Market-based instruments in Germany and the Netherlands: A case of competition versus co-operation?

Eumpean Environment, Vol. 5, 1-6 (1995)

MARKET-BASED INSTRUMENTS IN GERMANY AND THE NETHERLANDS: A CASE OF COMPETITION VERSUS

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CO-OPERATION? Walter Douglas, Graduate School of Environmental Studies, University of Strathclyde, Glasgow, UK

INTRODUCTION

he Fifth Environmental Action Programme, Towards Sustainability, is radical in its empha- T sis on the need for a fundamental change in

the current patterns of human consumption and behaviour. This in turn calls for a sharing of responsibility by a wide range of actors at all levels of society. The Programme indicates that this can only be achieved through a broadening and deepening of instruments, including greater use of market-based instruments. The fundamental aim of such instruments is to provide incentives for the internalization of external environmental costs to the decision-making frame of a wide range of actors, including producers and consumers. This paper, based on in-depth interviews with senior German and Dutch policy-makers, explores recent environmental policy-making trends to reveal significantly different approaches to the use of market-based instruments in the national policy packages of these Member States. The use of economic instruments and voluntary agreements with industry are examined in particular. The lessons for designing environmental policy packages of the future are also explored, especially in the context of incentives for technological innovation.

ENVIRONMENTAL POLICY PRESSURES AND TRENDS

Although Germany currently maintains an extensive network of regulatory controls, there has been continuing pressure in Germany for a greater use of specifically economic instruments which

CCC 0 6 1 -0405/ 95/ 01 0001 -06 0 1995 by John Wiley & Sons, Ltd and ERP Environment.

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emphasize a competitive model of environmental protection that might ultimately offer opportunities for deregulation.

The German Institute of Environmental Manage- ment, a highly influential liaison and policy-making forum for industrialists, politicians and academics, is particularly critical of traditional 'command and control' regulation on the grounds that it tends to adhere to an internal administrative logic of its own and takes little account of the commercial and technical processes which it sets up in affected companies. This 'black box' approach to regulation is held to result in an unproductive culture clash between regulators and industrialists. It is also pointed out that this is typically softened in practice by the use of administrative discretion, which ultimately results in enforcement problems.

The Institute also argues forcibly that such regulatory models may actually inactivate market incentives for technological innovation. Best Avail- able Technology standards tend to be determined by an adversarial lobbying process between regulators and industrialists, which results in an obscuring of the true technical potential of the innovative process. This means that the taking of competitive innovatory risks to get below the current 'state of the art' is not commercially rewarded and therefore does not achieve its development potential. This is blamed for the observed inertia in the movement from end of pipe pollution abatement to more sustainable source-directed prevention solutions involving the radical redesign of products and production processes.

In contrast, Dutch policy-makers emphasize a more co-operative model of environmental protection and have consistently reaffirmed their commitment to regulation as the dominant policy instrument. Environmental policy-making in the Netherlands is carried out by a detailed system of planning laid out in three successive National Environmental Policy Plans: NEPP, NEPP-plus and NEPP2 (Netherlands Government, 1989; 1990; 1993). Environmental problems are diagnosed by rigorous scientific research, meticulously quantified targets are set and then highly interventionist policies are designed to achieve them. A central feature of Dutch policy is the Target Group approach, which makes particular use of voluntary agreements to build a support base of consensus for new and more stringent regulation. However, despite the impressive design of these plans, debates in the Dutch parliament over NEPP2 in May 1994 have revealed a significant and widespread perception of failure to meet important NEPP targets and achieve a real integration of policies in practice.

EXPERIENCE WITH ECONOMIC INSTRUMENTS

Economic instruments have been used with some considerable degree of success by both German and Dutch policy-makers. However, Germany has taken the process a crucial step further by attempt- ing to introduce true market creation strategies.

The levy applied under the Dutch Pollution of Surface Waters Act is an example of a specific funding levy which is imposed pro-rata on an identifiable group of polluters. The Fuel Levy employed under the General Environmental Pro- tection Act is an example of a more general funding levy where costs can only be attributed to polluters in a very general way and so are shared between polluters collectively.

