G:339 \9 o II 5e ^ l= .LJ99. THE GREENING OF ECONOMIC POLICY REFORM VOLUME I: PRINCIPLES Jeremy J. Warford Mohan Munasinghe Wilfrido Cruz The World Bank A EEnvironmental Department and FART) Economic Development institute Fnl - I- I The Greening of Economic Policy Reform Volume I: Principles Jeremy Warford Mohan Munasinghe Wilfrido Cruz The World Bank Washington, D.C. Copyright i 1997 The International Bank for Reconstruction and Development/THE WORLD BANK 1818 H Street, N.W. Washington, D.C. 20433, U.S.A. All rights reserved Manufactured in the United States of America First printing February 1997 Environment Papers are published to communicate the latest results of the Bank's environmental work to the development community with the least possible delay The typescript of this paper therefore has not been prepared in accordance with the procedures appropriate to formal printed texts, and the World Bank accepts no responsibility for errors. Some sources cited in this paper may be informal documents that are not readily available. The findings, interpretations, and conclusions expressed in this paper are entirely those of the author(s) and should not be attributed in any manner to the World Bank, to its affiliated organizations, or to members of its Board of Executive Directors or the countries they represent. The World Bank does not guarantee the accuracy of the data included in this publication and accepts no responsibility whatsoever for any consequence of their use. The boundaries, colors, denominations, and other information shown on any map in this volume do not imply on the part of the World Bank Group any judgment on the legal status of any territory or the endorsement or acceptance of such boundaries. The material in this publication is copyrighted. Requests for permission to reproduce portions of it should be sent to the Office of the Publisher at the address shown in the copyright notice above. The World Bank encourages dissemination of its work and will normally give permission promptly and, when the reproduction is for noncommercial purposes, without asking a fee. Permission to copy portions for classroom use is granted through the Copyright Clearance Center, Inc., Suite 910, 222 Rosewood Drive, Danvers, Massachusetts 01923, U.S.A. Related World Bank publications include Economywide Policies and the Environment by Mohan Munasinghe and Wilfrido Cruz (World Bank Environment Paper No. 10) and Environmental Impacts of Macroeconomic and Sectoral Policies (forthcoming) edited by Mohan Munasinghe. Library of Congress Cataloging-in-Publication Data Warford, Jeremy J. The greening of economic policy reform / Jeremy Warford, Mohan Munasinghe, Wilford Cruz. p. cm. Includes bibliographical references. Contents: v. 1 Principles-v. 2. Case studies ISBN 0-8213-3477-8 1. Sustainable development-Case studies. 2. Economic policy- Case studies. 3. World Bank I. Munasinghe, Mohan, 1945- II. Cruz, Wilfredo. III. World Bank. IV. Title. HC79.E5W36 1997 333.7-dc2O 95-39068 CIP CONTENTS VOLUME I Foreword ................................................. v Acknowledgments ............................................ vii Authors ............................... viii 1. Overview ................................................. 1 2. Explicit Environmental Incentives ............................... 9 3. Sectoral Policies ............................................ 25 4. Macroeconomic Policy and the Adjustment Process ................ 45 5. Linkages Between the Environment and Economywide Policies: Recent World Bank Experience ................................ 65 6. Case Study Summaries ....................................... 81 7. Policy Implications ......................................... 93 Bibliography ............................................... 109 Abbreviations and Acronyms ................ .................... 119 iii iv Volume I Tables 4-1. Critical Environmental Links for Economic Planners ..... ........ 63 4-2. Critical Economic Policy Links for Environmental Planners .... .... 64 6-1: Scope of Economywide Policy-Environment Linkages Discussed in Case Studies . .......................................... 92 7-1: Simple Example Action Impact Matrix (AIM) ..... ............. 101 7-2: Example of Environmental Issues: Matrix Indicators and Causes of Selected Environmental Problems in Sri Lanka ..... .......... 102 7-3: Current Economic Conditions and Proposed Reforms in Sri Lanka . 104 7-4: Sri Lanka Action Impact Matrix ............................. 106 Figures 2-1: External Costs and Optimal Pollution ......................... 23 2-2: An Environmental Tax ........... .......................... 23 2-3: Subsidizing Pollution ............ .......................... 24 3-1: Marginal Opportunity Cost Pricing ............................ 44 3-2: Marginal Costs and Benefits of Reducing CO2 Emissions ..... ..... 44 Boxes 3-1: Increasing Water Scarcity .......... ......................... 29 3-2: Measuring Resource Use-the Metering Problem ..... ........... 31 4-1: Environmental Accounting .......... ........................ 47 4-2: Poverty and the Environment ......... ....................... 55 4-3: Environmental Concerns and Adjustment Lending ..... .......... 59 5-1: Fiscal Policy and Air Pollution in Mexico ...................... 70 5-2: Economic Transition and Sustainable Agriculture in China ......... 74 5-3. Industrial Growth and Pollution in Indonesia ...... .............. 76 FOREWORD Recent years have seen a wide range of economywide policy reform programs which have been undertaken in developing countries to address macroeconomic problems, such as those affecting international trade, government budgets, private investment, wages, and income distribution. Reform programs also address broad sectoral issues, such as those relating to agricultural productivity, industrial protection, and energy use. The economywide mechanisms for attaining these goals include altering the rates of exchange or interest, reducing government budgets, promoting market liberalization, fostering international openness, enhancing the role of the private sector, and strengthening government and market institutions-often coupled with pricing and other reforms in key sectors such as industry, agriculture, and energy. Although these policies are typically not directed explicitly toward influencing the quality of the natural environment, they may, nonetheless have major impacts upon it, either positive or negative. This book (and its companion volume of case studies) shows that there are significant payoffs in attempting to understand such impacts better and to act upon them. Positive impacts of economywide reforms on the environment can be used to build constituencies for reform. Potential negative impacts need to be analyzed, monitored, and mitigated. The importance of addressing economywide reforms and environmental management in an integrated manner has received growing recognition. As noted in the Bank's Annual Report on the environment, most country assistance strategies (CAS) now address the environmental challenges facing each country (World Bank, 1995, Mainstreaming the Environment). The CAS is the principal statement of the World Bank's overall development strategy in a given country. In some country assistance strategies, the links between environmental problems and their underlying causes are discussed (e.g., natural resource or energy price distortions). In others, the focus is on government efforts to address environmental issues at the country level. Recent examples include the CAS for Chile, China, Hungary, Latvia, Niger, Senegal, Swaziland, and Thailand. For example, in Senegal, although the main focus is on stimulating economic growth, the environment is listed as one of five problem areas that need specific attention. Environmental considerations are also featured in CAS discussions of sectoral policies and lending programs. These include water resource management (e.g., Brazil, India, FYR Macedonia, and Peru), urban sanitation (most countries), energy efficiency (China, and various countries in Eastern and Central Europe), industrial pollution control (Brazil, China, Ghana, and Thailand), mining (Estonia, Ghana, Peru, and Poland, among others), and agriculture (especially countries in Africa and Latin America) (World Bank, 1995, Mainstreaming the Environment). Although much literature of a theoretical nature on this topic is emerging, there has until recently been little empirical work to help improve our understanding of the links between economywide policies and the environment. In some instances, the direction of environmental impacts stemming from economywide policy reform is fairly straightforward. The extent of the impact, however, invariably requires empirical analysis. In more complex cases, even the direction of the impact is ambiguous. In view of their location-specific nature, involving a v vi Foreword range of economic, physical, institutional, and cultural variables, there is a clear need for more case study material to enhance our understanding of these relationships. The case studies summarized here (and presented in full in Volume II), which have been carried out within the World Bank over the last several years, are a contribution to this objective. They have already provided the basis for a comprehensive paper on economywide policies and the environment that was approved by the Bank's Board of Executive Directors, and presented at a special session of the 50th Anniversary Annual Meetings of the World Bank and International Monetary Fund in Madrid, October 1994 (World Bank, 1994, Economywide Policies and the Environment: Emerging Lessons from Experience). The case studies reflect a wide range of country situations and environmental problems. Pollution issues are addressed with reference to air quality and energy use in Poland and Sri Lanka, while a variety of natural resource-related issues are covered in the other studies: deforestation and land degradation in Costa Rica, migration and deforestation in the Philippines, degradation of agricultural lands due to overgrazing in Tunisia, fertility losses due to extension of cultivated areas in Ghana, water resource depletion in Morocco, and wildlife management in Zimbabwe. The case studies also utilize a variety of analytical methods to illustrate the different approaches available for identifying the environmental implications of economywide reforms. These methods range from those tracing the links between economic incentives and resource use through direct observation, to others relying on more complex economic modeling of policies and their environmental effects. In all the studies, however, the analytical approach uniformly requires identifying key environmental concerns and relating these to the agenda of priority sectoral and macroeconomic reforms under consideration. The analysis underscores the formidable difficulties of developing a general methodology to trace all possible environmental impacts of a package of adjustment reforms. At the same time, it offers evidence that careful case-specific empirical work may help identify better ways to deal with potentially serious impacts of specific economywide policies on high-priority environmental problems. We obviously have a long way to go before environmental impact assessment of economic policies can be used systematically in public decisionmaking; nevertheless, this work helps to reinforce the case that imperfect knowledge should not be an excuse for inaction. In many important cases, the potential environmental consequences of economic policies may be discernible, and the direction in which compensatory or defensive measures should go, is quite apparent. Andrew Steer Vinod Thomas Director Director Environment Department Economic Development Institute The World Bank Washington, D.C. vi ACKNOWLEDGMENTS We acknowledge the comments and suggestions that were received during the course of many discussions, workshops, and reviews, from colleagues within and outside the World Bank. These include Richard Ackermann, Dennis Anderson, Maria Concepcion J. Cruz, Luis Constantino, Partha Dasgupta, Mohamed El-Ashry, Ved Gandhi, Christopher Gibbs, Gunnar Eskeland, Stein Hansen, T. J. Ho, William Hyde, Emmanuel Jimenez, Ronald MacMorran, Karl- Goran Maler, Paul Martin, David Pearce, Jomn Rattsoe, Robert Repetto, Iona Sebastian, Robert Schneider, Anand Seth, Hu Tao, Adriaan Ten-Kate, Laura Tuck, Hirofumi Uzawa, and David Wheeler. We have attempted to address all their comments and are solely responsible for any remaining inadequacies. We are especially grateful to our case study authors: Gregory Amacher, Robin Bates, Jan Bojb, Robert Cunliffe, Boguslaw Fiodor, Herminia Francisco, Ian Goldin, Shreekant Gupta, Ramon Lopez, Paul Martin, Peter Meier, Stephen D. Mink, Kay Muir-Leresche, Zeinab Partow, Annika Persson, David Roland- Host, and Tilak Siyambalapitiya. Publication of this book was sponsored by the Environment Department and the Economic Development Institute of the World Bank. We thank Mohamed T. El-Ashry, Andrew Steer, Vinod Thomas, and Hatsuya Azumi for their support. This book has also benefitted greatly from comments received when a condensed version was presented to the Board of Executive Directors of the World Bank, as well as at a special Environment Seminar convened at the Fiftieth Anniversary Annual Meetings of the World Bank and the International Monetary Fund in Madrid. The complex research program behind this book was made manageable by the excellent Economywide Policies and Environment project team. We especially thank Adelaida Schwab, Noreen Beg, Shreekant Gupta, Annika Persson, and Nalin Kishor. Karen Danczyk assisted with the editorial work; Luz Rivera and Daisy Martinez provided secretarial support. Jay Dougherty and Rebecca Kary of Alpha-Omega Services, Inc., provided editorial and layout services. The project was supported in part by generous contributions from the governments of Norway and Sweden. Jeremy J. Warford, Mohan Munasinghe, and Wilfrido Cruz vii AUTHORS Jeremy J. Warford is Visiting Professor of Environmental Economics, Centre for Social and Economic Research on the Global Environment, University College, London. He was formerly Senior Adviser in the Environment Department and Economic Development Institute, the World Bank. Mohan Munasinghe is Distinguished Visiting Professor of Environmental Management, University of Colombo, Sri Lanka. He is on leave from the World Bank, where he was Chief of the Pollution and Environmental Economics Division, Environment Department. Wilfrido Cruz is Environmental Economist at the Environment and Natural Resources Division of the Economic Development Institute of the World Bank. He was formerly Economist at the World Resources Institute, a leading environmental policy research organization. viii 1 Overview ENVIRONMENTAL DEGRADATION poses an increasing threat to economic growth and development prospects worldwide. The range of issues