission caps were reduced. However, the reduced emission caps were met with minimal domestic abatement, as EU policymakers allowed the use of international emission credits (Certified Emission Reductions and Emission Reduction Units). Combined with the 2008 financial crisis, this importation of emission credits caused permit prices to fall from over 20€ per tonne to around €6 per tonne by 2012. A complete collapse in prices, as in the first phase, was prevented by allowing permits to be banked into the next phase.^57,76

The third phase, from 2013 to 2020, introduced a tighter cap of 20% below 1990 emissions levels, an increase in the number of auctioned allowances, tighter restrictions on offsets and the ability to bank allowances between phases. In particular, the replacement of national allocation plans with a single system-wide emissions cap addressed previous shortcomings of the ETS. Despite these measures, the persistently low allowance prices were a cause for concern. This was largely due to the sluggish economic recovery and the impact of other EU climate policies, such as renewable energy mandates and energy efficiency standards, which reduced overall demand for allowances. This led to fears of a complete failure of the EU ETS and, as a result, policymakers reduced the total volume of available allowances through backloading measures in 2013. This stabilised market prices but also highlighted the need for long-term stability measures. Such a system, in the form of a market stability reserve (MSR), was introduced in 2019 and permit prices increased dramatically.^57,76,45

The final phase has been characterised through a further tightening of the allowance market, raising the annual cap reduction rate to 2.2% from 2021 onwards. The intake rate of the MSR was doubled to 24% for each year, and a limit for the volume of the MSR was implemented. This limit is dynamically oriented after the previous year’s number of traded permits. All permits that exceed this limit are revoked and removed from the market. To prevent emissions shifting to other countries, member states were given the option to neutralize those permits that have been freed through additional abatement efforts. Furthermore, only industries at risk of carbon leakage continued to receive free allowances, with all other industries facing a gradual phase-out. A distribution system for auction revenues was also put into place. It allocates a portion of ETS revenues to an innovation and modernization fund to support decarbonization in lower-income EU nations, which also retained some free allowances for power plants.^45,57,79

The EU ETS offers several important lessons for the design of a cap-and-trade system. Firstly, there is no universal blueprint applicable to ETS implementation and management. Each system needs to be designed to fit specific conditions, with unexpected challenges likely to arise. This means that ETS implementation and management need adjustment time, which might conflict with the urgency of environmental issues. Furthermore, differences between the individual economic and structural contexts of member states in the EU have provided significant challenges for a stable and comprehensive ETS strategy. Thirdly, the balance of price stability and a limitation of carbon leakage effects make additional adjustments necessary, making the system more complex. It is also necessary for policymakers to have access to reliable data to ensure a fair distribution of allowances and to avoid over-allocation, as seen in the first two phases. 

The example of the EU ETS system´s shift from grandfathering to the auctioning of permits has shown that a reform of the system is possible even under strong pressure from powerful industries.⁵⁷ Generally, the EU ETS system can be considered a viable way to reduce greenhouse gas emissions with minimal costs. However, its limited scope of less than 50% of all EU greenhouse gas emissions shows that it is only environmentally effective in a limited way. Even though an expansion that includes the agriculture, housing and transport sectors are planned, their introduction into an individual system could prevent a cost-effective outcome.⁴⁵

Similarities and Differences Between Carbon Pricing Approaches 

Carbon pricing instruments, primarily carbon taxes and cap-and-trade systems, share fundamental similarities while showing distinct characteristics in their implementation and effectiveness. Understanding these nuances is crucial for policymakers and stakeholders in order to facilitate the successful implementation and combination of these instruments while limiting disadvantages. Stavins (2022) presents a well-structured and comprehensive review that compares these two instruments. Based on his work similarities of both instruments can be described as follows:

• Generating comparable incentives: When targeted at the same sources of emissions, in essence, both, carbon taxes and cap-and-trade systems, generate comparable incentives to achieve emission reduction by encouraging companies to internalize the social cost of carbon, leading to comparable reductions in the absence of uncertainty. Both instruments are potentially capable to address up to 98% of US CO₂ emissions when applied upstream, demonstrating the possibility to achieve significant coverage.^82,83
• Cost-Effectiveness: In competitive markets, both approaches ensure that firms reduce emissions until marginal abatement costs equal the carbon price (regardless of managing tax rate or allowance price), thus minimizing aggregate abatement costs. Since both systems encourage cost-effective reductions, they result in similar overall costs to society for achieving an emissions target.⁸³
• Generation of Revenue: Both, carbon taxes and cap-and-trade systems, are able to generate government revenue, but they do so in different ways. Carbon taxes directly raise revenue, while cap-and-trade systems only generate revenue if allowances are auctioned to companies or polluters in general. This generated revenue can then be used to reduce other taxes, lowering the net cost of the policy and addressing equity concerns.⁸³
• Distributional impact: Both instruments depend on the use of revenues to a large extent. They may be effective when tax cuts for low-income households are bolstered by the generated earnings. This application is able to offset receding effects such as higher energy prices, leading to both approaches stimulating low-carbon innovation equally by signalling identical price signals to companies for investing in cleaner technologies.⁸³

Despite these similarities, several key differences distinguish these approaches: 

• Price Stability: Carbon taxes are characterized by fixed rates set directly by policymakers. In contrast, fluctuating prices are a characteristic of cap-and-trade systems, which offer certainty of quantity through fixed emissions caps. This may result in price volatility in cap-and-trade markets, creating uncertainty for businesses and investors. However, mechanisms such as price collars do exist and may be implemented to mitigate this risk.⁸³
• Potential emission shift: Cap-and-trade systems potentially face more challenges than carbon taxes due to the “waterbed effect”, where emission reductions in one sector might lead to increased emissions elsewhere under a fixed cap. ⁸³
• Implementation and Management: Cap-and-trade systems tend to necessitate the establishment and oversight of allowance markets, leading to greater administrative complexity and additional costs. Conversely, carbon taxes tend to be more straightforward to implement and manage, though political processes may complicate their design. ⁸³
• Adaptability to new Information: Typically, carbon tax rates are set through legislation, potentially making them more challenging to adjust in response to new scientific or economic findings. In contrast, cap-and-trade systems possess the flexibility to adapt to relevant current information through adjustments to the emissions cap or through built-in review processes.⁸³
• Predictability of Revenues: While carbon taxes may provide greater revenue certainty, due to the tax rate and base being known, cap-and-trade systems can lead to less predictable revenue outcomes, contingent on allowance prices and allocation methodologies, which are not always easy to predict.⁸³
• Efficiency under Uncertain Conditions: When there is simultaneous and positively correlated uncertainty about both marginal benefits and marginal costs, quantity instruments like cap-and-trade may prove more efficient.⁸³
• Link with other Jurisdictions: While both instruments can be linked with policies in other jurisdictions, cap-and-trade systems are generally easier to link directly. However, integrating heterogeneous systems, such as a carbon tax with a cap-and-trade system, poses more significant challenges. ⁸³

Finally, it is important to note that these differences can be mitigated through careful policy design. As emphasised in the literature, the choice between carbon taxes and cap-and-trade systems is no simple dichotomous decision but rather exists along a policy continuum. Specific design elements can significantly influence outcomes, allowing policymakers to tailor either approach to their specific context and goals.

4.1.3      Other Environmental Policy Instruments

Even though a large part of the environmental policy literature discusses the question if MBI or regulatory approaches are favourable, other instruments can also offer significant advantages to policymakers. For this reason, this section provides a short summary of other important policy instruments that are beyond the dichotomy of MBIs and command-and-control instruments.