The Waste Water Levy is an analogous German example of economic instruments being used to provide positive rather than negative incentives. Initial attempts to introduce a charge of 80 DM per cubic metre for direct discharges failed due to political pressure. However, a charge of 40 DM per cubic metre was successfully implemented in 1986. An amendment was subsequently introduced in 1987 which allowed the levy to be waived comple- tely for dischargers who succeeded in reducing pollution levels in effluent below a pre-set target level. This served to reduce the cost of administra- tion and provided incentives to reduce emissions. Furthermore, it is thought that this measure has the potential to favour source-directed prevention technologies due to the fact that they are less sensitive to operational disruptions.

However, the greater ambition of German policy- makers for the use of economic instruments is clearly revealed in attempts at true market creation policies. The operational model for such policies is largely based on practical experience with tradeable emission permits currently being piloted within the Clean Air Act in the USA. These policies require the regulatory authority to identify targets for total emissions within a geographical area. This is then allocated in the form of quantified permits to companies. The fact that the permits are tradeable for cash offers the potential for optimization of cost as it allows companies who can reduce emissions cheaply to sell permits to those who have more difficulty. This in effect gives a market value to the resource of clean air, allowing the price mechanism to lend economic efficiency to the allocation of the scarcity. After the initial allocation period the permits can be scaled down or 'devalued on a pro-rata basis by the authorities to reduce total emissions. The created market is then allowed to deliver the reduction in an economically efficient, least-cost manner by further permit trading.

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To offer the opportunity to realize some of these potential benefits, provisions for the introduction of an emissions-crediting system known as the Compensation Rule were incorporated into the Federal Emission Control Act in 1985. In the following year it was then offered for practical application through the Technical Instructions on Air Quality (TA Luft). The Compensation Rule allows pollution abatement to below prescribed standards at one plant to establish emission credits which can then be transferred within a company or traded between companies to cover excess emissions at another plant which are more costly to reduce. Such emission credits can only be transferred within a given geographical area and for a broadly similar profile of pollutants.

However, despite this long-standing opportunity, trading in emissions has so far hardly occurred at all. Based on extensive consultation with industrialists, the German Institute of Environmen- tal Management indicates that this may be attribu- table to the fact that companies have perceived the introduction of these market-based instruments in parallel with more traditional regulatory instruments as having only experimental status. This has resulted in understandable caution about the building up of credits through innovation in the fear that traditional regulatory instruments might subsequently be used to generalize achievements at a single plant to all the others. The Institute is now calling for the development of a new strategy to create a perception of stability by reinforcing its commitment to market creation in this policy area, while at the same time making permissible emission levels progressively more challenging. It is hoped that such a strategy would provide emitting companies with increased competitive incentives to stimulate research and development of radically redesigned products and production processes to allow the eradication of pollution at source.

EXPERIENCE WITH VOLUNTARY AGREEMENTS

Voluntary agreements have been used effectively in both Germany and the Netherlands. However, in the case of the Netherlands this instrument is accorded a particularly prominent support role for the implementation and enforcement of increasingly stringent regulatory standards.

There are approximately 40 voluntary agreements currently operating in Germany. The agreement between the German Government and the Aerosol Industry Association (IGA) provides a good example. In 1987 the IGA entered into a voluntary agreement with the German Government

to reduce chlorofluorocarbon (CFC) emissions to 90% of their 1976 levels by 1990. This agreement went considerably beyond the levels set interna- tionally at that time by the Montreal Protocol of a 50% reduction in 1987 levels by 1999.

This agreement offered advantages to both the aerosol industry and the German Government. It allowed the industry to exercise discretion over which products could use CFCs according to market requirements and technical progress. The government achieved higher standards than the Montreal Protocol and simultaneously avoided potential political problems with non-tariff trade restrictions under EU competition policy. Italy and the UK had blocked CFC reduction at EU level, so unilateral regulation might have brought interven- tion from the Commission or Member State actions in the European Courts. However, the voluntary approach did raise practical competition problems for the aerosol industry itself in that European competition regulations prevented them advertis- ing the CFC-free benefits of their products. This meant they were in serious danger of losing market share due to the cost disadvantage inherent in CFC substitutes.