categorized as "environmental" is, of course, huge. It includes deforestation, elimination of species, soil erosion, pesticide buildup, industrial and municipal pollution, acid rain, climate change, and the threat to the ozone layer. Developing countries are in a specially difficult posi- tion. Unlike the industrial countries, most of them still have to resolve massive local environmental problems such as the provision of safe drinking water and sanitation services, their difficulties being compounded with regard both to the degradation of agricultural and forest resources, as well as the need for urban services by explosive rates of population growth.At the same time they are confronted with the global problems arising from the emission of transboundary pollutants, which, at least to date, are primarily due to economic growth in the industrial world. I 2 VOLUME I Attitudes toward environmental matters on questions of financing and resource in developing countries have changed sig- mobilization. While these concerns remain nificantly over the past two decades. At the of importance, and indeed, warrant still time of the 1972 Stockholm Conference on further effort, it is becoming increasingly the environment, there was a fairly clear evident that they are not sufficient to make north-south split on the issue. The develop- a serious dent in the main environmental ing countries generally regarded environ- problems facing the planet, and that it is mental concerns as a luxury that only the necessary to devote more effort to using rich nations could afford, and they resented economnics to integrate environmental issues the efforts of interest groups in the industri- into the mainstream of economic policyma- al countries to persuade them otherwise. king. This involves, inter alia, ongoing Since then, there has been a considerable review of the prospects for so-called sus- narrowing of the gap between north and tainable development, which calls into ques- south. This is the good news. The bad news tion commonly held views about the role of is, of course, that a major reason for the technical progress, human capacity to adapt change is that in the intervening period to natural resource scarcity, and the potential environmental degradation has become so for substituting manmade for natural capital. serious that its implications for economic A switch in emphasis from micro to growth are becoming increasingly obvious. sectoral or macro concerns, is therefore Indeed, far from being a luxury, there is under way. The growing physical interde- increasing evidence that sound environmen- pendence between nations, and importance tal management is essential if economic of the "global commons" opens up still growth is to be achieved-even in the short further avenues where economic policy run. This, however, is not to say that the formulation has a potentially major role to developing countries and the industrial play. Research needs, however, abound. countries see eye to eye on all the issues, These include valuation issues as well as and marked differences continued to be analysis of the conceptual and practical observed at the 1992 United Nations Con- problems involved in integrating environ- ference on Environment and Development. mental management into economic For example, the former, quite correctly, policymaking. In general, the main need point to the latter's responsibility for the appears to be to recognize the essentially state of the global environment, and claim multidisciplinary nature of environmental that it is unfair to expect them to invest issues, and to improve understanding of the heavily in measures to redress the situation. linkages between economic policies and the On the other hand, the growth in energy natural world. Economic research needs are consumption in the developing world in the primarily of an applied nature: it may indeed future will considerably outstrip that of the be argued that there is no "environmental presently industrial countries. Their contri- economics" as such-merely the application bution to incremental atmospheric pollution of well established theoretical principles in and climate issues is thus a legitimate con- a wider context. Existing tools are highly cern. relevant, but extending the horizons of econ- Traditionally the main focus of environ- omists-over space and time-is still re- mental economics has been on micro-level quired. resource allocation (cost-benefit and cost- effectiveness analysis combined with envi- Policy and Project Interventions ronmental impact assessment of individual projects), with latterly increasing emphasis It is increasingly being recognized that most environmental problems are less the 1. Overview 3 result of individual large scale development implications, but in practice environmental projects that have gone wrong than the consequences have traditionally not been combined consequences of countless rela- considered in their formulation. tively small scale activities-unsustainable For an individual country, an environ- agricultural practices, small scale polluting mental action program should therefore activities, and individual decisions to exploit consist of the following three deceptively tropical forest resources. Subjecting each simple steps: such decision to social cost-benefit analysis, environmental impact assessment, or regula- (a) identification of major environmental tion, or indeed a system of environmental problems in a country, assisted where taxes that requires monitoring of individual possible by cost-benefit analysis and actions, is often not feasible. It is therefore efforts to relate damage to national necessary to search for the underlying income accounts causes of such activities, and identify policy interventions (which will often have to be (b) search for proximate and underlying somewhat blunt instruments) aimed at the causes of damage source, rather than the symptom of the problems.' (c) on the basis of the previous step, iden- Because of the pervasive nature of envi- tify policy reforms and investments, ronmental problems, the traditional project- and sources of funding. by-project approach, while important and deserving of more effort, therefore needs to The second of these steps is at the heart be supplemented by the integration of envi- of the analysis. Proximate causes are rela- ronmental management into economic tively easy to identify. Much more difficult, policymaking at all levels of government. but of primary importance, is the analysis of Special attention should be given to the role underlying causes. Typically these will be of economic incentives in influencing envi- found in economic incentives, often com- ronmental behavior, and existing economic bined with a complex mix of social and policies should be subjected to environmen- political factors. For example, it may be tal evaluation. Policies with a wide ranging easy to identify the inefficient productive impact-i.e., those of a sectoral or macro- processes of certain industrial enterprises as economic nature-are specially relevant. being the source of air pollution. It is, how- Many of them may have a profound im- ever, more difficult to understand the forces pact-for good or ill-on the environment.2 that bring this about, and to determine the Fiscal, exchange rate, agriculture, energy, policy reforms that will not simply affect industrial, and land tenure policies might all individual plants, but have pervasive effects, be expected to have major environmental impacting on a wide variety of industrial operations. There are in practice many opportunities 'This theme was elaborated on in World Bank for economic policy reforms which also 1987. A similar message emerges from the yield environmental benefits. Environmental Brundtland Report (WCED 1987). degradation often stems from market distor- tions, which may be explained by externali- 2A similar argument may be applied to health, ties or "commons" problems, or which are which may be impacted directly, through income induced by government policies. The search effects, or indirectly, through changes in the natural environment resulting from macro- or sector-level for policy reforms which address market policies. See Warford 1995. For a review of the failure and also improve the environment literature, see Cooper-Weil et al. 1990. 4 VOLUMEI (i.e., "win-win" actions) should be a central Chapter 3, Sectoral Policies, contains a feature of a country's environmental policy.3 review of the relationships between sectoral Generally, the range of technical options policies pertaining, for example, to agricul- that might be employed to address environ- ture, energy, and industry, and the often mental problems is also well known, but unanticipated but major environmental practice clearly lags well behind theory. This consequences stemming from them. Empha- gives rise to the question as to why techni- sis is given to the scope for achieving "win- cally and economically efficient solutions win" reforms, i.e., those that satisfy both are not in fact adopted. This is an area where economic and environmental objectives. economics should play an even more impor- Chapter 4, Macroeconomic Policy and the tant role, namely the analysis of underlying Adjustment Process, then addresses the causes of environmental problems. In many general nature of the linkages between cases, the root cause may lie in policies or macroeconomic and sectoral policies and events that are at first sight far removed the environment. It introduces the generic from the environmental problem itself. findings resulting from the series of case Environmental damage may, of course, stem studies conducted by the World Bank, and not only from incorrect government actions also draws upon the lessons from work done (sins of commission), but also of failure to by other researchers in recent years. The take action to reduce environmental degra- results of the various studies are discussed dation act (sins of omission). Either way, in terms of various themes, namely (a) improved understanding of underlying efficiency-motivated policies (b) policy, causes is a prerequisite for policy reform. market and institutional imperfections (c) macroeconomic stability and (d) longer-term Structure of the Volumes poverty and income distributional effects. Following this introduction to the case This is the first of two volumes that studies in terms of the themes that emerge address the relationships between from them, Chapter 6, Case Study Summa- economywide policies and the environment, ries, briefly introduces the research on a with special reference to recent World Bank country-by-country basis. Clearly, many of research efforts. the issues identified in the preceding chapter Volume I contains seven chapters. After interact with each other in any real-world this Overview, Chapter 2, Explicit Environ- situation, as illustrated in this chapter. In mental Incentives, briefly reviews economic general, the studies provide convincing and other policies specifically designed to evidence of the environmental impact of address environmental problems, and which countrywide policies, and for the conclusion are essentially required to address the conse- that the adjustment process is both a neces- quences of market failure. The chapter sary, but not sufficient condition, for long- discusses the role of market-based instru- term, sustainable, growth. ments and regulatory approaches to environ- Chapter 7, Policy Implications, draws mental management and, in light of experi- together the conclusions of the case studies, ence from the industrial countries, the feasi- and makes recommendations about the bility and relevance of such approaches in integration of environmental concerns into the developing world. economic decisionmaking. It also proposes as a tool of analysis, the Action Impact 'The scope for "win-win" policies is heavily Matrix, which can be used to highlight emphasized in WCED 1987 and in World Bank relationships and mesh economic decisions 1992k. with priority environmental and social im- 1. Overview 5 pacts. Chapter 7 concludes Volume I, which, less, affect it for good or ill. This book as it contains the essence of the case study indicates that there are significant benefits to results, can be read as a self-contained docu- be gained from a better understanding of ment. For the reader interested in a more such linkages. Focusing attention on the detailed treatment of the case studies, this is positive impacts of economywide reforms to be found in Volume U.4 on the economy as well as the environment, helps to build consensus for such refonns Scope of the Study and improves cooperation among both environmental and economic managers. No Economywide policies are defined here to less important are the potential negative include all policies of a pervasive nature. environmental impacts of economywide Although the emphasis of the book is upon policies that need to be analyzed, monitored economic policies (such as energy and and mitigated. agriculture sector pricing, trade and fiscal In some instances the direction of envi- policies, and privatization), other sectoral ronmental impact stemming from policies (including the legal and institutional economywide policy reform is fairly framework, land tenure arrangements, popu- straightforward. The extent of the impact, lation, and social policies and attitudes) are however, invariably requires empirical all relevant. Indeed, understanding of the analysis. In more complex cases, even the interplay between these various factors is direction of the impact is ambiguous. There- essential if economic policy prescriptions fore, the book relies heavily on empirical are to be firmly based. findings and draws on a country-specific A wide range of economywide policy approach to deal with links between reform programs has been undertaken to economywide policies and the environment. address macroeconomic problems (such as The book contains a review of World those affecting international trade, govern- Bank case studies and other recent research, ment budgets, private investment, wages, and provides examples that reflect a wide and income distribution) and broad sectoral range of country situations and environmen- issues (such as those relating to agricultural tal problems. Pollution issues are addressed productivity, industrial protection, and with reference to air quality and industrial energy use). The economywide mechanisms pollution in Poland. Environmental aspects for attaining these goals include: altering the of energy use are addressed in the Sri Lanka rates of exchange or interest, reducing gov- case. A variety of natural resource related emnment budget deficits, promoting market issues are covered in the other studies: liberalization, fostering international open- deforestation and land degradation in Costa ness, enhancing the role of the private sec- Rica; migration and deforestation in the tor, and strengthening government