Information-based environmental policy instruments

Information-based environmental policy instruments rely on the dissemination of knowledge to influence behaviour and promote sustainable practices. They play an important part for environmental policy as they provide a cost effective and simple way to induce desired behavioural changes. Such policies utilize mechanisms such as public disclosure, ratings, certification schemes and labelling with their main premise being that by making environmental information transparent and accessible, individuals, businesses and governments are encouraged to adopt environmentally friendly behaviour on a voluntary basis. Their popularity is often traced back to the Toxic Release Inventory introduced by the US Environmental Protection Agency in the 1980s. Systems like these mandate the disclosure of pollution data by firms for assessing the compliance with set pollution limits.⁵³

Bowen et al. (2020) suggest a classification of information-based environmental regulation based on if they are mandatory or voluntary and if they incentivize better environmental performance beyond the compliance with already implemented environmental regulation. They differentiate between traditional, performance, proactive, and assurance schemes. Traditional schemes represent mechanisms like the Toxic Release Inventory which require the disclosure of specified information. Case studies show that such schemes can provide sufficient industry pressure to improve environmental information disclosure and performance.^53,84 Similarly performance schemes require the participation of firms but they include the opportunity for firms to disclose more information then mandated. Thus, such schemes incentivize further environmental efforts in order to improve their public image and thus induce higher demand. Proactive schemes on the other hand are voluntary but specify a set of best-practise rules. These schemes provide firms with standards which they can voluntarily adhere to in order to earn recognition for their environmental performances. Lastly, assurance schemes provide companies with the possibility to disclose if they are complying with a mandatory environmental regulation.⁵³

Similar to other environmental policy instruments, the effectiveness of information-based policies in achieving environmental objectives can vary. While they are a cost-effective and less intrusive policy option compared to regulatory approaches, they lack stringent enforcement mechanisms, relying instead on voluntary compliance or public accountability for inducing changes in behaviour. In instances where firms are not motivated by the risk of reputational losses, their impact is limited.^53,85

Technology-push instruments

Another important set of environmental policy measures are so called technology-push instruments. These instruments are directed at stimulating innovation and adoption of green technologies by reducing financial barriers and providing economic incentives. They are implemented on the premise that by incentivizing the use of environmentally friendly technologies the use of more harmful technologies decreases, thus indirectly reducing environmental damages. An important instrument for supporting the implementation of more sustainable technologies are R&D subsidies.⁸⁶

R&D subsidies are designed to encourage firm investments in specific technologies. In the context of R&D subsidies as a form of environmental policy, their objective is to stimulate higher investments in green technology innovation, thereby resulting in environmental benefits. They achieve this by reducing the financial burden of innovation investments, thereby encouraging firms to invest in the specified technology. Such subsidies have been linked to increases in sustainable technology investments, particularly in regions where regulatory policy measures have been less effective. However, it should be noted that the impact of such measures can vary depending on regional differences and the specific design of the subsidy programme.⁸⁶ Furthermore, R&D subsidies have been found to not lead to the desired level of green innovation if not coupled with effective regulatory policies. They can also vary in their economic impact on firms, as those companies with high asset-liability ratios benefit more significantly from R&D subsidies.^87,88

Feed-in tariffs are another form of technology-push instruments which is used in the context of renewable energy production. This system functions by guaranteeing renewable energy producers a fixed payment for each unit of electricity produced, thereby encouraging the production of renewable energy. A notable application of feed-in tariffs is in the context of the German renewable energy transition, where they have contributed to a substantial increase in investment in photovoltaic and wind electricity generation capacities. Numerous studies have recognised the German feed-in tariff system for its success in reducing greenhouse gas emissions from fossil fuel electricity generation, by facilitating the transition to renewable energy sources. This is further highlighted by the fact that since the introduction of the German feed-in tariff system in 1991 the production capacities for energy from renewable sources have increased to 54.4% of the German energy mix. Furthermore, the increased investments in renewable energy have also been credited with increasing employment numbers in the sector and in related industries.^89,90,91

Despite their success, feed-in tariffs are not without shortcomings. Feed-in tariffs have been the subject of particular criticism with regard to their distributional and economic effects. The German example demonstrates the regressive nature of feed-in tariffs, with associated costs being passed on to consumers through a levy. The high financial threshold for acquiring a suitable photovoltaic cell array, which is necessary to benefit from the feed-in tariff, has meant that lower-income households have been confronted with higher electricity costs without an offset opportunity. This highlights the distributional challenges policymakers face when implementing environmental technology push instruments.⁹²

These examples demonstrate that technology-push instruments can offer significant economic and environmental benefits, however careful design and implementation are necessary to mitigate potential shortcomings. Especially distributional effects need to be considered when designing these policies. 

4.2   Perspectives on Economic Growth

The debate surrounding the right instrument choice for environmental policy is deeply interlinked with whether instruments should be implemented that impose limits on growth for the purpose of ensuring environmental health, or whether economic growth will ultimately serve as a catalyst for enhanced environmental wellbeing. This is also reflected in the ongoing debate between supporters of regulatory approaches and market-based instruments. 

Generally, the notion of achieving a harmonious balance between economic growth and environmental health through green growth strategies appears to be a popular one among economists. In this regard, Bowen et al. (2012) have proposed a revision of conventional growth policies, such as government investments in education and infrastructure, to incorporate the risks posed by climate change.⁹³ Others, such as Stern’s Economics of Climate Change (2007), argue that environmental policies will lead to a surge in growth also known as “Schumpeterian growth”. The reason for this surge is seen in innovations brought forward by the private sector in response to environmental policies. Additionally these bursts of growth would also extend to the services sector and would ultimately allow for the decoupling of economic growth and environmental damage.⁹⁴

However, these theories are often challenged within the scientific community. Most importantly these notions fail to incorporate systemic rebound effects which tend to negate the positive marginal effects of innovations to the environment through raised consumption. Furthermore, the classical idea of “Schumpeterian growth” relies on the fact that innovations are adding value for customers through improved product quality or the addition of new features. The innovations necessary to reduce the environmental impact, however, tend to aim at factor-savings rather than adding value for customers. Thus, the implicated growth through these innovations can be doubted. An example for this is the appeal of green energy which does not offer any functional advantages to the consumer compared to energy sourced from fossil fuels.⁹⁵

Nonetheless, the theoretical foundations of the idea of green growth can be found in the Environmental Kuznets Curve (EKC). This model even suggest that economic growth can be a factor in improving the environmental effects of economic activities. This hypothesis is based on the notion of the Kuznets Curve, which was initially brought forward by Simon Kuznets. The hypothesis advanced by Kuznets was that income inequality would rise with increasing economic growth before decreasing following an inverted U-shape.⁹⁶ Similar to this idea, the theory of the Environmental Kuznets Curve, which was first proposed by Grossmann and Krueger in 1995,⁹⁷ suggests that the negative environmental impact of economic growth increases in early growth phases. However, at a certain per capita income level this relation is reversed suggesting that economies that have grown to a high-income threshold are supporting environmental improvements. This theory suggest that the per capita impact on the environment follows a similar inverted U-shape as the original Kuznets Curve.⁹⁸ Explanations for this rely several factors and effects. Most prominently the technique effect, which assumes a shift in the input mix towards less polluting resources and technological improvements that allow for more efficient and less polluting production of goods. The basic assumption for this effect is the use of environmental policies to motivate industries to shift their inputs and invest in technological innovation, similar to the idea of Schumpeterian growth in the context of environmental policies.⁹⁸

In the same vein, the theoretical validity of the EKC has been doubted by many scholars due to a range of shortcomings, the most important being the difficulty of decoupling growth and environmental impact. When looking at greenhouse gas emissions and their necessary reduction to reach the internationally agreed upon goal of lower than 2 degrees of global warming by 2050, it becomes clear that the reduction rate must be significantly larger than the historic rates, thus making the EKC seem unrealistic.⁹⁹ Furthermore, the shift of production to energy- and carbon-intensive developing economies, due to globalization, increases the worldwide pollution intensities. The individual environmental efficiency gains of more developed nations might be offset. Apart from the already described rebound effects, lock-in effects through long-term investments into environmentally damaging infrastructure also hinders the proposed decoupling process. Another more theoretical flaw lies in the progressive nature of abatement costs, as reducing the environmental impact for economic activities is relatively cheap and easy at first. However, when these options run out, further abatement becomes more and more costly.¹⁰⁰ Even if these costs can be reduced through technological progress, the progressive nature of marginal abatement costs means that as environmental targets become more stringent, the total cost of production which include abatement costs, will rise. This calls into question the idea of further growth under these conditions.⁹⁹