It is significant that this national agreement established in Germany was closely followed by an agreement at Community level. A Council Resolution (Council of the European Commu- nities, 1988) invited the Commission to make voluntary agreements with relevant industries for the substitution of ozone-depleting substances in industrial production. The instrument chosen for establishing these voluntary agreements at the level of the EU was a Commission Recommendation (Commission of the European Communities, 1989), which was addressed to aerosol manufacturers, industry sector organizations and Member States.

Voluntary agreements, of which there have been about 60 to date, are under particularly intense development in the Netherlands as the main support instrument to help overcome compliance problems with new and existing regulation to achieve the challenging targets of the NEPP. They are specifically designed to build consensus and support within the Target Groups for this purpose. In keeping with the observations of the Fifth Environmental Action Programme, the Industry Target Group is considered to be particularly important in this respect.

The Dutch Government recognizes that the Industry Target Group is very diverse and that different sectors are faced with different problems. Plans for industry as a whole are spelled out in the Memorandum on the Implementation of Target Group Environmental Policy for Industry (Nether- lands Government, 1992). Integrated environmental

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objectives have also been drawn up for each sector for 1994, 2000 and 2010 within NEPP. These objectives cover emission reductions, waste production, energy consumption and soil decontami- nation.

Covenants for the implementation of the Inte- grated Environmental Target Plan are to be set out in Declarations of Intent. In sectors which are deemed homogeneous, such as the printing industry, these Declarations are being negotiated on behalf of the industry by the relevant industrial association and formalized at sector level. This is an essentially similar format to the German aerosol industry example. However, in sectors deemed heterogeneous, such as the chemical industry, individual Declarations incorporating company environmental plans will be required. The Declara- tions contain meticulous and stringent targets for the reduction of specific waste streams down to compound level in some instances, together with rigid disposal targets for the remainder in terms of incineration and dumping. They also include carefully quantified and ambitious targets for emissions into air and water, soil clean-up and energy conservation.

It is important to note, however, that Dutch voluntary agreements also offer particularly favourable opportunities for the pooling of research and development costs and benefits at sector level. This is facilitated by the Dutch National Environmental Technology Programme operated through state-funded Innovation Centres, where groups of companies can have new products and processes tested against future regulatory develop- ments. This clearly has the potential to provide valuable economies of scale in the entire innovation process.

It is also significant that Dutch policy-makers are currently engaged in a vigorous campaign within the Commission, not only to defend the greater role for voluntary agreements within their domestic policy, but also to promote the instrument for use at Community level. In contrast, German policy- makers regard the agreement instrument as valuable in particular circumstances, but limited in its scope of application by undesirable effects on economic competition, as highlighted in the aerosol industry case study. This difference in policy emphasis is currently the subject of a vigorous debate within the Commission.

Article 85(1) of the Treaty prohibits all agreements which distort competition in the Single European Market. However, under Article 85(3) derogations can be granted for agreements which promote technical progress. Indeed, the Commis- sion prepared the way for the Community level agreement on CFCs with a formal decision

(Commission of the European Communities, 1988) that this derogation may apply specifically to the environment. However, the question of whether general principles or class exemptions should be established for voluntary environmental agreements at Member State level is still a matter of active controversy within the Commission. On the other hand, the position of the Commission with regard to the more widespread use of voluntary agreements at Community level is a little more apparent. The Principal Administrator at DG XI (Jorgensen, 1994) has indicated that such agreements are likely to require individual mandating from the Council and Parliament and that this will 'probably make the voluntary approach at least as time consuming and cumbersome as the traditional legislative approach.

MARKET-ORIENTED REGULATION AND LIABILITY REFORM

Analysis of some regulatory and legal instruments demonstrates the ability of both German and Dutch policy-makers to use these more traditional instruments in a remarkably creative way to apportion liability in an economically rational and market- oriented manner.

The Soil Protection Act in the Netherlands provides a general framework for the prevention of soil pollution and clean-up of contaminated land. Legislation on the general rules for the notification and clean-up of contaminated land is also pending in the Netherlands, as in many other Member States. However, the most effective measures for the protection of the soil are usually provided in the permit under the Nuisance Act. Granting of such permits increasingly requires a soil survey. The condition of the soil is thereby determined at the moment the new permit enters into force. It can then be proved which part of the contamination occurred under the new permit and only then may clean-up of such contamination be required under the Nuisance Act. This important provision under current Dutch legislation means that the innocent purchaser of contaminated land cannot be held liable for historical contamination which took place before his or her ownership.