and Philippines; degradation of agricultural market institutions, often coupled with lands due to overgrazing in Tunisia; fertility pricing and other reforms in key sectors losses due to extension of cultivated areas in such as industry, agriculture and energy. Ghana; water resource depletion in Mo- Although these policies are not directed rocco; and wildlife management in Zimba- explicitly towards influencing the quality of bwe. the natural environment, they may, nonethe- The case studies also utilize a variety of analytical methods to illustrate the different 4W. Cruz, M. Munasinghe, and J. Warford (eds.), approaches available for identifying the The Greening of Economic Policy Reform, Volume environmental implications of economywide II, Case Studies (Washington, D.C.: World Bank). . reforms. The methods range from those 6 VOLUME! tracing the links between economic incen- Unintended adverse side effects occur, tives and resource use through direct obser- however, when economywide reforms are vation, to others relying on more complex undertaken while other neglected policy, economic modeling of policies and their market or institutional imperfections environmental effects. In all the studies, persist. The remedy does not generally however, the analytical approach requires require reversal of the original identifying key environmental concerns and economywide reforms, but rather the relating these to the agenda of priority sec- implementation of additional comple- toral and macroeconomic reforms under mentary measures (both economic and consideration. noneconomic) that remove such policy, The analysis underscores the difficulties market and institutional difficulties. Such of developing a general methodology to complementary measures are not only trace environmental impacts of policy re- generally environmentally beneficial in form. At the same time, it offers evidence their own right, but also help to broaden that careful case-specific empirical work on the effectiveness of economywide re- the most important potential environmental forms. Typical examples of potential impacts may help identify better ways to environmental damage caused by remain- deal with them, and sets out several practical ing imperfections include: steps by which the findings may be imple- mented in operational work. The book also Policy distortions: Export promotion and demonstrates the considerable scope for trade liberalization, that increase the developing better analytical tools to trace export profitability of a natural resource, environment-economic policy linkages. might encourage excessive extraction or harvesting of this resource if it were Main Findings and Conclusions underpriced or subsidized (for example, low stumpage fees for timber). The specific findings of this study are presented below-grouped according to the Market failures: Economic expansion principal ways in which economywide induced by successful adjustment may be policies interact with the environment, and associated with excessive environmental highlighting how they might help in the damage, for example, if external environ- design of better adjustment programs. mental effects of economic activities (such as pollution), are not adequately Removal of price distortions, promotion reflected in market prices. of market incentives, and relaxation of other constraints (which are among the Institutional constraints: The environ- main features of adjustment-related re- mental and economic benefits of forms), generally will contribute to both economywide reforms could be negated economic and environmental gains. For by unaddressed institutional issues, such example, reforms which improve the as poor accountability of state-owned efficiency of industrial or energy related enterprises, inadequately defined property activities could reduce both economic rights, or weak financial intermedia- waste and environmental pollution. Simi- tion-which tend to undermine incen- larly, improving land tenure rights and tives for sustainable resource manage- access to financial and social services not ment. only yields economic gains but also pro- motes better environmental stewardship. 1. Overview 7 * Measures aimed at restoring macroeco- environmental resources. Increasing nomic stability will generally yield envi- efficiency and reducing waste, as well as ronmental benefits, since instability un- properly valuing resources, will help dermines sustainable resource use. For reshape the structure of growth and re- example, stability encourages a longer- duce undesirable environmental impacts. term view on the part of decisionmakers at all levels, and lower inflation rates lead Practical Implications to clearer pricing signals and better in- vestment decisions by economic agents. The findings have important policy impli- These are essential prerequisites for en- cations. While the relationships between couraging environmentally sustainable economywide policies and the environment activities. are complex, there is usually a small number of identifiable linkages affecting high prior- * The stabilization process also may have ity environmental concerns. The environ- unforeseen adverse short-term impacts on mental analysis and implementation efforts the environment. For example, while related to specific programs can therefore be general reductions in government spend- sufficiently focused to be practical and ing are deemed appropriate, targeting effective. Proper recognition of the generally these cutbacks would be desirable to positive environmental consequences of avoid disproportionate penalties on envi- economywide policy reforms would help to ronmental protection measures. Another build additional support for such programs. important issue is the possible short-term At the same time, broader recognition of the impact of adjustment on poverty and underlying economic and policy causes of unemployment, which may aggravate environmental problems can enhance sup- existing pressures on fragile and "open port for environmental initiatives-both in access" natural resources by the poor, due terms of environmental policies as well as to the lack of economic opportunities. In projects. The following are immediate steps this case, appropriate measures designed that can be taken by decisionmakers: to address the possible adverse social consequences of adjustment will be justi- * Problem Identification: More systematic fied even further-on environmental efforts are needed to monitor environ- grounds. mental trends and anticipate emerging problems when policy reform proposals * Economywide policies will have addi- are being prepared and implemented. A tional longer-term effects on the environ- review of the range of currently available ment through employment and income environmental information would help distribution changes. Several of the ex- identify the highest priority pre-existing amples confirm one predictable con- or emerging environmental problems, and clusion-adjustment-induced changes their sensitivity to policy measures. generate new economic opportunities and sources of livelihood, thereby alleviating * Analysis: Serious potential environmental poverty and reducing pressures on the impacts of proposed economywide re- environment due to overexploitation of forms identified in the problem identifi- fragile resources by the unemployed. cation stage should be carefully assessed, However, while growth is an essential to the extent that data and resources per- element of sustainable development, it mit. Many of the techniques and exam- will necessarily increase pressures on ples presented in this book will be helpful in tracing the simpler and more obvious 8 VOLUME I links between economywide policies and on preparing contingency plans to be the environment. invoked ex post (see below). Remedies: Where potential adverse im- * Follow-up: A follow-up system for moni- pacts of economywide reforms can be toring the impacts of economic reform identified and analyzed successfully, programs on environmentally sensitive targeted complementary environmental areas should be designed, and resources policies or investments need to be imple- made available to address environmental mented in order to mitigate environmen- problems that may arise during imple- tal damage, and enhance beneficial ef- mentation. fects. Where linkages are difficult to trace ex ante, greater reliance should be placed Explicit Environmental Incentives General Principles IN RECENT YEARS A GOOD DEAL OF ANALYTICAL WORK has addressed the potential role of economic instruments in dealing with enviromnental problems, and this has been matched by a perceptible shift in actual policies, particularly in the industrial countries. Attention has focused to a consid- erable extent on pollution, but the general principles con- tained in the literature and recent policy experience are of wider application. Economic instruments may take a variety of forms, ranging from measures designed explicitly to achieve environmental objectives, such as pollution charges and taxes, tradeable permits and subsidies, as well as user charges for water resources, energy and transportation, where inefficient usage has adverse environmental conse- quences. For further elaboration of the major themes contained in this chapter, see Pearce and Warford 1993, and Pearce and Turner 1990. 9 10 VOLUME I This chapter considers the role of eco- This illustration introduces the concept of nomic instruments and policies with respect "optimal pollution." In practice, it is unre- to their use for explicitly environmental alistic, and indeed undesirable, to aim at purposes, central to the ongoing debate elimination of pollution or most other types being the appropriate roles of market-based of environmental degradation. This in fact is instruments versus "command-and-control" of central importance for environmental approaches to environmental management. policy, in which tradeoffs, or choices be- The environmental consequences of sectoral tween environmental and other develop- policies will be considered in Chapter 3. mental objectives must continually be made. Traditionally, environmental economics It will be observed that most of the eco- has focused heavily upon the failure of nomics literature, and indeed practice, with markets to achieve an optimal allocation of regard to the use of explicit environmental resources, with externalities, and, to a lesser incentives, has been in the context of pollu- extent, public goods problems. An externa- tion problems. This is not to say that envi- lity can be defined as any action which has ronmental objectives have not played a part an unintended impact upon another party's in the design of economic instruments em- welfare, and which is uncompensated or ployed in the agriculture or forestry sectors. unappropriated. The classic case may be For example, the use of stumpage fees represented by an industrial plant that dis- aimed at reducing depletion of forest re- charges waste into a river, imposing down- sources, or the use of tradeable permits for stream costs on fisheries, municipal water fisheries, could be defined as being primari- suppliers, or other industrial water users. As ly "environmental." There is no way of long as the damage done remains less than unambiguously defining such a policy as fully compensated, an external cost is said to sectoral or environmental, and in organizing exist. It should also be noted that an external the material in this book we have tended to benefit can be defined in a parallel way. treat policies which have other than a purely Figure 2-1 illustrates the concept of environmental objective in the sectoral or external cost. MB is the marginal benefit, or macroeconomic policy category. profit derived from producing an extra unit Explicit instruments may be defined to of the polluting product, or in other words, include charges and taxes (with an important the polluter's "marginal net private benefit" distinction being made between emissions curve. Typically, MB can be expected to charges/taxes and product charges/taxes), decline as output expands. The marginal subsidies, deposit-refund schemes and per- damage cost (MDC) represents the marginal formance bonds, market creation and finan- cost of damage to those who suffer from the cial enforcement incentives. The general pollution. In the absence of any government rationale for market-based instruments as intervention, the level of output of the pol- opposed to regulatory methods has been luting product will be at Q1; i.e., output will extensively covered in the literature, with increase up to the point that net marginal some aspects of special relevance to envi- gains from further expansion are zero. How- ronmental health having recently been re- ever, Q, corresponds to a greater than opti- viewed for the World Health Organization. mal output; in fact, the optimum is at Q2, In practice, economic and regulatory instru- where marginal benefits equal marginal ments tend to be used in combination with costs. Beyond this point, marginal damage each other. In selecting the appropriate costs are greater than marginal benefits, environmental policy instrument, the while up to that point, the benefits of further following criteria should be employed: output exceed the marginal damage costs. 