Empirical evidence for the EKC also varies, as some scholars suggest that especially with regard to energy production in developing countries, a positive effect between GDP growth and negative greenhouse gas emissions can be seen.^101,102 However, it is important to note that decarbonization alone is not a sufficient condition for reaching green growth. Moreover, the fact that economic growth can be empirically linked to a rise in pollution emissions and concentrations in a global context, overshadows these limited gains speaking in favour of the EKC´s applicability.⁹⁸

Although the EKC and green growth offer an attractive notion, its feasibility is questioned by most contemporary scholars. Even the International Monetary Fund (IMF) not generally known for its critique of economic growth, concluded that growth policies may have surpassed their benefits.¹⁰³

Alternatively, other scholars propose a contradictory approach to growth, with the idea of a zero or negative growth strategy, especially with regard to the dangers of climate change. The barriers discussed above lead them to conclude that economic growth cannot be reconciled with achieving the necessary emissions targets and that the only option left is economic downsizing. At first glance, this line of thinking seems plausible, but the effectiveness and feasibility of degrowth strategies is questioned in the respective literature.

An important point here is the fact that it is very difficult to predict how a certain degree of reduction in growth, measured in GDP, would affect emissions. This can be exemplified by the emission reduction following the 2008 global economic crisis which did occur but was smaller than many experts had anticipated.¹⁰⁴ This highlights the fact that other factors apart from growth, like consumption and production patterns or energy mixes, play important roles in determining global emissions. The complex dynamics shaping the interaction between these factors leads to the conclusion that any proposed rate of degrowth would lead to arbitrary outcomes in actual emission reduction.⁹⁵

Furthermore, it is argued that there are serious risks associated with deliberate degrowth strategies. Pursuing a degrowth strategy could lead to a prolonged period of unemployment due to reduced confidence in the economic situation. This would be compounded by the already reduced tax revenues due to a shrinking economy, thus hampering investment in necessary welfare programs, public goods and innovation.⁹⁵

It is important to note that these shortcomings of degrowth strategies apply to the strategies that address degrowth as a reduction in GDP. Other forms of degrowth, such as reduced consumption, reduced working hours or physical degrowth, may offer solutions through even deeper changes in societal structures. Although these approaches offer intriguing ideas and solutions to environmental problems, their implications for this work are more limited, which is why they are not discussed in more detail. 

A third perspective on growth in the context of environmental health is the so called “agrowth strategy”. It proposes that the factor of economic growth should be excluded from specific policy decisions regarding environmental and human welfare. It is aimed at resolving the problem of environmental growth and its negative impact by a certain degree of indifference towards GDP development. An example might be that in periods where environmental problems are pressing, policies that might offer solutions at the cost of a lower GDP should be implemented. This approach can be understood as a case-by-case solution to the question of growth in the context of environmental challenges. It might offer a bridge between pro- and anti-growth approaches and a more flexible policy structure for tackling societal and environmental problems.⁹⁵ In conclusion, it can be said, that the academic debate on economic growth and its policy implications is quite complex and this section should only be understood as a critical overview of important arguments. 

However, perspectives on the inverse relationship between environmental damage and economic growth are relatively limited. Existing studies show the volatile nature of the status quo in terms of economic growth. For example, Acheamong and Opoku (2023) found that environmental degradation can affect economic growth in several ways apart from the more obvious dangers to society and infrastructure due to more intense storms or rising sea levels.¹⁰⁵ One such channel is health, as it is an important determinant of productivity, since a workforce suffering from health problems is less productive and less able to acquire new or more advanced skills. Therefore health is also an important prerequisite for economic growth.¹⁰⁶ The impact of environmental degradation and climate change on our health is difficult to pinpoint at this stage, but polluted water and air, higher temperatures and the increased spread of diseases such as malaria are just some of the many possible health risks from environmental degradation. The effects of climate change can also lead to food and water insecurity, making people more susceptible to infections that wouldn’t otherwise affect them.¹⁰⁵ These risks to people, and thus indirectly to the economy, are often overlooked in the dominant literature on the growth debate. However, their importance should not be ignored in the policy-making process.

4.3   Environmental Policy Impacts on Competitiveness

The effects of environmental policy on an economy´s competitiveness have been touched on in the last chapter with regard to the individual instruments. As such effects are influential in policy design, it is important to understand the underlying theoretical economic mechanisms in order to understand the development of these effects. Especially with regards to sustainable and technological innovations, research suggest that environmental policy can provide chances for companies to gain a competitive advantage on a globalised market.^9,107 This chapter is aimed at providing an economic perspective on the discourses of environmental policy effects on competitiveness, providing some background for chapter 6.3 that examines these effects from the management perspective. 

As capital and trade flows have increasingly integrated with the advancement of globalised markets, corporations and policymakers alike have voiced their concerns that large differences in the employment of environmental policy regulations on a global scale might cause emission intensive industries to shift into less regulated economic spaces. Such shifting of production capacities could have significant consequences on national industrial production capacities as well as international trade flows. These effects have caused concerns especially among governments that are the vanguard in implementing far reaching environmental policy measures, as their increased environmental efforts might cause their emission intensive industries to fall behind their international competitors in terms of economic competitiveness.⁵⁸

In the environmental economic literature two main perspectives have formed that analyse the impact of asymmetric policies on firms competing in the same market: the pollution haven hypothesis and the Porter hypothesis.

The pollution haven hypothesis states that, all else being equal, polluting firms in a shared market that face stricter environmental policies will have a competitive disadvantage compared to firms that face more lenient environmental policies. Research supporting this theory argues that higher regulatory costs of complying with stricter policies make it more difficult for firms to invest in more innovative technologies or efficiency improvements, thus slowing overall productivity growth. Such effects would subsequently lead to the loss of market share in favour of those companies facing less regulatory pressure.⁵⁸

The concept of carbon leakage is considered to be derived from the pollution haven hypothesis and refers specifically to the effects of environmental policy on CO₂ emissions. This theory refers to the idea of emission-intensive industries relocating to countries not employing reduction measures for CO₂ emissions thus negating the emission reduction effects initially intended. Furthermore, this relocation of pollution intensive industries is seen as weakening the economic situation of a country that has stricter environmental policy measures in place. The concept of carbon leakage has been thoroughly explored in the scientific literature, establishing its existence while debating about its actual effects under real-world conditions. Richter (2015) provided an overview on empirical studies on the effects of carbon leakage and concluded that it is an important factor in international carbon reduction efforts.¹⁰⁸ The magnitude of this effect is still under debate, however. Nonetheless, studies have shown the importance of supply- and demand-elasticities as pivotal factors in influencing the extent of this phenomenon. These suggest that higher elasticity correlate with higher leakage rates. Thus, in cases where demand is more sensitive to price changes than supply, demand-side policies will be more affected by leakage than policies targeting fossil fuel supply.¹⁰⁹

Other research suggests that carbon leakage also has an intertemporal effect. Hans Werner Sinn (2008) first proposed such a theory as the “green paradox”, explaining that anticipation of forthcoming demand-side policies leads fossil fuel producers to increase their extraction rate in order to maximise net present value. This increase in the supply of fossil fuels subsequently leads to a fall in prices and thus a positive influence on consumption rates, thereby avoiding the intended effects of the planned carbon policy. The actual implications of this hypothesis are debated in the literature, as although many studies have examined the theoretical implications of the green paradox, there is limited empirical evidence proving its effects.^110,111,112