It is therefore clear that liability for soil contamination attaches only to the polluter in the Nether- lands with no possibility of liability arising purely out of ownership, as it still can in some other European jurisdictions. This provides an important example of how new and systematic regulation can actually allow environmentally relevant markets to operate more efficiently by ensuring that liability is apportioned on a rational basis in accordance with


the polluter pays principle. This allows companies to promote long-term profitability by developing land in an environmentally acceptable way, which in turn prevents the institutional inertia with regard to land transactions and clean-up of contaminated sites which is so conspicuous in some other Member States.

The importance of rational liability provision as a prerequisite for the efficient operation of markets is further emphasized by analysis of the provisions of the German Environmental Liability Law, which was passed in Germany in 1990 with a view to compensating for environmental damage in a fairer way. The new law also aims to provide incentives for increased prevention on the part of companies by increasing the possibility of significant damages payment.

Before the Environmental Liability Law was passed, all actions required proof of fault except where Section 22 of the Water Resources Law applied. This usually implied that the pursuer had to prove foreseeability, which is notoriously difficult in the face of developing scientific knowl- edge. An extremely onerous burden of proof of causality was also placed on damaged parties, which presented enormous practical difficulties due to the scientific uncertainty characteristic of many environmental phenomena.

However, the new German Environmental Lia- bility Law takes these difficulties into account and seeks to redress the balance between pursuer and defender by introducing strict, no-fault liability for all environmental damage. The burden of proof of causality has also now been eased, with a crucial new assumption in favour of causality if a plant can be shown to have possibly caused the damage. This will encourage the keeping of gap-free emission and discharge logs on the part of companies, something which has proved difficult to enforce by regulation. Before the passage of the new law, operation in compliance with a licence was tantamount to an unshakeable defence against pursuit for legal damages. This has also been removed by the new law, which will fundamen- tally change the risk versus cost calculations of companies. This in turn should provide incentives for technological innovation to enable companies to get well below the licence limits, rather than aiming for mere compliance; a good example of the operation of the radical German precautionary principle in practice.

It is particularly significant that this piece of German legislation already embodies many of the proposals of the Commission’s recent Green Paper for Remedying Environmental Damage (Commis- sion of the European Communities, 1993), which lays out proposals for the establishment of an EU

W. DOUGLAS

approach to environmental liability. These proposals seek to give life to several important principles of the Fifth Environmental Action Programme, including prevention, the polluter pays principle and the provision of ’economic incentive for management and control of risk, pollution and waste’.

CONCLUSIONS

It is clear, therefore, that policy pressures for the selection and use of market-based instruments reveal a tendency to adopt a more competitive model of environmental protection and technology development in Germany and a more co-operative approach in the Netherlands.

However, experience in both countries demonstrates that the costs and behaviours of business are complex and cannot be estimated precisely. This makes it notoriously difficult to set and target economic instruments precisely. To make the situation even more difficult, this is often carried out against a background of political resistance, as highlighted in the case of the German Waste Water Levy. In this example the target cost of 80 DM per cubic metre was reduced to 40 DM per cubic metre due to political difficulties. In practice, therefore, a unit price was pre-set for the emission which was purely arbitrary in economic terms in the hope that it would be sufficient to allow the market to bring about the desired reduction in quantity.

Applied like this, the instrument is really only a mirror image of traditional regulation with an economically arbitrary setting of the price of emissions instead of quantity. As such, it loses the cost-efficiency advantages offered by true market creation strategies such as tradeable permits. However, this is not to deny the potential advantage of each unit being charged for, which does provide an incentive for an overall reduction in pollution emissions in accordance with the polluter pays principle. The instrument is also relatively easy to implement and has enormous potential to change behaviour.