2. Explicit Environmental Incentives 11 * Environmental effectiveness lems such as the greenhouse effect.) * Economic efficiency (in terms of cost- In fact a central obstacle to the successful benefit, or cost-effectiveness tests) outcome of a bargaining solution, and one * Revenue raising which is of generic significance in the envi- * Equity, fairness, acceptability ronmental debate, concerns the incidence of * Administrative feasibility and cost the costs and benefits of environmental improvement. Conflict of interest-or ext- It is possible that the optimum level of ernalities-tends to characterize the output, Q2, in Figure 2-1 could be achieved environmental problem. Vested interests are by other means. In principle, the party or important, and almost by definition the poor parties suffering from the externality (i.e., or disadvantaged suffer at the expense of those to whom MDC applies) could ask the those who have a greater say in the polluter what sum of money he would re- decisionmaking process. While there are quire to reduce his pollution load from the some examples of the bargaining solution in existing Q, level. In fact, reducing pollution practice, they are few and far between. to Q2 could be in both parties' interests When the parties damaged are politically because while the damaged party should be weak, poorly organized, or unaware of their willing to pay any amount less than MDC, rights, or are simply future generations, the polluter should be willing to accept any there are reasons to be pessimistic about amount greater than MB. Such a bargaining reliance upon the bargaining solution to approach could therefore result in the opti- resolving environmental problems. mal level, Q2. Similarly, if the damaged party held the property rights to the whole Market-Based Instruments versus area, the polluter could be permitted to pay Command and Control for marginal damage caused. This would be both acceptable to the sufferer and to the Where the market does not work prop- polluter up to, but not beyond, the Q2 level. erly, some form of public intervention is The foregoing suggests that in theory, and required. Assuming that the political will according to a narrow economic efficiency exists to overcome the distributional and objective, if individuals can create markets political obstacles referred to above, essen- in externalities, there is no need for govern- tially three different approaches can be ments to intervene, regardless of who owns employed: command and control, in which the property rights.' In practice, this possi- pollution or emissions standards are set and bility faces a great many difficulties. First of emitters are simply required to achieve those all, it does not work when other than com- standards; environmental taxes, in which petitive conditions apply in the economy. polluters are taxed according to the level of Moreover, its apparent unfairness inhibits emissions produced; and a system of trade- cooperation. Its distributional implications able permits, in which polluters are allo- are unsatisfactory-for example, it could not cated permits to pollute up to a given stan- be used to handle long-term issues in which dard, but are given the option of buying and the damaged parties are future generations selling those permits in the market place. since they have no bargaining power. (Exis- Environmental taxes and tradeable per- tence of disproportionate bargaining power mits are examples of market-based incen- is also particularly relevant with regard to tives. Command-and-control approaches, on the resolution of global environmental prob- the other hand, do not make use of the mar- ket at all. There is a considerable literature on this subject, with the work dcme by Allen 'See Coase 1960. 12 VOLUMEI Kneese and his colleagues at Resources for Second best issues (see below) might also the Future in the 1960s, and the Organisa- indicate cautious adoption of market-based tion for Economic Co-operation and Devel- instruments. Furthermore, command-and- opment (OECD) advocacy of the "Polluter control measures tend to appeal because of Pays Principle" in the 1970s being of major the greater certainty of achieving given significance.2 In general, economists have effluent or ambient standards; the experi- tended to favor market-based instruments mentation that may be inherent in the use of over command-and-control or regulatory market-based instruments may make reli- ones, on the grounds that the former will ance upon them less feasible. allow pollution control targets to be attained more cheaply.3 Environmental Taxes The argument is that the command-and- control approach is deficient in a number of Market-based incentive systems operate ways. First, it requires the regulator to use by simulating market conditions. An envi- up resources to acquire information that ronmental tax may alter the price of the polluters already possess. Second, polluters polluting input or technology, or the pollut- vary in the ease with which they can abate ing product, or all of them. From an effi- pollution. Their costs of control therefore ciency standpoint, an ideal tax would be one differ, and control is not concentrated in the which equals the MDC imposed by the sources that find it cheapest to abate pollu- discharge of a pollutant. This is depicted in tion. Overall, compliance with the standard Figure 2-2, the optimal discharge, as noted are therefore not achieved as cheaply as they earlier, being at point Q2. The effect of such could be. Market-based instruments on the a tax is to shift the after-tax MB curve down other hand may encourage pollution control to MB(t). By leaving the firm to maximize efforts to be carried out where it is cheapest its after-tax profits the firm automatically to do so. goes to Q2. Note, however, that command-and-con- The case for an environmental tax is trol does have an important place in the largely based upon its cost-effectiveness in array of environmental instruments, and any achieving a given environmental target. environmental policy should employ a Emitters of C02, for example, can be judicious mix of economic incentives and charged according to the carbon content of regulations. In general the economists' the fuels they burn. Coal would attract a argument is that the current dominance of higher charge than oil which would attract a command and control is an imbalance that higher charge than natural gas. The effect of needs to be corrected. They would, however, the tax would be to induce: (a) substitution typically acknowledge that regulations have of lower carbon fuels for high carbon fuels; a role; for example outright bans, or specific (b) substitution of noncarbon energy (nu- means of treatment or disposal of certain clear power, renewables) for carbon energy; toxic or hazardous wastes may be required. and (c) energy conservation. A carbon tax would be a relatively effi- cient means of achieving the environmental 2Kneese 1964 and OECD 1975. For a recent objective of reducing CO2 emissions, since review of the literature, see Eskeland and Jimenez a fairly direct and unambiguous relationship 1991. between fuel consumption and emissions 3See Baumol and Oates 1988. Proof that can be estimated. However, in many cases, 3See Baumol and Oates 1988. Proof that marketable permits minimize compliance costs can taxes on inputs are somewhat blunt instru- be found in Pearce and Turner 1990, Chapter 8, and ments, since they do not discriminate be- in Tietenberg 1985. tween more and less efficient users of the 2. Explicit Environmental Incentives 13 input. There may not, in other words, be a costs of compliance with the standard be- proportional relationship between consump- cause it concentrates the costs of control on tion of the input, such as fuel, and the emis- those who can most easily afford to adopt sion of pollutants. A tax on coal consump- abatement measures. tion, designed to reduce emissions of A frequent objection to tradeable permits particulates, for example, would not in itself is an ethical one, namely that industries are encourage environmentally sound behavior. given a "license to pollute," as long as they Nor would a tax on electricity consumption can afford to do so. However, all regulatory at the retail level. A gasoline tax may also approaches allow pollution up to the level of be an imperfect instrument, since propor- the standard, and tradeable permits are no tionality between fuel consumption and different. If the criticism is intended to mean emissions cannot be assumed. A pollution that there should be zero pollution then this tax on outputs, or effluents, is a more pre- would have to be justified-as in the case of cise instrument. Unfortunately, this option is all other types of control-in terms of some often precluded by the cost of the sophisti- nonefficiency objective. cated inspection and monitoring system that pollution taxes require. Economic Instruments and A major advantage of environmental Transboundary Effects taxes, compared with tradeable permits or command-and-control alternatives, is of Greenhouse gases (GHGs) course that they raise revenue. In principle, A similar set of theoretical and practical such revenue could be used as a fiscally issues arise when the analysis of market- neutral substitute for other taxes. This raises instrumenthe pollutis controket- the issue of "green taxes," discussed below.4 based instruments for pollution control is extended from the national to the global Tradeable Permits level. For example, there have recently been strenuous efforts to arrive at a global proto- Tradeable permits require an acceptable col on greenhouse gases, which could in- level of pollution to be determined. This clude uniform targets for greenhouse gas may be expressed, for example, as an allow- reduction. But, just as it is inefficient to set able national emissions level for SO2. Per- the same target reduction in emissions for mits are then issued for the level of pollut- each polluter, it is equally inefficient to set ants up to the allowable level. Once the each country the same target. While it may initial allocation is made (a significant appear equitable for each country to achieve, distributional issue), polluters are free to say, a stable emissions target, the definition trade pollution rights. This will permit of fairness becomes ambiguous where the reduction in SO2 to be done most cheaply. A cost of achieving the target varies from firm that finds it comparatively easy to abate country to country. pollution will find it profitable to sell its The aim of any measure to reduce green- permits to a polluter who finds it expensive house gas emissions should clearly be to to abate. The overall environmental standard bias the reductions towards those countries will remain unaltered because permits just which can most easily achieve them. The sufficient to achieve the quality standard in logic of this requirement is fairly simple: if aggregate have been issued. The reallocation one country has lower costs of abatement of permits between polluters minimizes the than another, it will be cheaper to require more control in that country than in the high abatement cost country. A protocol which 4Page 1977. requires equal emissions reductions by 14 VOLUMEI country offends this principle and hence US$28. Higher costs, largely dependent incurs an unnecessary aggregate cost bur- upon more ambitious or longer-term targets, den. Equally, any burden-sharing arrange- or which are less ambitious about adaption ment must allow for the development needs prospects, have been estimated in several of the developing nations. other studies. An internationally agreed upon set of Sometimes these estimates have been standards for achieving GHG reduction presented in terms of their implications for could in principle achieve the ninimum cost a carbon tax which, in effect, would be objective, particularly because global warm- required to equilibrate marginal abatement ing would affect different countries in dif- costs with the marginal (global) benefits of ferent ways. A few may conceivably gain the given reduction in emissions. For exam- from climate change. But even if all lose, ple, for the United States, Manne and some will lose far more than others. Under Richels (1990), modeling energy-economy these circumstances it is going to be difficult interactions explicitly, estimate how large a to secure agreement on appropriate targets carbon tax would have to be to stabilize and on the allocation of emissions reduction U.S. emissions at their 1985 rate through targets between countries. Furthermore, if 2010, and then reduce emissions by 20 global warming is reduced it will generally percent after this date. Their estimates indi- be of benefit to all countries, and no country cate that the tax would have to peak in 2020 can be excluded from the benefit. Any one at US$700 per ton of carbon, or US$500 per country could secure the benefit of a global ton of coal-more than ten times the actual agreement without sharing in the cost: it price of coal in 1988. An estimate by OECD could refuse to cooperate and wait for the in 1991 is that to cut the output of CO2 by rest of the world to solve the problem, i.e., it 20 percent between 1990 and 2010 and would become a "free rider." Whether a stabilize it thereafter would need a tax in carbon tax or a marketable permit solution is 2020 averaging US$215 per ton of carbon the preferred mechanism is therefore, at this (equivalent to US$36 per barrel of oil). stage, somewhat premature. Some countries London Economics (1991), faced with the will be net losers, and it is difficult to see wide variety of models, assumptions, and how they could be persuaded to cooperate, targets, ran a regression on the results of the without compensating subsidies from the major studies, and came up with an average gainers. marginal cost for CO2 reduction from 1988 There have been many efforts to estimate levels by they year 2005 (the "Toronto tar- the costs of meeting various targets of get") of around US$120 per ton of CO2 greenhouse gas reduction. The studies vary reduced. considerably in terms of targets, timing, and As noted, most of the above studies relate country emphasis.5 Most of them are appli- to industrial countries. A far more optimistic cable to the industrial countries, but some scenario is implied by the work of Sasmojo attempt to estimate global costs. For exam- and Tasrif (1991) with regard to Indonesia. ple a pioneering study in the United States Their estimates suggest that, by taking by Nordhaus (1991) suggests that to achieve advantage of opportunities for technology a 20 percent reduction in CO2 emissions changes, and reducing energy intensity by over the next 20 years, the cost per ton of price deregulation and imposing differential carbon would range from zero to about taxes on fossil fuels, substantial reductions in CO2 emissions can be achieved with-at least in the short run-little impact on the 5For further details on these studies, see the Sfi economy. This finding, in common with Lanka case study in Volume II. 2. Explicit Environmental Incentives 15 other analyses in the same issue of Energy been criticized on the grounds that the com- Policy in which it is presented, as well as mercial value of the elephant offers its best other work done in the Asia region,6 provide prospect for survival (Pearce and Warford substantiation of the potential scope for "no 1993). regrets" policies in the developing world. The estimated magnitudes of such a tax vary The international subsidy solution widely according to target. The compensation approach can be illus- In considering the case for a carbon tax, trated at the international level by three the availability of alternative (untaxed) fuels should be addressed. The carbon tax might examples: be counterproductive to the extent it might (a) Payment by a country damaged by induce consumers to substitute wood, char- coal and crop residues (highly inefficient pollution to the country causing it. The costs of achieving marginal reductions sources of fuel) for commercial sources. in pollution increase rapidly as higher However, one advantage of a carbon tax is standards are reached. Consequently, that it would reduce the emnissions of other marginal abatement costs in Eastern pollutants such as S02, not only because it would reduce energy consumption in gen- European countries tend to be lower eral, but would also encourage substitution thansi the stern Ere coun- of cleaner fuels like natural gas for dirtier Where tandard areluch eigher ftuels such as coal. Where transboundary pollution exists, therefore, there are opportunities for T)rade bans Western European countries to subsi- dize pollution abatement in Eastern Banning international trade in endangered countries, and thereby achieve reduc- species or other threatened resources is an tions in domestic pollution levels at explicit environmental policy, based upon relatively low cost. command and control. For example, timber export bans have been used in developing (b) Debt for Nature Swaps, where special countries, such as Indonesia, but the primary interest groups compensate countries goal has been to protect domestic wood for taking conservation measures in processing. Such policies raise generic the perceived global interest. issues about the role of market forces in achieving efficient solutions, both from an (c) Global Environment Facility (GEF) economic as well as environmental stand- Montreal Protocol, where the interna- point. tional community compensates coun- Proponents of trade bans argue that con- tries for the incremental costs incurred trol is justified since trade of a specific in addressing global objectives. commodity or product causes externality either in consumption (in the importing Generic to all the above are problems country) or in production (in the exporting inherent in provision of subsidies. These are country). similar to those observed at the domestic It is, however, often argued that trade level: i.e., how to ensure that the subsidy bans may be counterproductive. Banning will be used for the intended purpose (moni- international trade in ivory, for example, has toring and compliance); measuring incre- 6See, for example, Phantumvanit and Panayotou 1990. 