Independent of the actual effects in a specific context, the pollution haven hypothesis and the risk of carbon leakage are taken seriously by policymakers. The most prominent example is the planned EU Carbon Border Adjustment Mechanism (CBAM). It is aimed at aligning prices for goods produced outside of EU CO₂ regulation to those of domestic products that fall under EU environmental policy. This is done to reduce possible competitive disadvantages for own emission intensive industries as well as to negate carbon leakage.¹¹³

Contrary to the negative conception of environmental policy with regards to innovation and competitiveness, other economists propose a different understanding with the Porter hypothesis. Porter (1991) and Porter and van der Linde (1995) were the first to posit the idea of environmental policy influencing competitiveness and productivity in a positive way through incorporating its stimulative effects on innovation.^114,115 This approach represents a more dynamic understanding of competitiveness effects compared to the one-dimensional focus on costs in the pollution haven hypothesis. Jaffe and Palmer (1997) formulated that the Porter hypothesis can facilitate its effects in a weak version, a strong version and a narrow version. In the weak version, environmental policies stimulate only those innovations that have higher opportunity costs compared to their direct benefits for the firm. The strong version postulates that environmental regulation can stimulate innovation in a way that firms gain competitive advantages offsetting or even exceeding the regulation´s compliance costs. Lastly, the narrow version of the Porter hypothesisunderscores the notion that MBI´s provide firms with a greater degree of flexibility and incentive for innovation compared to regulatory approaches of environmental policy.^58,116,117

Another argument derived from the Porter hypothesis claims that policymakers can facilitate a first-mover advantage for the innovation of clean technologies of domestic companies, if they are the first to introduce environmental regulation for emission reduction.⁵⁸

A large amount of environmental economic research has been dedicated to assessing the real economic effects of each of the Porter hypothesis versions. However, definite conclusions are difficult, as the results of empirical studies have tended to contradict each other. In their meta-analysis on studies which examined the Porter hypothesis, Cohen and Tubb (2018) found that though most findings support the positive effects of environmental regulation on innovation, their significance and characteristics differ between the examined contexts.¹¹⁷ Reasons for these discrepancies in study results have been examined by Ambec et al. (2013). They concluded that differences in regulatory environments, sector and industry contexts, the addressed environmental issue, companies’ environmental management approach, and the methods applied for measuring the Porter hypothesis effects influenced study outcomes.¹¹⁸

In general, the literature presents substantially different results regarding environmental policy effects on economic competitiveness on a globalized market. Research shows that the examined scope, market and regulatory context, and examined timeframe influences how such effects are evaluated. This is exemplified by the fact that environmental regulations have been linked to adverse effects on short-term productivity on an industry level, while other studies have shown that positive effects on innovation and competitiveness can be seen on the national and international level.^58,117

4.4   The Case of Supply Side Environmental Policies

The overview of environmental policy instruments has shown that the prevalent environmental policy instruments are generally aimed at effects on the demand-side in order to reduce environmental damages. Especially in the most researched context of reducing greenhouse gas emissions, policymakers seem to predominantly target the point of fossil fuel combustion rather than its production and processing. Especially market-based instruments have been found to aim at pricing on the demand rather than the supply side of fossil fuels. As a result of demand-side policies shortcomings, an increasing number of research is dedicated to exploring the possible potentials of supply-side policy instruments to further decrease fossil fuel use. Thus far such approaches have been underrepresented in scientific publications compared to the vast amount of research dedicated to demand-side policies.¹¹⁹ The Obama administration´s ceasing of new leases for fossil fuel extraction on federal land and water have proven the potential of such measures. However, the further expansion of fossil fuel production under the Trump and Biden administrations have also shown their unpopularity with most policymakers.^119,120

The reason for this underrepresentation of supply-side approaches for climate policy measures can be linked to several factors. The greater political appeal of demand-focused measures in comparison to supply-oriented approaches is one reason for their unpopularity with environmental policy actors. The reason for this lies in the fact that solutions and industries that support low-carbon innovation tend to face minimal political opposition. Moreover, policy actions aimed at reducing fossil fuel production directly through taxation, restrictions, or quotas may cause intense pushback from influential fossil-fuel lobbying organisations that hold significant influence on the political stage.¹²¹

Another reason for the neglect of supply-side climate policies lies in the conventional perceptions surrounding fossil fuel markets which emphasizes the focus on demand-sided measures. The predominant notion is often centred around the excessive usage of fossil fuel rather than its production. This might be due to the assumption that restricting production would merely shift, rather than reduce, overall fossil fuel production due to the possibility of polluters choosing to change their facilities to places with less environmental regulations. This effect is usually known as carbon or market leakage. While it’s true that market leakage can undermine the effectiveness of supply policies, these effects have been found to impact demand sided policy measures as well.^119,122

An additional reason lies in the prevailing method of accounting for carbon emissions. The prevailing system is based on territorial accounting, which acts as a disincentive to supply-side action and sometimes has counter-productive effects. Territorial emissions accounting, endorsed by the UNFCCC, places responsibility on consumers of fossil fuels rather than their suppliers. For example, a country that taxes coal exports while ignoring domestic consumption could ostensibly reduce coal use and emissions in other countries. Paradoxically, it could indirectly stimulate domestic consumption and increase its own emissions. This conventional accounting framework discourages the adoption of supply-side measures, even though they could make a significant contribution to climate protection.^119,121

Arguably, if demand-side policies were sufficiently ambitious and broadly implemented, they could potentially achieve the 2°C target. However, the reality of the climate crisis has shown that the broad effects on reducing carbon emissions have not materialized.³ As the urgency of the climate crisis has escalated, the necessity for a more diverse array of solutions has grown apparent. In this context, supply-side policies can offer several advantages.

As discussed in the previous section, different policy instruments differ in their level of administrative and transactional costs. Typical demand-side climate policy instruments, like emissions standards or carbon taxes are highly complex, requiring complicated rules, procedures, and regulatory bodies to monitor and verify greenhouse gas emissions at the facility or consumer level. This complexity undermines their effectiveness in several ways. First, the significant transaction and administrative costs themselves reduce efficiency. Secondly, the availability of facility-level emissions information is asymmetric in favour of regulated entities, making it difficult to curb deliberate manipulation and inadvertent underreporting of emissions. This compromises the environmental outcomes of carbon pricing systems. Third, administrative and transactional burdens in demand-side schemes limit liability to large emitters above a certain emissions threshold, leading to incomplete coverage and further reductions in efficiency¹²³

In contrast, supply-side policies have been found to have lower administrative and transaction costs. Due to the high initial costs for extraction-infrastructure the number of fossil fuel suppliers is limited in most cases. Subsequently, policymakers need to monitor only a limited number of fossil fuel suppliers. Furthermore, the commodities involved, especially coal and oil, can be monitored with relatively little effort compared to greenhouse gases, and are often already tracked by companies for tax assessment and environmental compliance.¹²¹ As a result, the total and average costs associated with monitoring, reporting and verification, as well as the uncertainties in abatement outcomes, tend to be lower compared to similar demand side measures. In addition, supply side measures automatically achieve widespread coverage as downstream consumers face higher prices for fossil fuel inputs, leading to reduced consumption.¹²³

Another advantage of supply-side climate policies are their price and efficiency effects. Reducing the supply of a product inevitably drives up its market price, which has a cascading effect on goods that depend on it. In the context of fossil fuels, such constraints lead to higher absolute and relative prices for products that use these fuels. This price increase can subsequently discourage consumption which is simultaneously the core premise of demand-side policies such as carbon pricing.¹²⁴

In theory, policy instruments without technological and pollutant biases, such as a universal cap-and-trade system, offer a way to achieve abetment of emissions at the least possible cost. Profit-seeking firms optimise their strategies by seeking the optimal mix of supply and demand side responses through various channels, such as investment in renewable energy, forest sequestration and reduced car use. However, practical implementation often falls short of this comprehensive ideal. Real-world carbon pricing schemes, designed to minimise administrative costs and overcome political barriers, rarely achieve universal sector and facility coverage. This limitation curb the potential effectiveness of market-based demand-side strategies by excluding certain abatement opportunities.¹²³