It is undeniable that the theoretical advantages of market creation strategies are extremely appealing. They seek to achieve cost efficiency in achieving any given level of protection standard, while at the same time harnessing full market incentives for the fundamental redesign of products and production processes to achieve more sustainable source- directed prevention as opposed to end of pipe pollution abatement. However, the German experi- ments serve to illustrate some of the difficulties of moving from the simple theoretical model to full application in reality. Not least of these may be the

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fact that combinations of regulation and market instruments are to some extent mutually antago- nistic, yet the move to exclusively market instruments remains a daunting policy leap.

The German competitive versus Dutch co- operative approach to market-based instruments is thrown into particularly sharp relief by differ- ences in their relative enthusiasm for voluntary agreements. The Dutch experience clearly demonstrates their enormous potential for generating economies of scale in technology development. However, German concerns clearly demonstrate that more widespread application of the approach will ultimately depend on crucial practical relation- ships with EU competition policy and, indeed, the wider political constraints for their use under Community law.

In defence of the continued use of more formal legal instruments, the Dutch policy on contaminated land demonstrates in a very practical way how carefully drafted regulations can allow markets to operate more efficiently and, rather than create market distortions and failures, can actually remove those which existed before their enactment. The contaminated land discussion clearly demonstrates that regulation can be a market-oriented instrument. This point is further emphasized by analysis of the new German Environmental Liabi- lity Law. Although not a regulatory instrument in the classic sense, it is by definition legalistic in its approach. Nevertheless, it is proving extremely effective in fulfilling a fundamental aim of the Fifth Environmental Action Programme, namely the internalization of previously external environmental costs to the decision-making frame of a wide range of actors. This provides another example of how good law can actually make markets operate more effectively by ensuring that environmental costs are an integral part of commercial decisions.

It is apparent, therefore, that instruments should not be selected or rejected on the basis of either competitive or co-operative ideology, but rather by a full and clear analysis of all their likely practical effects. In terms of the earlier analogy this means opening the regulatory ’black box’ to reveal the internal processes by which a company is likely to respond to the instrument in question. These internal processes can only be revealed by liaison

and communication between industrialists and environmental policy-makers. Although this is likely to involve careful consideration of economic motives and incentives, it does not imply dogmatic adherence to a limited range of pre-designated ‘economic instruments’ in preference to regulation. Indeed, it is clear from the examples given here that a wide range of instruments, including regulation, environmental liability reform and voluntary agreements, can, with the help of careful collabora- tive analysis, be applied in market-oriented ways.

REFERENCES

Commission of the European Communities (1988) Commission Decision 88/541/EEC of 11.10.1989 Relating to a Proceeding Under Article 85 of the EEC Treaty 1Vl 32.368lBBC. BROWN. BOVERY. 01 L 301 of 4.11.1988, p.68.

Commission of the European Communities (1989) Commission Recommendation 89/349/EEC on the Reduc- tion of Chlorofluorocarbons by the Aerosol Industry. OJ L 144 27.5.1989, p.56.

Commission of the European Communities. (1993) A Green Paper on Remedying Environmental Damage. COM 93 (47).

Council of the European Communities (1988) Council Resolution 88lC 285lOl of 14.10.1988 for Limitation of Use of Chlorofluorocarbonsand Halons. OJ C 285 of9.11.1988, p.1.

Jorgensen, J. (1994) Voluntary agreements and other voluntary measures as elements in EC environmental policy, paper presented at the Governing Our Environ- ment Conference, Copenhagen, 17-18 November 1994.

Netherlands Government (1989) National Environmental Policy Plan: To Chose or to Lose, MHPPE.

Netherlands Government (1990) National Environmental Policy Plan Plus, MHPPE.

Netherlands Government (1992) Memorandum on lrnple- menfation of Target Group Environmental Management Policy for Industry, MHPPE.

Netherlands Government (1993) National Environmental Policy Plan 2: the Environment: Today‘s Touchstone, MHPPE.

BIOGRAPHY

Walter Douglas Graduate School of Environmental Studies University of Strathclyde 7.11 Graham Hills Building 50 Richmond Street Glasgow G1 lXN, UK Tel.: 0141 552 4400 ext. 3644; Fax.: 0141 552 5498


Market-based instruments in Germany and the Netherlands: A case of competition versus co-operation?

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