16 VOLUMEI mental costs; game playing; and cost-effec- of such instruments. It was also partly due to tiveness.7 recognition of increased regulatory costs as environmental controls are further strength- Market-Based Instruments ened in industrial countries.9 in OECD Countries Recent developments in the OECD coun- tries indicate a substantial increase in the To date the use of market-based instru- use of economic instruments since the 1987 ments for pollution control has been fairly survey, it being estimated that the number limited in the industrial world. An OECD has increased by perhaps as much as 50 survey in 1987 of the range of market-based percent.' The important thing to note is that instruments used for pollution control in the instruments that have been introduced industrial countries concluded that while most frequently are product charges (other- user charges (e.g., charges for water supply, wise known as presumptive charges), and landfilling waste, etc.) were widespread, deposit-refund systems. In the countries for specific environmental taxes were compara- which data are available, the increase in the tively rare.8 In general, the levels of these use of these approaches have been 35 and charges were rarely adequate to have any 100 percent, respectively. However, their incentive effect. Indeed, rather than influ- practical impact is somewhat difficult to encing environmental behavior, recovery of assess. Emissions charges do not appear to the administrative costs of regulation ap- be used more frequently now than they were pears to have been the primary objective. in 1987, and there are in fact a limited num- Command-and-control, or regulatory meth- ber of convincing examples of successful ods were dominant. Moreover, of the 150 application of emissions charges. Excep- instruments identified, about 40 were in the tions are the systems in place in Germany form of subsidies, which in general run and the Netherlands, but these require highly counter to the arguments in favor of market- sophisticated monitoring and enforcement based instruments. capability. Recognition of the important role that Revenues from such charges are generally economic incentives can play in environ- earmarked for environmental expenditure, mental management has become more ap- and their role in creating incentives for parent in recent years. Appropriate pricing improved environmental behavior continues and taxation structures are gradually emerg- to be small. On the other hand, tax differen- ing, although actual levels still generally fall tiation in the automobile transport sector, in well below those necessary to effect major particular, with regard to leaded gasoline, behavioral change. In January 1991, guide- has typically had an overtly environmental lines for the application of market-based objective, and been aimed, with some suc- instruments (in conjunction with regulation) cess, at shifting production and consumption in environmental policy were presented at from leaded to unleaded fuel. User charges the ministerial meetings of the Environment for waste collection and disposal and for Committee of the OECD. The announce- sewerage and sewage treatment are common ment was partly motivated by the experience in OECD countries. Tradeable permits have of OECD countries, indicating the feasibility also been introduced in the United States. 'Refer to Munasinghe and King 1991 on chlorofluorocarbons (CFCs). 9See OECD 1991. 8Qpschoor and Vos 1988. '"As summarized in OECD 1993. 2. Explicit Environmental Incentives 17 Specifically, some recent developments for research in forestry, agriculture and in OECD countries include the United King- environmental issues, but there is evidence dom's announcement that it will increas- that they have had some effect in reducing ingly rely upon environmental taxes and fees fertilizer and pesticide consumption. rather than command and control. Examples Deposit-refund schemes, which are vari- of actual taxes and charges aimed specifi- ants of pollution taxes, are now widely cally at altering consumer and producer employed. When the product is purchased behavior include differential pricing of its price contains a tax which is then refund- gasoline, with a higher price applying to able on proper disposal or recycling of the gasoline containing lead additives. This has product. Traditionally used for purely com- been adopted by France, Germany, Norway, mercial purposes for beverage containers, Sweden, and the United Kingdom, while this approach continues to be used for bot- some other countries rely upon regulation of tles and aluminum cans, and has been ex- the maximum allowable concentration of tended to car hulks in Norway, Sweden, and lead in gasoline. Germany. Other energy pollution taxes, typically Tradeable permits are employed in the based upon inputs rather than emissions United States for air pollutants, and were (i.e., product or presumptive charges), are introduced for a limited period for lead in becoming increasingly advocated in OECD gasoline and for one case of effluent to a countries. Sweden has been a leader, having, watercourse. The permit system introduced for example, introduced the world's first under the U.S. Clean Air Act is the most carbon tax in 1991. In the energy sector the ambitious to date. The anount of trading tax is levied on oil, coal, natural gas and activity between different polluters has been liquid petroleum gas; in the transport sector less than anticipated. This has possibly been the tax is imposed on gasoline, diesel and on due uncertainties regarding other firms' domestic air traffic. A value added tax also willingness to trade, the costs of obtaining applies to all fuels and electricity. Sweden regulators' permission to trade, uncertainty also has a sulfur tax. France has announced about just what emissions credits ensue plans for nitrogen oxide and sulfur dioxide under legislation, and uncertainty due to the taxes, and Italy and the Netherlands are prospect of rising permit prices. However, considering the introduction of carbon taxes. emissions trading either within firms or With regard to air pollution from fuels, between firms have apparently resulted in France has introduced charges on the sulfur considerable cost savings compared with a content of fuels, and Finland and Sweden command-and-control approach. have charges on vehicle fuels. Finland and Although the "polluter pays principle" is Germany have lubricant oil charges, while widely advocated, in fact, in many cases, charges for solid waste, especially relevant governments actually provide subsidies to for products that require recycling or safe induce industry to cooperate in pollution disposal, are to be found in an increasing abatement policy. Various forms of subsidy number of countries. are to be found, and used either as purely Agriculture input taxes, aimed at reduc- political measures to ensure cooperation, or ing chernical pollution, have also been to alleviate short-term transition problems, introduced; once more, Sweden has taken such as the avoidance of industry closure or the lead. It levies a special charge on nitro- unemployment. Subsidies might take the gen and phosphate fertilizers and another on form of low interest loans, tax breaks such the acreage of land treated with pesticides. as accelerated depreciation, or outright Revenues raised by Swedish taxes are used grants. Japan, for example, has had a com- 18 VOLUME I prehensive, and highly successful program used to finance the regulatory agency. Prob- of assisting small businesses to meet in- lems with this system have been due to the creasingly stringent environmental stan- fact that the levy has been too low to be dards."1 Subsidy programs (as U.S. experi- effective, enforcement has been inadequate, ence indicates) clearly have major disadvan- and there is little incentive to do more than tages. These include large administrative just meet the minimum standard. costs of ensuring that subsidies are used for In Izmir and Istanbul, Turkey, sewer the intended purpose, distortion of invest- charges are assessed for industrial ment decisions where some expenditures discharges into the sewer system, motivating qualify for subsidy while others do not, and factories to treat industrial effluents. Enter- of course the fiscal costs of the program. prises face both treatment and disposal costs (sewer charges). Charges are low relative to Use of Market-Based Instruments sewage collection ancL treatment costs. in Developing Countries However, if they were much higher, the problem of illegal disposal would arise-a Although the evidence is somewhat generic issue in environmental management. fragmentary, the following review of avail- (A similar problem has been encountered in able material-which does not pretend to be Sao Paulo, Brazil.) comprehensive, but is at least illustra- In Poland, emission fees have been in tive-suggests that there are few cases in existence for a number of years, but have which explicit economic instruments are not been effective. This has primarily been effectively used in developing countries, because enterprises have lacked the incen- although they may have existed in a legal tive to respond efficiently to such charges, sense for some time. This is unsurprising in because the price mechanism in general did view of the slow rate of adoption of market- not work. Also the levels of fees sometimes based instruments for pollution control in were too low to matter. the industrial world. There are, however, Some efforts have recently been made to signs that this situation is changing. Some introduce emissions taxes in some of the examples are as follows.12 rapidly industrializing economies of Asia."3 The air pollution prevention fee in Taiwan Emissions charges (China), will include an emission charge on stationary sources of air pollution, while in effluont chges for water pollution hav end the Republic of Korea emission charges for emission fees for air pollution have been air and water can be levied on enterprises used for a number of years in China. In whose emissions fail to meet legislated cases where pollutants discharged fail to standards. Charges are, however, not related meet state or local standards, an additional to the level of excess emissions nor is there fee, based upon the amount and concentra- an upper limit on the amount of the levy. As tion of pollutants is levied. Until recently in China, there is therefore no incentive to about 75 percent of the levy was actually do other than just avoid violation of the returned to the enterprise, the balance being existing standards. A review of a number of countries in Latin America also shows little evidence of "Aoyamna et al. 1994. effective use of emission fees, although four "This draws upon Berstein 1993, which should states in Brazil are in the process of intro- be consulted for further details on environmental managemnent instruments in both industrial and developing countries. "See O'Connor 1993. 2. Explicit Environmental Incentives 19 ducing effluent charges for industrial sewer- mental degradation, and in levying charges age based upon pollution content.'4 It is too or fines. Even in industrial countries, this is early to judge the results of these policies. a major problem, and one which applies Brazil also has a system of fining violators equally to command-and-control systems as of emissions standards, but the fines are not well as those based upon market-based related to the damage done by actual emis- instruments. Administrative realities there- sions, and vary more according to frequency fore suggest the need to look beyond ex- of violations rather than to toxicity or inten- plicit, narrowly focused environmental sity. Similarly, in Buenos Aires, Argentina, interventions, particularly where pollution is discharge of waste into the air or water caused by large numbers of waste discharg- requires an operating certificate, without ers. Blunter instruments, which can be which fines may be imposed, depending on introduced at a higher level in the economic the level of violation. In practice, fines are system and which have pervasive impacts, so low that there is no incentive to adopt not only upon environment, but on other control measures. On the other hand, it has aspects of development are more likely to be been found that fines set according to the required in developing countries. The most severity of pollution have contributed to the direct approach is to make use of product or control of surface water pollution in Mex- presumptive charges, which are based upon ico. 5 a presumed technical relationship between Monitoring of emissions is of course (a) certain inputs such as coal or gasoline considerably reduced if emission charges are which are used in production processes or restricted to a relatively few major discharg- final consumption, and (b) the environmen- ers of waste, and particularly if those dis- tal damage that is caused by these uses. chargers are fairly homogeneous. A notable It is fairly apparent that developing coun- exception to the generally unsatisfactory tries lag behind the OECD countries in experience with such charges is provided by making effective use of such charges. In- Malaysia, which is of general relevance, and deed, there remain many cases of where not simply for developing