Consequently, the effectiveness gap between a practical carbon pricing approach and supply side constraints is narrower in practice than in theory. In a world where the perfect climate policy is unattainable, a hybrid strategy emerges as advantageous. This involves reinforcing demand-side policies with supply-side counterparts. This confluence is particularly critical given the global interconnectedness of energy markets. The success of demand-side policies in one country, by reducing demand for fossil fuels, can trigger carbon leakage effects. While an ideal world with universal carbon pricing could avoid such effects, practical constraints currently preclude its realisation. Large energy consumers such as the US, China and India have significant influence over global fossil fuel prices through their climate and energy policies.¹²³

However, such price reductions may inadvertently hinder the transition to low-carbon production on a global scale. While this is beneficial for goods without negative externalities, it poses a challenge for accelerating the industrial transformation targeted by demand-side policies. In this context, restrictive supply-side policies are important to mitigate countervailing price effects. The synergy between supply-side and demand-side policies is emerging as a catalyst for the industrial transformation needed to meet climate change objectives.^121,125

As explained above, this could be achieved by tackling carbon leakage, which can be seen as a factor constraining both supply- and demand-side policies when implemented in isolation. As shown in Figure 3, supply and demand side measures can generally achieve the same goal of reducing fossil fuel consumption. This is shown by the dotted lines. However, the higher price on the global fossil fuel market resulting from a potential supply-side measure in one part of the world will lead to an increase in production in countries not covered by the measure. For example, if the EU imposes a production quota on coal, thereby limiting production, the global market price would rise, as other producers then meet the same demand. As a result, the real global emissions reduction is smaller than the model suggests.

The same applies to demand-side climate policies. For example, if a carbon pricing scheme is implemented in one part of the world, demand in that region and therefore globally will fall. This also has a downward effect on the price, which in turn increases demand for fossil fuels in areas not affected by the demand policy. 

The right choice of demand-side or supply-side measure is important to reduce this effect. As explained above, the relationship between demand and supply elasticities is the most important factor in this case. Therefore, taking into account the elasticities in the market that a climate policy is intended to affect should be an important step for policy makers when deciding which option to choose. However, combining the two measures can yield even more effective results, as can be seen in the simplified market model of Figure 3. The new equilibrium, which takes into account both demand-side and supply-side policies, leads to a lower level of fossil fuel consumption than either demand-side or supply-side policy alone. 

This general idea is also supported in the literature, as Pellegrini and Arsel (2022) find that pursuing both demand- and supply-side policies together can help avoid the shortcoming of intertemporal and inter-country carbon leakage. Moreover, this combination could help signal commitment to all stakeholders while providing insurance in case one policy fails.¹²⁶

Fœhn et al. (2017) provide a more nuanced approach to combining these policies, as their optimal combination also depends on other factors. In their case study of Norwegian emissions reduction policy, they conclude that when marginal abatement costs take into account carbon leakage effects, it is much more cost-effective to use a combination of both policies.¹²⁵ It is clear that marginal abatement costs of supply-side measures are significantly lower in this case, taking into account global leakage effects and economies of scale at higher levels of abatement. This example shows that the specific mix of policy measures depends on several factors. In this case, it makes more sense to use a higher proportion of supply-side measures because Norway has relatively high initial marginal abatement costs due to its heavy reliance on hydropower.¹²⁵ Other countries may have different conditions, it is therefore important for policy makers to take into account country-specific variables.¹²⁵

It has become clear that supply side climate policy can offer solutions for shortcomings of demand side policy instruments like insufficient emission reduction, high monitoring and enforcement costs, or carbon leakage. For this reason an increasing number of researchers is demanding the inclusion of more supply side policies into national and international climate policy.¹²⁷ Nonetheless, the research has also shown that to foster these positive effects a combination of supply and demand side policies are necessary. This notion has become prevalent not only in the debate on demand and supply side policies but in the larger environmental policy context. Fort this reason the last section of this chapter is aimed at giving an overview on how policy mixes are designed and applied in real-world policymaking.

4.5   Environmental Policy Mixes

The previous sections have shown that there is no single superior environmental policy instrument, but that the combination of different instruments and measures, adapted to the specific economic and social context, is a possible solution for successful and effective environmental policy implementation. The Tinbergen Rule states that each policy goal requires a dedicated instrument, thus the coexistence of multiple policy objectives, as it is the case for policies addressing climate change and biodiversity loss, necessitates a mix of policy measures.¹²⁸ This understanding is fundamental to the concept of the environmental policy mix as it is increasingly recognized as essential for addressing complex and multi-dimensional environmental problems. In essence, policy mixes consist of the strategic combination of different policy instruments in support of a specific environmental objective. While earlier research focused on the economic and environmental advantages through simply combining individual environmental policy instruments, more recent concepts emphasize a broader and more holistic strategic approach to facilitate sustainable transitions.^129,130This chapter thus aims to provide the reader with a broad understanding of the characteristics of well-designed policy mixes to promote sustainable development. It also reviews key findings from empirical studies to provide policy makers with a well-rounded perspective.

The concept of policy mixes emerged from a number of different scientific fields like environmental economics, innovation studies, and policy analysis. In general, the term policy mix refers to the strategic combination of various policy instruments to achieve policy objectives. In the case of environmental policy, a policy mix would refer to the combination of instruments like regulations, market-based tools, subsidies, or informational campaigns. The concept recognizes that no single instrument can address complex sustainability challenges effectively. For example, regulatory instruments like a technology-based standards can be complemented by subsidies for renewable energy technologies to additionally stimulate innovation.¹³¹

This rather basic understanding has been expanded upon by Rogge and Reichardt (2016) to develop a policy mix framework that facilitate sustainable transitions. They extend the understanding of policy mixes introducing three dynamic perspectives to the concept.¹³¹ First they underscore the importance of recognizing real world complexities. Secondly environmental policy mixes need to incorporate a process-oriented perspective based on the policy cycle. At last the need for including a strategic vision for long-term development is emphasised to reach ambitious environmental objectives. Their approach highlights the dynamic nature of environmental policy mixes, which evolve over time in response to changing circumstances and interactions between instrument and economic actors.¹³¹

Four important terms are used to describe the characteristics of successful policy mixes: consistency, coherence, credibility and comprehensiveness. Consistency of a policy mix refers to the degree of alignment between elements of the policy mix, ranging from the absence of contradictions to active synergy effects. This alignment can take place between individual instruments or instruments and strategies. Even though coherence is often used interchangeably with consistency in the literature, Rogge and Reichardt (2016) define it as an individual concept that is referring to the process of synergistic and structured policy implementation, directed at a clear objective.^129,131 Credibility describes the believability and reliability of processes and individual elements of the environmental policy mix. It can be influenced by the demonstrated commitment of policymakers and the use of a consistent combination of instruments. Clear communication of policy objectives is also important for a credible policy mix. Credibility has been identified as a crucial factor for the achievement of policy objectives, as the perception of planned policy measures can affect the behaviour of polluters.^9,131

The last important characteristic of environmental policy mixes is their comprehensiveness. It refers to the extent of its individual instruments, the existence of clear policy objectives, as well as how extensive the decision-making process is. A combination of instruments is considered to be more comprehensive if it addresses identified failures of individual instruments. With regards to the above example a policy mix that combines subsidies for clean technologies with a technology-based emission standard is more comprehensive than the emission standard in itself as the policy mix also addresses the possible negative innovation effects of the technology standard. Therefore, the highest degree of comprehensiveness is reached if a policy mix addresses all policy dimensions linked to sustainable development. In contrast, poor policy mix design can also lead to negative effects which enhance the shortcomings of individual instruments, underscoring the importance of well-designed policy mixes according to the described characteristics.¹³¹