countries. In that products which can be assumed to have country, the imposition of effluent charges adverse environmental health impacts when for the palm oil industry helped reduce total used are actually subsidized rather than pollutant loadings into water by a factor of taxed. Agricultural pesticides and fertilizers almost 300 over the decade beginning in the are perhaps the clearest example. Recent early 1980s.'6 improvements in this regard, assisted by the introduction of integrated pest management Product (or presumptive) charges systems in countries such as Indonesia are, Developing countries typically lack the however, encouraging. Similarly, the tradi- institutional capability for implementing an tional subsidization of low quality (high- environmental management system that sulfur content) coal in China is now being relies heavily upon monitoring, inspecting, phased out. Price differentiation, to reflect and regulating the activities of large num- variations in environmental damage of bers of polluters or other sources of environ- otherwise similar products, has also recently been introduced to encourage the substitu- tion of unleaded for leaded gasoline in a number of countries, including Thailand and '4Margulis 1993. Taiwan (China). Incorporation of sewerage "Quoted in Bernstein 1993. pricing into water pricing can be seen as a form of product charge, this being further '6World Bank 1993f. 20 VOLUME I discussed below, as is the use of gasoline taxes, user charges, or some combination taxes in general. While documentation of thereof. Charging for collection on the basis the extent to which product charges exist is of volume of municipal waste disposed of entirely inadequate, it does appear that many might yield benefits, but problems of illegal opportunities exist for reforms along the dumping arise, as experience in a number of lines that are now being observed in the countries, such as Guatemala and Mexico, OECD countries, and that these should merit has shown. A more common approach is to high priority. incorporate a fixed charge into the local Tradeable permits-rare in the industrial property tax. Monitoring and enforcement of countries-are even less apparent in the such a system is in principle more straight- developing countries. An exception is to be forward for larger waste dischargers. Tip- found in the case of Chile, where air pollu- ping fees for solid waste transfer and dis- tion rights have been allocated to fixed posal are sometimes used, though problems sources in Santiago. Still in the process of of illegal tipping also constrain such a pol- evolution, the system allocates the maxi- icy. For obvious reasons, discharges of mum level of daily emissions, to be reached hazardous and toxic wastes are usually by the end of 1997. Any emission above the subject to regulations, or outright bans, limit and below the emissions standard must rather than to pricing instruments. be compensated by reduction of emissions from some other source. A number of ad- Subsidies ministrative and other issues are still to be resolved, but this system appears to beAlhuhntwldomee,its desolvelpn quthit wel. Saporehars a ls believed that specific subsidies for environ- deeopn qut wel .igpoehsas mental purposes are widespread. Typically introduced auctionable permit systems for metlprosaewisradTycly these form part of a carrot and stick ap- rights to import and use ozone-depleting proach, in which they complement other substances. economic or regulatory instruments. The Asia region again provides good examples.'7 Deposit-refund systems Thus in Taiwan (China), Thailand, and These are now being introduced in a Indonesia, various forms of subsidy are number of non-OECD countries, particularly available for investment in pollution control in the Asia region. For example, Korea and equipment. Depending on the country, these Taiwan (China), have recently introduced may take the form of duty free imports, deposit-refund systems. These cover items reduction in corporate income taxes, accel- such as food and beverage containers, pesti- erated depreciation, low interest loans, and cide containers, lubricant oil, plastics, and so on. While often a necessary price to pay certain domestic appliances. However, to achieve the cooperation of industry in deposit rates tend to be too low to achieve environmental management, subsidy pro- significant results. Nevertheless the admin- grams are in general undesirable, not simply istrative mechanisms are in place and this because they involve a fiscal burden for potentially could be a significant policy government, but also because they distort instrument. investment decisions. Even more prevalent than specific environmental subsidies are User charges for solid and hazardous those sectoral subsidies which in effect wastes Solid waste operations in developing countries are commonly financed by local '"O'Connor 1993. 2. Explicit Environmental Incentives 21 subsidize environmental degradation, as instruments, particularly those that generate noted in the next section. public revenues. It should be noted that the While we do not find many examples of general view is to regard the imposition of success stories in developing countries, pollution or GHG taxes as a major impedi- trends in the industrial world do point to- ment to growth, the analogy of the oil price ward strategies applicable to the poorer increases in the 1970s and 1980s often being countries. A common theme throughout the employed. However, as distinct from the debate on economic instruments revolves latter case in which costs were exogenously around their administrative feasibility. With imposed on oil-importing countries, oppor- regard to explicit policies, the OECD coun- tunities are available to use the revenue tries are increasingly emphasizing the use of generated for beneficial purposes. Indeed, product charges and taxes, which are admin- environmental taxes may help to address istratively manageable, and therefore con- fiscal concerns in two ways: not only do trast with other economic or regulatory they generate revenue, but by discouraging methods which depend upon continuous environmentally damaging behavior in an monitoring of large numbers of waste dis- efficient manner, they also reduce the need chargers. The use of deposit-refund systems for environmental expenditure. From a fiscal also appears to be on the increase in both point of view alone, the potential use of developing and industrial countries, and pollution taxes as a substitute for distorting administration of such schemes does not taxes on effort and enterprise therefore seem to have posed major problems. merits close scrutiny in both developing and Administrative simplicity is of particular industrialized countries. importance in a developing country context, in which institutional capacity tends to be Subsidies much less than in the industrial countries. In It follows that developing countries in light of this, the following recommendations particular should avoid subsidizing pollut- regarding the use of economic instruments prtich subsidi zin pollut- ers. Such subsidies may have been accept- in developing countries may be made. First, able in the past for certain industrial coun- given the undoubted merits of emissions tries which have been able to stand the fiscal taxes, to identify the relatively few, large consequences and which have the adminis- scale waste dischargers, and apply emissions trative capability to avoid the abuses and charges to that group (i.e., the Malaysian distortions inherent in the provision of palm oil industry example). Second, devote subsidies. This may have applied in the past a major effort to the design and implementa- tion of presumptive product charges and taxes-as well as deposit refund Market failure and government failure schemes-in the developing countries. As noted, governments rarely rely upon Conclusion: Role of Market- taxes as a major weapon in their environ- Based Instruments in Developing mental armory. Indeed, far from employing Countries market-based instruments in a positive way, they often actively encourage environmen- Green taxes tally degrading activities by subsidizing them. For governments faced with urgent fiscal Figure 2-3 presents a contrasting situa- needs, arguments in favor of environmental tion to that depicted in Figure 2-2. As illus- taxes are persuasive. Countries should ex- trated here, a government subsidy lowers a plicitly consider the case for market-based 22 VOLUME I firm's production costs, so MB is artificially economic system and which have pervasive increased to MB(s). Thus, private profit is impacts, not only upon the environment, but everywhere greater than it was previously. on other aspects of development are more The polluter expands production to Q3, and likely to be required in developing countries. the total amount of external cost is even These are discussed in the next chapter. higher. Since subsidies are typically not In practice, environmental policy should justified in standard economic terms, this typically consist of a combination of eco- suggests that there is scope for bringing nomic and regulatory instruments, aimed at about environmental improvements that are the achievement of economic and environ- justified in economic terms as well. In fact, mental efficiency, and designed in light of as the next chapter demonstrates, there are the various political, institutional, and ad- many opportunities in developing countries ministrative constraints that each type of for policy reforms which meet both eco- intervention involves. Whether regulatory or nomic and environmental criteria. economic instruments are employed it is of course essential that they are soundly based Administrative constraints: need for from an engineering, chemical, biological, blunter instruments and epidemiological standpoint. Such exper- In view of the slow rate of adoption of tise is required in the valuation of environ- market-based instruments for pollution mental damage, which should ideally be the control in the industrial world, it is not basis for determining the level and structure surprising that there are few examples of of environmental standards or taxes. such policies in the developing countries. The design of product charges and of Although the efficiency-or cost-effective- responses in anticipation of the effects of ness-arguments in favor of market-based macroeconomic policies also requires such instruments suggest that they should be skills. Inter alia, these require an under- seriously considered by developing coun- standing of the kinds of resources and mate- tries, reform will not be accomplished im- rials used in industrial and agricultural mediately. processes or final consumption; the relation- Developing countries typically lack the ships between their utilization and the even- institutional capability for implementing an tual discharge of waste material, and the environmental management system that technical processes by which they are trans- relies heavily upon monitoring, inspecting, formed; the consequent impact upon the and regulating the activities of large num- natural environment; and upon human bers of polluters or other sources of environ- health. Economic instruments, as well as mental degradation, and in levying charges regulatory ones, must be based upon a good or fines. Even in industrial countries, this is understanding of such key technical rela- a major problem, and one which applies tionships if they are to be effective. Quite equally to command-and-control systems as apart from providing specific technical well as those based upon market-based expertise, the above suggests that environ- instruments. Administrative realities there- mental advisers in both government and fore suggest the need to look beyond ex- international agencies have an important plicit, narrowly focused environmental role to play in bringing various disciplines interventions. Blunter instruments, which together in the design of economic or other can be introduced at a higher level in the policy instruments. 2. Explicit Environmental Incentives 23 Figure 2-1. External Costs and Optimal Pollution. Benefits and Costs Q2 Q' Quantity of PoDudon Figure 2-2. An Environmental Tax. Benefits and Costs Q2 Q' Quantity of Polludon 24 VOLUME! Figure 2-3. Subsidizing Polution. Benefits and Costs $ \ MB QMB(s) Q2 Q3 Q' Quantity of PoUution Sectoral Policies "Win-Win" Policies THIS CHAPTER IS CONCERNED WITH THE IMPLICATIONS of economic policies that are adopted for sectoral purposes but have wide-ranging impacts, including significant effects on resource use and the environment. These include policies, such as energy pricing, which have pervasive impacts on all other sectors, as well as policies with specific sectoral purposes, such as a combination of crop price supports and subsidies for fertilizer and credit designed to encourage agricultural intensification. The examples that follow demonstrate that the environmental consequences of sectoral policies and programs on the environment have been considerable, but often unanticipated. 25 26 VOLUME I These environmental consequences occur festations are many and refer primarily to through production and consumption shifts those policies which encourage wasteful due to changes in relative commodity prices resource use (i.e., consumption for purposes or factor incomes associated with a wide in which social costs exceed social benefits), range of sectoral policy reforms. Since many resulting in excessive rates of depletion and of these environmental effects are not re- pollution. Clearly, some ambiguity sur- flected in market prices, very little system- rounds the definition of "economic" objec- atic attention has been paid to these in the tives, which do not always focus on efficien- past. cy goals and might legitimately encompass This chapter is primarily about govern- efficiency, fiscal, distributional and growth ment or policy failure. In a definitional criteria. However, the many opportunities sense, the distinction between the subject of that exist for policies in which tradeoffs this chapter and that of Chapter 2 is some- between environmental and other objectives what artificial, since inadequate measures to are minimal, suggest that the appropriate address market failure can also be defined as strategy for developing countries as well as government or policy failure. However, international development agencies should while the role of government may be viewed be to give high priority to policy reforms to be a passive one in not dealing with mar- which pass "win-win" tests. ket failures, in the sectoral policy examples As a general example of the opportunities discussed below government policy takes a for such reforms, consider pricing policies. more active role in creating the distortions Just as pricing may be consciously aimed at underlying the environmental problem. The the achievement of multiple objectives, distinction between explicit environmental inadequate attention to its often pervasive interventions and sectoral policies is also consequences may result in multiple, often not clear-cut. For example, policies on unanticipated, consequences. From a soci- royalties in the mining sector and timber etal point of view, the price of consuming a felling fees are both sectoral and environ- natural resource (including using it as a mental policies. However, in practice these medium for disposal of waste) should equal policies have not been generally espoused its marginal opportunity cost (MOC). This for explicit environmental goals such as price equals the sum of marginal private achieving an optimal level of resource ex- cost (MPC), marginal user (or depletion) ploitation. Most royalties, licenses, and cost (MUC), and marginal external cost charges are either nominal or established (MEC)' or, if the resource is internationally primarily for revenue generation, and they traded, its border price, if this is greater. In have limited if any contribution towards practice, it is rare to find prices being set in achieving sustainable resource management. this way; in fact, the situation depicted in Central to the discussion is the concept of Figure 3-1 is more common. the "win-win" policy, i.e., a measure which Ideally, in terms of Figure 3-1, price meets both economnic and environmental should equal P,, i.e., equal to the border objectives. Due to widespread government price, if the resource concerned is a trade- inefficiencies, both in developing and in- dustrial countries, many opportunities exist for policy reform that fall into the "win-win" 'Note that MPC includes MUC when rnarkets category. Examples of such policies, as work perfectly. Also, MEC will be included in MPC noted below, are to be found in the energy, where externalities are internalized by government intervention, for example, in the form of pollution industry, water resource, transportation, taxes or regulations. Environmental costs are an agriculture and forestry sectors. The mani- important-often the dominant-component of external costs. 3. Sectoral Policies 27 able. If not a tradeable, the MOC price per unit of output as well as controlling the would be P2; the MPC price would be at P3; level of pollution per unit of energy gener- average (financial) cost (AFC) pricing ated can be achieved by combining the would be P4. Setting price below MPC not potential contribution of technical interven- only implies a financial subsidy which is a tions with price reform. In past efforts at drain on public revenues, but also encour- energy conservation and pollution control, ages excessive consumption, resulting in there has been almost exclusive dependence both waste of resources and environmental on technical or regulatory approaches. This degradation.2 It also creates "rent," i.e., the section highlights the potential impact of difference between the economic benefit ob- price reform that can eliminate wasteful tained and the apparent cost of consumption, consumption or switch energy use from low and therefore has distributional implications. to high value uses. Such conditions are frequently encoun- In many countries' energy sectors, the tered in developing countries where prices major opportunity for immediate improve- frequently fail even to reflect purely finan- ment, at little or no cost, lies in reform of cial costs (AFCs) of production; i.e., they electricity pricing policies. On average, are at P5. While the optimal level of con- developing country electricity prices are sumption-at least for a tradeable-is Ql, about one half of those in developed coun- the actual level is Q5. Economic and tries. Ideally (and assuming that marginal environmental gains may therefore be costs are defined to include those of deple- achieved by simply ensuring that prices tion and external damages), price should be reflect financial costs of production. Raising equal to both short-run marginal cost prices to MPC, and still further to MOC, (SRMC) and long-run marginal cost increases both economic and environmental (LRMC). However, in practice this may not gains. The final shift, to border price, be possible due to capital indivisibility. A achieves further efficiency gains only. The pragmatic approximation, and one which potential for "win-win" policy reform in this recognizes that the true economic costs of case is clear. We now consider the scope for incremental consumption imply bringing such reform on a sector-by-sector basis. forward the need for additional investment in capacity, even if excess capacity currently Energy Sector exists, is to set price equal to average incre- mental cost (AIC).3 Numerous environmental problems are Kosmo's (1989) study of electricity pric- associated with energy consumption, includ- ing in developing countries showed that ing emissions of greenhouse gases and SO2, prices were invariably well below LRMC, water pollution, and the resettlement and the level at which an efficient allocation of ecological impacts of large projects, such as resources would be achieved. In a more dam construction. Energy conservation has recent survey of electricity tariffs in 60 enormous potential, but it is not a panacea. developing countries, tariffs were shown to Even under an energy efficient scenario, have decreased between 1979 and 1988, economic development will require substan- from US$0.052-US$0.038 per kWh in 1986 tial increases in fossil fuel consumption for the foreseeable future. Nevertheless, sub- stantial progress in reducing energy needs 3Sometimes referred to as "discounted unit cost," average incremental cost is the present worth of incremental system costs divided by the "present worth" of future consumption. For elaboration, see 2The assumption of increasing marginal costs is Saunders, Warford, and Mann 1977; this is also obviously necessary here. summarized in Meier (ed.) 1983. 28 VOLUME I dollars. These prices were less than half oping countries, where supply shortages are those prevailing in OECD countries even endemic, that there will be substantial trans- though average power supply costs in the fers of electricity consumption to higher developing countries assessed were higher value uses. Where excess demand continues than in OECD countries. Average tariffs for to prevail, an immediate impact upon emis- nearly 80 percent of the utilities concerned sions of pollutants would not be achieved did not cover long run marginal costs.4 Such since pollution arises from the generation low prices require enormous subsidies that side. However, once excess demand is represent major drains on government bud- alleviated, the future growth rate in emis- gets. For example, the World Development sions would be slowed. Report 1992 (World Bank 1992k) notes that Also, perhaps as significant, the immedi- energy subsidies exceeded US$150 billion ate effect would be a reduction in pollution annually in developing countries. For elec- per unit of GNP. If LRMC pricing were tricity consumption alone, the subsidies used, Kosmo (1989) estimates the annual amounted to about US$100 billion per year, value of energy savings at US$9 billion for suggesting that both capital and energy China and US$4 billion for India. Even in sources were being wasted on a very large highly industrial countries, electricity poli- scale. cies also leave something to be desired. The Prices are typically even below the aver- savings for the United States, for example, age cost to the utilities, which are them- from an application of LRMC pricing would selves commonly heavily subsidized be about US$60 billion annually. Even if through favorable interest rates, or fuel total energy consumption is unchanged, prices, or outright grants. Raising electricity price reform to recognize the additional cost prices to at least LRMC (or as an approxi- of peak loads would reduce the daily varia- mation, AIC) is a priority. More ambi- tion in power use and would therefore yield tiously, it should equal MOC, and as noted both efficiency and environmental benefits earlier, this might be facilitated by ensuring if power authorities relied heavily upon old, that external damage costs are included in inefficient plants at peak periods. the rate base, perhaps by employing charges Other economic objectives, such as re- which will stimulate switching to cleaner duction of budget deficits or provision of energy sources. For example, carbon taxes social safety nets, may also be achieved by could encourage power utilities to switch such reforms. Where, as is typical, LRMC from coal to natural gas. of power supply is rising, efficient pricing Price reform will thus typically fall well will raise revenues in excess of average into the "win-win" category. For example, (financial) costs. In many developing coun- the benefits from increased electricity tariffs tries electricity supply is being subsidized would be twofold. The first would be effi- from public revenues, and there would be ciency gains, where the reduction in con- financial constraints on supply expansion.5 sumption due to higher prices may result in Power generation projects currently have savings in capital and operating costs. It has little incentive to generate revenue due to been estimated that many developing coun- the subsidy traditionally provided by gov- tries consume about 20 percent more elec- ernments. Tariff structures can also be de- tricity than they would if consumers had to signed to ensure equitable treatment and pay the true marginal cost of supply. Aside facilitate access to service. One example from reduced demand, it is likely in devel- would be the use of "lifeline rates" for 4Saunders and Gandhi 1993. 5Anderson 1990. 3. Sectoral Policies 29 Box 3-1: Increasing Water Scarcity Surface and groundwater sources have been deteriorating in quality or have been depleted in many urban areas throughout the world. Due to increasing scarcity, unit costs of water are rising rapidly, and are typically 2 to 3 times the current project cost (Bhatia and Falkenmark 1992): In Amnman, Jordan, the average incremental cost (AIC) of supplying water when groundwater sources were still available was estirated to be US$0.41 per cubic meter. With declining groundwater availability, surface water sources are now being tapped, increasing AIC to US$1.33 per cubic meter. * In Shenyang, China, groundwater sources have declined in quality, and water will have to be conveyed more than 50 kilometers from a surface source. This shift will mean an increase in per cubic meter water supply cost from US$0.04 to US$0.11. * In Lima, Peru, long-term plans now estimate the AIC of water to be US$0.53 per cubic meter, compared to US$0.25 in 1981. The reason is that the traditional sources of groundwater are no longer available since the aquifer has been severely depleted, and interbasin water transfers will have to be made. * In Mexico City, Mexico, there have been problems of lowering of water tables, and land subsidence, as well as water quality deterioration in the Mexico Valley aquifer. This has meant that water from the Cutzmala River now has to be pumped to an elevation of I kilometer, using a 180 kilometer long pipeline. The AIC is thus US$0.82 per cubic mneter, which is 55 percent more than the cost from the previous source. Source: World Bank 1993i. poorer consumers. Finally, prices which percent of the average (financial) cost of reflect social costs will also be a stimulus to supplying it. Internal cash generation pro- the search for more efficient and cleaner vides only a small proportion of project means of supplying and consuming energy. costs-8 percent in Asia, 9 percent in Sub- Saharan Africa, 21 percent in Latin America Water Supply and the Caribbean, and 35 percent in the Middle East and North Africa. There is little As in the case of electric power, munici- economic justification for overall subsidiza- pal water supply, both to domestic and tion of urban-or indeed rural-water sys- industrial users is typically heavily subsi- tems. Generally the bulk of the water con- dized, with prices well below even financial sumed in developing country cities is by a supply costs. This leads to excessive con- small number of relatively wealthy con- sumption and depletion of water resources, sumers-large residential, commercial and and generation of waste water. Unit costs of business users-who are well able to pay for water, particularly for large urban areas, are it.6 Indeed, the system is such that subsi- rising rapidly almost everywhere, as conve- dized services have meant rationing, and nient sources are exhausted, and water has many of the urban poor actually end up to be brought in from ever greater distances. paying much more because they are forced These distances range from 50 to more than to get their water from alternative sources. 100 kilometers in metropolitan areas in For example, in Jakarta, Indonesia, house- many countries, requiring large investment holds without municipal water system con- costs for pipelines and pumping equipment. nections, buy water from street vendors for Some examples are described in Box 3-1. US$1 .5-US$5.20 per cubic meter, depend- A recent review of World Bank munici- pal water supply projects concluded that the price charged to end users was only about 35 6See Warford and Julius 1977. 