Empirical evidence has shown that policy mixes can regularly outperform single instruments under real-world conditions. The most promising policy mixes found are the combination of green innovation subsidies with an emissions tax and the combination of information provision with a cap-and-trade system.¹³⁰ The reasons identified are that the combination of complementary policy instruments compensates for the shortcomings of individual instruments, and that the policy mix increases stakeholder support by addressing multiple interests. However, it has been more difficult to identify positive synergies that increase the positive environmental effects of policy mixes beyond the level of individual instruments. So far, documented cases of positive synergies have been limited to policy mixes where the provision of information increased the effectiveness of pricing instruments.^130,132

Furthermore, Rastegar et al. (2024) show that policy mixes in the case of renewable energy innovation have been linked to drive technological advancement in the sector through addressing market and innovation failures. This underscores the potential economic advantages of successfully implementing policy mixes. Yet the poor design of policy mixes can lead to so-called “deadweight effects”. This refers to circumstances in which resources are wasted on firms already capable of innovating independently.¹³³ Additionally, policy overlap has been found to cause inefficiencies or unintended consequences when multiple instruments target the same issue without proper coordination.¹³⁰Furthermore, Rastegar et al. (2024) show that policy mixes in the case of renewable energy innovation have been linked to drive technological advancement in the sector through addressing market and innovation failures. This underscores the potential economic advantages of successfully implementing policy mixes.¹³³

The complexity of policy mixes is also a major challenge for policymakers. They require sophisticated governance structures for designing, implementing, monitoring and enforcing policies. This makes policy mixes difficult to implement for governments that lack the necessary resources. Moreover, high complexity can lead to incoherence or inefficiency if not properly managed.¹³⁴ Political and social constraints further complicate the design of policy mixes. Although the ability to take different stakeholder interests into account when designing the policy mix can be beneficial, political trade-offs can also result in sub-optimal combinations.¹³⁰

Germany’s energy transition provides a useful example to illustrate the dynamics and challenges of environmental policy mixes. The policy mix implemented combines feed-in tariffs, renewable energy subsidies, emissions trading and energy efficiency standards with the aim of facilitating a transition to renewable energy. A key driver is the promotion of innovation in renewable electricity generation technologies such as wind and solar. The individual policies aim to correct market failures and address innovation system failures by improving the financial viability of renewable technologies. These combined efforts have led to a 54.4% share of renewables in Germany’s electricity.^91,130

Synergy effects between feed-in tariffs and subsidies for technological development and grid infrastructure have been found to have accelerated the adoption of more sustainable technology options. However, over time inconsistencies within the policy mix emerged. The introduction of the EU ETS, with a simultaneous continuation of subsidies for coal-generated electricity weakened the price signal and thus slowed the phase-out of fossil fuels.^135,136 Complexities through coordinating policy efforts across EU, national, and regional levels have led to a fragmented implementation of Germany´s energy transition policy mix. In combination with exemptions and concessions for energy intensive industries, the complexity issues have led to a reduced environmental effectiveness.¹³⁶ Additionally, early subsidies for solar PV led to situations where financial support was provided for projects that would have been viable without subsidy assistance. While this issue has been addressed by the German government through transitioning from a general feed-in tariff system to the auctioning of feed-in capacities, it has been criticised for slowing down the renewable energy transition.^135,137 The case of Germanys energy transition shows that policy mixes can be a useful tool for rapidly developing renewable energy generation. It highlights the advantages of facilitating synergy effects to effectively act on an environmental issue. However, it also underscores the complexity and risks associated with environmental policy mixes. 

5        Business Perspective on Environmental Policy

The design, composition, and implementation of different instruments and policy mixes discussed before can have a significant impact on corporate and civil actors alike. However, their influence to change consumer behaviour and the industrial status quo is also dependent on the actions of corporations. The strategic responses of firms to environmental policy can have extensive influence on the effectiveness of environmental policy efforts and thus are an important factor of the sustainability transition.⁸ In order to help individual actors understand the leverage that business actions can have on sustainable development, this chapter aims to provide insights into the business perspective on environmental policy, its challenges, strategic responses and the opportunities and risks that it can offer business actors to gain competitive advantage.

Firms and corporate interest groups have long been seen as active and direct opponents to most environmental policy measures. This has been mostly due to the perception that environmental policy compliance would only lead to increased costs and the binding of firm resources which could be used in the core business process. This notion is supported by the fact that many environmental problems worldwide can be traced to corporate action driven by the pursuit of profit.^8,9 Firms and corporate interest groups have long been seen as active and direct opponents to most environmental policy measures due to the perception of increased costs and the use of firm resources that could be used in the core business process. This notion is supported by the fact that many environmental problems worldwide can be traced to corporate actions in the pursuit of profits.^8,9

However, the relationship between businesses and environmental policy is more nuanced and complex than this traditional view suggests. Research has demonstrated that the relationship is bidirectional.⁸ As environmental concerns have become more prominent on a global scale, companies have had to adapt their strategies and operations to address these issues and follow the guidelines and requirements of policy instruments. Consequently, corporate sustainability programmes have become prevalent in most corporations and compliance with environmental policy legislation is now a critical strategic domain for corporations.^8,9 Concurrently, companies and their interest groups have influenced the design and implementation process of environmental policies at all levels of government. A range of studies has demonstrated this influence, resulting in regulations that align with corporate interests or even the complete termination of specific policies.²¹

In general, different studies have proven that mandatory environmental policy measures have had significant impacts on companies environmental performances.^138,139 This is primarily due to the enforcement and application of sanctions and reputation losses in the event of non-compliance. Increased stakeholder pressure also plays an important role.¹⁴⁰On the other hand, adherence to environmental policy measures can result in various management challenges and drawbacks for companies. These challenges include the possible increase of operational costs, as compliance efforts usually require the investment of financial and organisational resources. These costs can include investments for emission abatement efforts, costs for implementing environmental management systems, or direct costs from environmental taxes or emission permits in a cap-and-trade scheme.⁹ In addition, increased environmental regulation can also have significant impacts on short-term productivity and employment, especially in sectors that are particularly energy and pollution intensive.⁵⁸

International firms face even more complex circumstances, as they must navigate varying regulatory environments across different countries. The extent to which environmental policy regulations have encouraged internationally active firms to enter specific markets or shift certain economic activities to less regulated areas, as the theory of carbon leakage suggests, remains unclear in the literature. Some studies suggest that international firms pursue comprehensive environmental strategies, implementing them in markets with weak and ineffective environmental regulations.^141,142 In contrast a more recent study by Wright and Nyberg (2017) suggests that companies in globalised markets prioritize their short-term profit over comprehensive environmental efforts beyond the necessities of specific market environments.¹⁴³ In these cases the focus of international firms enviornmental strategy lies predominantly on communicating and seeking legitimacy compared to effective efforts to reduce their negative environmental impact.^9,144

The subsequent section will discuss the internal and external factors that influence how companies respond to these challenges. Afterwards an examination of potential environmental compliance strategies and a showcase of how companies can facilitate a competitive advantage through a comprehensive environmental strategy. It should be noted that these factors vary between studies, and it is challenging to offer a universally applicable perspective on them. The examined literature underscores the difficulty for extending findings beyond the specific research context. Nevertheless, possible influences on firms should be considered when deciding on environmental strategies at a corporate level, thus it makes sense to examine some possible influences on firms environmental strategies.⁹

5.1   Influences on Management Responses to Environmental Policy

The factors that influence how corporate actors react to environmental policy measures can broadly be categorised based on their internal or external leverage. The first internal factor identified as a key influencing factor on the impact of mandatory environmental regulation on a company’s environmental strategy and performance is its organisational size. Darnall et al. (2010) demonstrate that firm size is a significant factor in the impact of stakeholder pressure on a company’s environmental strategies.¹⁴⁵ This increased felt pressure has been linked to increased environmental efforts. In addition, shorter lines of communication, closer interaction or the presence of the founder are further explanations for why smaller firms have been found to surpass the environmental requirements of policy measures.^145,146 However, firm size has also been linked to having an opposing effect, as studies suggest that smaller firms are more often unwilling to increase their sustainability efforts above the mandated levels.¹⁴⁵

Another internal factor are the attitudes of managers towards environmental issues and policies. Especially negative perception of environmental policies have been found to influence the implementation of environmental strategies in a negative way.⁹ In contrast, the foresight of managers in anticipating impending environmental regulations is regarded as a driver for proactively implementing more ambitious environmental strategies in order to gain a future competitive advantage.^147,148

The flexibility regulations offer with regards to their implementation on the firm level is an important external factor influencing a firms policy response. As discussed in the previous chapter, the various environmental policy instruments offer companies different degrees of freedom in their options for reducing their environmental impacts. Research indicates that technology standards, for example, can result in reduced environmental performance compared to performance-based standards. Offering more freedoms and flexibilities for abatement options and thus the possibility to choose the most cost effective options seems to be an important reason firms go beyond the minimum requirements in their environmental strategies.^9,149

The operating context is another key factor influencing firms’ environmental strategy decisions. Research has demonstrated a correlation between a company’s country of operation and its propensity to make environmental investments. This phenomenon appears to be influenced not only by regulatory measures specific to the country, but also by its legal system. In European countries which practice civil law, companies tend to invest more in their environmental strategies compared to countries which practice common law. Further studies have also found that the existence of complementary goods influences the compliance efforts of firms. However, further research is needed to understand the exact relationships at play and to gain more meaningful insights into how different operating environments influence firms’ environmental strategies. The current research is primarily focused on highly regulated industries, such as the energy sector and mining operations, which limits the generalisability of the findings to other industries.^9,150,151

Another external factor that has been identified in the literature is uncertainty. A significant number of studies have been dedicated to examining its effects. Generally, firms encounter significant uncertainty when confronted with new and ambiguous policy measures. Subsequent decisions on the timing of investment approaches for new technologies and processes to comply with these policies are crucial strategic decisions. Existing research suggests that firms can either adopt a cautious approach, examining the situation’s development while focusing on short-term profitability, or proactively investing into improved environmental performances in the hopes of getting ahead of policy measures thus gaining an advantage later on.¹⁵² However, the existing literature does not offer a clear consensus on whether uncertainty poses a significant barrier to improving a firm’s environmental performance. Some suggest that, as firms are obligated to comply with environmental policy measures irrespective of their initial uncertainty, the impact on environmental performance and strategic decisions is limited. Conversely, others have highlighted that the possibility of policy revocation or significant alteration could potentially incentivise companies to delay changes in their environmental behaviour and impact. This suggests that a higher degree of uncertainty could lead to better environmental performance of firms. However, further research is needed to better understand this relationship and its potential implications.^{9,148,149,153}

5.2    Strategic Responses to Environmental Policy

In the face of mounting pressure on companies to reduce their environmental impact and align themselves with the goals of sustainable development, various strategies and management systems have been developed to incorporate changes in operations. As these management concepts have already been examined in more detail in other Sustainability-Management-Wiki articles, this section is aimed on providing a short overview of possible environmental management strategies that enable firms to efficiently comply with mandated policy measures as well as extending their sustainability efforts beyond the policy set minimum.

The implementation of an overarching structured environmental management system is usually the first and most important strategy. The International Organization for Standardization´s (ISO) DIN EN ISO14001 standard, for example, provides firms with a structured framework to improve the efficiency of compliance efforts. It also offers firms a clear process for planning, implementing, examining, and adjusting their environmental performance as well as their compliance with mandated regulations. Thus it offers clear guidelines for improving a corporate environmental performance while also providing cost savings and enhanced stakeholder trust.^154,155

The research has shown that corporate environmental efforts extend beyond the strategy level into most important areas of operation. Sustainable Human Resource Management (HRM) also known as Green HRM for instance is crucial for cultivating a workforce that aligns with the direction of the environmental strategy. To do so, Green HRM implements additional training, motivation, and incentives to encourage employees to adopt sustainable practices, like reducing waste, conserving energy, and supporting corporate sustainability initiatives. Additionally, specific measures are aimed at increasing leadership commitment for environmental efforts to drive further organisational changes.^156,157

Green marketing strategies, on the other hand, promote more sustainable products and practices. These include recyclable packaging, energy-efficient production, and eco-friendly branding. These initiatives are targeted at consumers who are environmentally conscious, with the aim of improving financial performance by differentiating products from market competitors. Research suggests that firms engaging in environmental marketing experience increased customer loyalty and enhanced brand reputation, leading to long-term economic benefits.^157,158 However, studies also show that these advantages can lead companies to overstate their environmental efforts while ignoring the environmental harm caused by their operations. This form of false communication is also known as greenwashing and is regularly criticized by activists and policymakers.⁸ Moreover, Aragón-Correa et al. (2016) demonstrate that especially large international firms disclose more information about their environmental efforts, although their actual environmental performance is lower than that of smaller firms within their industries.¹⁵⁹

Sustainable logistics and supply chain management involves green procurement, responsible manufacturing, and waste reduction efforts at every stage of a firm’s production and procurement process. This strategy entails a company’s focus on sourcing environmentally friendly raw materials, reducing greenhouse gas emissions, and optimising transportation to minimise environmental impact. Sustainable supply chain management efforts can be categorised in forward and reverse logistics. Forward logistics minimises environmental impact at the source, e.g. by using environmentally friendly materials, while reverse logistics refers to reducing environmental impact at the end of the production cycle through easier recycling and material reprocessing.^157,160

Environmental management accounting practices have been implemented in cases where financial and environmental information merges. It presents a valuable tool for assessing a company’s costs, savings, and earnings associated with sustainability efforts. Such information enables managers to gain valuable insights into resource allocation and efficiency. One form of environmental management accounting is Material Flow Cost Accounting (MFCA), which has been found to have a positive impact on the financial and environmental performance of companies.¹⁵⁷

The development and implementation of concepts like Corporate Social Responsibility (CSR) shows that companies and managers are increasingly recognizing the significant societal role of businesses in the context of sustainable development. The CSR concept is based on the idea of the triple bottom line approach to sustainable development and reinforces sustainability by integrating eco-friendly practices into corporate strategies. Firms that actively participate in CSR initiatives aim to boost their environmental performance, improve stakeholder engagement, and enhance their financial situation. Studies have shown that these strategies form a comprehensive approach to corporate environmental responsibility and drive long-term sustainability while also improving firms economic situation.^161,157,162

Despite increased costs and challenges that additional environmental efforts and strategies can cause, a growing number of companies are using sustainability strategies not only to meet regulatory expectations but also to create competitive advantages.⁸ By developing innovative environmental technologies and practices, firms can improve efficiency and reduce costs. Studies have demonstrated that environmental leadership enhances brand value and strengthens reputation. To underscore these benefits, the next section summarizes important findings on the advantages that the implementation of proactive environmental management strategies can bring.

5.3    Advantages through Compliance and Proactive Environmental Action

Regardless of the instrument choice, the implementation of mandatory environmental policy measures usually leaves affected companies, assuming they stay inside the boundaries of the law, only with the choice of compliance. Even though especially larger corporations have been found to influence the policymaking process, when mandatory environmental policy measures are put into action companies have to act accordingly.²¹ As discussed in section 5.3 the implementation of such measures can lead to advantages for firms through the induction of innovation facilitating a competitive advantage. However, such effects most often manifest themselves on an economy wide scale and might not be noticeable on the level of individual firms or sectors.^58,117 This section is therefore aimed at the possible benefits from environmental policy on a firm level and the advantages firms can utilize when expanding their sustainability efforts above the set threshold of mandatory environmental policy. Being aware of these firm level benefits is also important for policymakers as firm benefits might be utilized to support the environmental goals of future policies. 

On a firm level mandatory environmental policy measures can encourage firms to explore new and more sustainable technology if the costs of investing in the necessary R&D efforts are lower than the costs of buying emission licenses, tradeable permits, or paying an environmental tax.⁵⁸ Further investments in more sustainable technology development can enable firms to take on a innovation leadership role hence differentiating themselves from competitors. In doing so companies can reinforce or even expand on their market position. Furthermore, catering to the growing consumer demand for environmentally friendly products can further enhance these effects. Hence, leveraging the innovation pressure firms face through environmental policy and further expanding upon it can give firms significant market advantages compared to competitors who are choosing a more conservative approach. Nonetheless, the associated risks that come with developing new technologies, like the uncertainty of market success for instance need to be incorporated in the decision process.^159,163

This effect can also be enhanced by the potential for fast-moving companies to get ahead of their competitors. If firms can anticipate future policy objectives and are able to adapt and comply quickly with mandated environmental policies, they can increase their competitive advantage in markets with evolving environmental standards. The leveraging of this advantage however is highly depended on individual managers ability and knowledge of future policy and market development.⁹ As Luan et al. (2012) examined the underlying risks for firms moving ahead of the competition with environmental compliance efforts, they come to the conclusion that carefully strategizing environmental efforts can be more economically viable for firms.¹⁶⁴

On the other hand, the investment in cleaner production methods and energy efficiency initiatives can lead to significant long-term operational cost reductions. Hence, firms that adopt proactive environmental strategies often experience improved long-term productivity and financial performance due to innovation and efficient resource usage. The focus on pollution prevention and process innovation can further increase organizational learning effects as well as improve and expand on employee skillsets. These long-term effects enable firms to be prepared for potential future environmental policy initiatives, thus encouraging proactive sustainability efforts.¹⁶⁵

Possible reputation improvement can also incentivize firms to expand on their environmental policy compliance measures. Bowen et al. (2020) highlight the positive effects of information disclosure policies on the environmental performances of firms. Hinting at the fact that the reputational gains companies expect from voluntarily disclosing data on their environmental performances induces firms to focus on enlarging their investments in improvement of environmental performance.⁵³

In conclusion, firms that comply with and go beyond environmental policy mandates can leverage several economic benefits like innovation leadership, enhanced reputation, expansion of their market position, and realized cost savings. These advantages not only improve firm performance but also enhance on the expected environmental effects of mandated policy measures.

6        Practical Implications

This literature review has demonstrated the crucial role of environmental policymaking in the overarching sustainability transition. Since its humble beginnings in the late 19^th century the processes and objectives of environmental policy have expanded to reach all areas of policy making, and with the increasing severity and complexity of global sustainability issues its importance for aligning economic, social, and environmental considerations into the policymaking process is only increasing. However, it has also become clear that nationally and internationally implemented environmental policy measures have not yet reached the necessary scope to effectively address all pressing issues such as climate change in its entirety. This underscores the need for speeding up the deployment of new and more effective instruments as well as the adjustment of existing ones to realign with the comprehensive objectives of sustainable development. For this reason, policymakers and corporate actors alike should reevaluate their strategies and increase their efforts in the context of sustainability problems. To provide some orientation on how these shortcomings can be addressed, this final section shall provide a summary overview on the practical implications for policymakers and corporate actors that can be derived from this interdisciplinary literature review. 

6.1    Implications for Policymakers

The policy process model highlights the significance of political pressure and momentum in the policy-making process, as it is a crucial element for initiating and progressing the policy cycle. This is particularly evident in the context of environmental policymaking, where the efficacy of sustained pressure from public interest groups and grassroots organizing in achieving favourable environmental policy outcomes has been repeatedly demonstrated. For this reason, policymakers might increase the accessibility of the policy-making process to the public sphere, facilitating political momentum and thereby furthering ambitious environmental policy objectives. However, it is equally important to acknowledge the frequently detrimental influence of corporate interest groups in adapting environmental policy measures to their own agenda. History has demonstrated that this has often resulted in the weakening and stalling of environmentally effective policy initiatives.⁸ Policymakers must be aware of such influences in order to withstand the political pressures brought on by fossil fuel and other economic lobby organizations. 

Furthermore, the assessment of different policy instruments, as well as their implementation, has highlighted the importance of careful and deliberate policy design. Policymakers must consider the complex environmental, social, societal and economic effects as well as possible shortcomings like carbon leakage or employment reductions in carbon intensive industries. Policy mixes can offer a possible solution for addressing these potential instrument shortcomings. However, they require careful design to utilize synergies and minimize conflicts. The assessment of market-based instruments has shown that policymakers need to be aware of the use-side effects of policy instruments, and apply measures that release pressure on low income groups especially.

Adapting policy mixes to specific contexts is also essential for maximising their environmental and economic performances. The discussion of supply side policies has also shown that balancing supply and demand sided policies in a policy mix can offer a possible solution for the problem of carbon leakage, thus ensuring the environmental effectiveness of policy mixes. When designing policy mixes policymakers should also include considerations regarding the specific marginal abetment costs of the intended industry or sector. As discussed in chapter 5.4 cases where initial marginal abetment costs are high might favour the larger application of supply-side policy instruments in the policy mix.

Additionally, the differences in governmental resource requirements for individual policy instruments have been identified as a deciding factor for environmental policy implementation. Governments with limited administrative capacities need to consider the higher effort needed to design, control, and enforce regulatory approaches even though they can offer higher environmental effectiveness. In these cases, less resource intensive policy options like information-based instruments or environmental taxes should be considered. The example of the EU ETS has highlighted the need to anticipate setbacks and to prepare plans for adjusting and reevaluating policy instruments. The policy process model offers a helpful tool for orientation in manoeuvring the complex cycle of continual and regular monitoring of policy effects, which is necessary to ensure that policy objectives are achieved. The time-intensive nature of addressing policy setbacks should also be acknowledged by policymakers. In the case of environmental issues where time is of the essence, instruments that can unfold their effects faster should therefore be preferably chosen.

Policymakers should also pay attention to the failures of past instruments as they can offer important insights for the design and adjustment of future policy measures. The failure of EU regulation enforcement and design in the context of the VW emissions scandal could represent such an example. This case offers valuable insights for policymakers to improve the design and enforcement of future instruments.

In conclusion, it can be assessed that the extant research on environmental policy offers a plethora of possible options and solutions for policymakers. The reliance on these insights should provide policymakers with the necessary tools to address the problems of environmental policy. 

6.2   Management Implications

On the other hand, the management perspective has shown that the role of corporations is essential for successful environmental policy efforts. The actions and strategies of firms can prove to be drivers or barriers for environmental policy. This unique position underscores their importance and the necessity for policymakers to include the perspectives and ideas of corporations into policy design. Research also shows that a firm´s compliance with environmental policies is influenced by internal factors, such as leadership commitment and organizational culture, as well as external pressures, including regulatory requirements and market expectations. These influences can be decisive for companies to expand their sustainability commitments beyond the mandated levels of environmental policy. For this reason, managers that strive to limit their company´s environmental impact can leverage these effects in order to simplify the introduction of effective environmental strategies. 

The potential economic benefits of environmental policy for individual firms have also been highlighted. Especially positive effects on sustainable technology innovations can be leveraged by firms to improve their market position. Furthermore, the implementation and communication of proactive sustainability measures can lead to an improvement of public perception and higher peer pressure on competitors. Managers should acknowledge these potential benefits and integrate them into their strategic decision making as these can facilitate important competitive advantages. Furthermore, policymakers should also understand these possible firm level effects as they can prove useful for future policy design. 

However, it is also important to note that environmental policy may also have negative effects on specific sectors and firms. Therefore, it is important that managers have the ability to anticipate the implementation of environmental policy measures and their impact on the firm, and adjust their strategies accordingly. 

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