30 VOLUME I ing on the distance to the public tap. Similar itself. As shown not only in the water supply findings have been reported in other urban sector itself,9 but also, with regard to peak areas, such as Karachi, Nouakchott (Mauri- load pricing, for electric power,'0 the deci- tania), Dhaka, Tegucigalpa (Honduras), and sion whether or not to meter is in fact arne- Port-au-Prince, where low-income house- nable to sensible cost-benefit analysis. This holds who have no access to the municipal is an important issue because of its generic system end up paying as much as 25 to 50 relevance to the environment, in which the times more per unit of water.7 cost of exclusion is inherent in the resolu- Studies also show that charging the full tion of externality or public goods problems. economic cost for water where marginal costs are rising (i.e., where marginal cost is Transportation greater than financial cost), is practicable since consumers' willingness to pay for Typically, the transportation sector in water connection is high. For example, a developing countries is characterized by study recently completed by the World Bank inefficiency, and is increasingly dominated on rural water supply in Brazil, Haiti, India, by the private automobile. Traffic conges- Nigeria, Pakistan, Tanzania, and Zimbabwe tion and pollution are a growing problem. indicates that the cost of private household Many policies have contributed to this connections can be recovered by including problem. For example, in Indonesia, subsi- an amortization charge in the monthly water dies for diesel fuel lead to air pollution and bill. This considerable willingness to pay road congestion and damage. Similarly, the appears to be much more common than prevalence of low vehicle registration fees previously believed in many rural communi- have encouraged congestion and pollution in ties.8 many countries." The political acceptability of increasing Although most sectoral reform efforts in charges for basic necessities will always be this area have been motivated by goals of a concern. However, higher prices will also reducing road damage and congestion and foster conservation among users so that generating infrastructure maintenance reve- there should be opportunities for govern- nues, there are indirect beneficial effects on ment to ensure basic supply for those who air quality. Policies that encourage mass are really disadvantaged. The large revenue transit systems, such as railroads, also re- yields that can be expected from higher duce energy use and emissions per commu- water pricing could also be used to provide ter mile and therefore merit close scrutiny. basic supply for low income groups, who In addition, since pollution-related effects could be charged a "lifeline rate" for basic are associated with emissions in densely needs. populated areas, policies that discourage use One of the obstacles to employing a of congested areas will also be beneficial. pricing system based upon volume con- Thus, these reforms that are implemented sumed is that of measuring an individual's for transport sector goals might also be consumption. The "metering problem" (see expected to result in pollution reduction. In Box 3-2) clearly arises with water supply, addition, they will also have nontransport where the costs of measurement are high relative to the cost of consuming the product 9See, for example, Middleton, Saunders, and Warford 1978. 'World Bank 1993j. 'Munasinghe 1990. 8World Bank 1992k, pp. 6-7. "World Bank 1992d. 3. Sectoral Policies 31 Box 3-2: Measuring Resource Use-the Metering Problem The metering problem is generic for many types of resource or environmental management problems. Many services derived from natural resources and the environment have public goods characteristics. For example, air pollution control programs benefit people whether or not they pay for it. Other resource and environmnental services-environmental amenities, tourism values, clean water-exhibit these characteristics to some degree. Irrigation water, for example, may be viewed as a quasi-public good in many developing countries. Canals, once constructed, cannot be limited only to farmers who pay irrigation fees. Secondary and tertiary ditches often traverse other farm land parcels before reaching the field of paying clients. Thus, farmers can directly tap into unlined or unprotected canals, and it may be very costly to exclude them. This introduces the problem of "free- riding" since potential users may attempt to reduce or altogether avoid paying for a share of environmental protection or resource investment costs. Metering introduces the possibility of requiring potential users to pay for their use of resources or environmental services. Where marginal benefits for various categories of users differ, metering systems may provide the additional advantage of differential pricing. However, the cost of installing and monitoring such systems may exceed the social benefits of installing them. For example, the previous example of canal irrigation services suggests that volumetric metering systems will be prohibitively expensive. However, rotation-oriented metering of water use may provide some advantage over open access. For municipal water supply, the potential savings may or may not outweigh the cost of providing meters for water use, depending upon (a) the incremental cost of water, (b) the impact of metering on water consumption, and (c) the cost of metering (Middleton, Saunders and Warford 1978). It should be noted that the sums involved are not trivial. In Mexico City, it has been estimated that the absence of metering and the prevalence of illegal water connections has led to a federal subsidy that exceeds US$1 billion annually. This is about 0.1 percent of gross domestic product (GDP) and equals the amount of annual sector investment needed to supply Mexico's water and sanitation needs to the end of the century. Note the contrast in metering costs between water supply and electricity. In the latter case, metering costs are relatively low when compared to incremental capacity and energy costs. Thus, more sophisticated pricing-e.g., varying by time of day-may be economically justified for electricity supply. sector economic contributions in terms of are many examples where congestion has less traffic accidents, noise, and savings in been significantly reduced at low cost with commuting time and vehicle costs. Thus, the use of traffic management schemes. fiscal, distributional, efficiency and environ- Such approaches include promoting mass mental objectives might be achieved by transit, controlling on-street parking to policy reform in this sector. increase traffic flow, and reducing the use of Various means of bringing about im- private cars (Armstrong-Wright 1992). A provement should be considered. Gasoline noteworthy example is the case of Singa- pricing reform seems to present the best pore, which in 1975 introduced an area opportunity since prices in developing coun- licensing scheme that required motorists to tries average about US$1.25 per gallon, pay for a special license to enter the city's compared with US$3-US$4 per gallon in central business district (CBD) in the morn- Europe and Japan. Other possibilities that ing rush hour. The CBD includes about 620 should be considered include (a) imposition hectares of Singapore where traffic conges- of a carbon tax, (b) congestion charges or tion is greatest. In addition to the licensing restrictions on use of city centers, (c) and scheme, Singapore also introduced a trans- reform of policies which discriminate port policy package that included: (a) free against fleet modernization. entry into the CBD by car pools, (b) higher Among the sectoral policies that have parking fees in the CBD, and (c) progres- indirect environmental benefits listed above, sively increasing taxes on car importation, those aimed at reducing traffic congestion purchase, and registration (Bernstein 1993). are becoming increasingly popular. There 32 VOLUMEI The package contributed to significant Industry reductions in automotive air pollution. The volume of private cars entering the CBD Efforts to promote industrial growth, declined by 71 percent, and taxis decreased whether through direct subsidies or through by about 65 percent. Car traffic started to industrial protection, may have important rise again after 1977, but have remained implications for resource use and the envi- significantly below pre-1975 levels. In ronment. Some of the links are quite direct. conjunction with Singapore's other efforts For example, low energy prices are often in industrial pollution control and in pro- justified in development planning on the moting the use of more efficient cars, the basis of providing cost advantages to indus- impact on air pollution was significant. try. This leads industrial expansion into Total acidity, smoke, nitric oxide, and nitro- energy-intensive product lines or technology gen oxide in the CBD declined, and the choice. Similarly, the impacts of industrial increase in carbon monoxide was moder- tax/subsidy programs and trade policy might ated. be reviewed to check the extent to which Policies that affect fleet modernization they discourage innovation; protect old- also have important environmental implica- fashioned, inefficient industry; or discourage tions. In China, until the early 1980s trucks development of backstop technologies. and cars had to be produced locally. With Many countries promote the development limited production, vehicle demand could of resource-processing oriented industries by not be met. Thus, the local fleet remained directly subsidizing investments or by con- outmoded and was characterized by fuel trolling the prices of their raw materials. inefficiency and excessive pollution."2 Simi- Investment subsidies may be implemented larly, subsidies to mass transit may also in the form of tax credits, subsidized loans, have environmental advantages but have to and tariff exemptions on the importation of be carefully assessed. Typically justified as capital equipment. The costs of raw materi- a social service, mass transit subsidies may als are often controlled indirectly, by pre- also contribute to reducing traffic congestion venting producers from exporting their and air pollution (Heggie 1989). In China, products or levying taxes on their export. rail transportation is favored over road The taxation of log exports (described be- transport. For hauling distances of about 100 low) is one of the more common examples km, transport tariffs for cargo are about four of this effect. In this case the domestic price times more expensive by road than by rail. of the raw material for the forest industry However, subsidies usually create other sector, timber, is reduced significantly be- problems, aside from their immediate fiscal low world market prices. In contrast to consequences, and environmental benefits "win-win" policies that promote gains in need to be weighed against potentially broad both efficiency and the environment, these distortions. For example, in China, the industrial protection policies lead to ineffi- failure of freight rates to reflect costs ciency for the protected industry and to spreads inefficiencies throughout the econ- increased resource exploitation. omy, affecting all sectors. Direct industrial subsidies may, however, have both beneficial and negative environ- mental impacts. The negative aspects are illustrated by studies on Eastern European countries, demonstrating how centralized planning systems have led to excessive industrial pollution. In many of these coun- '2World Bank 1992c. tries, overinvestment in energy-intensive 3. Sectoral Policies 33 heavy industry, relatively few (or poorly if a more stable decisionmaking context enforced) environmental regulations, and an leads to more conservation. overriding concern to meet production Using the example of smallholder pro- targets, often at the cost of the environment ducer prices in Malawi, Barbier (1991) and health and safety issues, have been examined the incentive effects of fluctuating instrumental in producing the highest levels relative prices on land degradation. The of sulfur dioxide emissions in the world study indicated that crop pricing policies can (Hughes 1992; chapter by Bates, Fiodor, and have an important influence on land man- Gupta in Volume 1). All these pollution agement in general if there is an effect on studies illustrate the unanticipated effects of relative price fluctuations. Fluctuations in industrial regulation and protectionism on relative crop prices and returns reduced the air pollution. incentives for smallholders to invest in One important example of the potential improved cropping systems and land man- beneficial effects of direct industrial subsi- agement by increasing the degree of price dies is in eco-tourism, which in most devel- risk. The risk arising from fluctuating prices oping countries primarily serves a foreign is not conducive to improving farming market. Where tourists may be attracted to a systems, incorporating new crops or invest- country to visit a unique nature park or site, ing in improvements in cropping patterns, government subsidies for managing or cultivation practices, and conservation improving such sites could generate both efforts. economic and environmental benefits. In In addition to the general effect of price many cases, institutional reforms, designed fluctuations on land management, the extent to ensure that more of the revenues from of fluctuations may also differ among crops. tourism are actually used to protect and and government intervention will have land enhance the natural environment, are re- quality implications depending on whether quired. See, for example, Lindberg (1991). price stabilization ends up encouraging crops that promote more stable soil condi- Agricultural Commodities tions, such as groundnuts and pulses, versus the more erosive crops, such as maize. If Tax and subsidy policies are often associ- policies allow greater fluctuations among ated with government efforts to promote the former crops, they may further reinforce agricultural production or to stabilize prices. the general disincentive to improved farm- Subsidies are introduced during periods ing systems and land management among when international crop prices are low, and poor farmers. crops are taxed when prices are high. The Aside from price policies leading to direct income benefits of price stabilization unanticipated substitution-type effects, one are probably limited, although there would problem with many price stabilization ef- be additional benefits if stabilization poli- forts is that price support subsidies are often cies reduced risk-related constraints to inadequate during periods of low prices. By agricultural investment.3 Promoting invest- contrast, when crop prices are high tax ment will also be good for the environment policies tend to be more effective. Indeed, due to revenue generation goals, such taxes often tend to be institutionalized, leading to a long-term bias against agricultural output '3The problem with many price stabilization adicms hscetsteudryn efforts is that price support subsidies are often and incomes. This creates the underlying inadequate while revenue generating taxes tend to be basis for income effects that can have signif- institutionalized, leading to a long-term bias against icant environmental implications. agricultural output and incomes. 34 VOLUMEI In another example for Malawi, Crom- are either promoted or discouraged have well and Winpenny (1991) showed that crucial environmental implications. This government efforts to provide crop price point has also been made in the context of supports were ineffective and the actual indirect incentives for various crop activities prices received by many small farmers were in West Africa. Differential rates of implicit substantially less than the statutory market- taxation among crops significantly affect ing board prices. Legislation also prevent land use, and many countries in Sub-Saha- smallholders from competing with estates in ran Africa have historically discriminated producing more profitable plantation crops. against export crops relative to domestic These policies depressed rural incomes, but food crops. This may appear to be environ- farmers were also effectively prevented mentally beneficial since many environmen- from seeking nonagricultural employment talists have presumed that export crop pro- since the government also strictly controlled motion aggravate soil erosion. However, it rural to urban migration. These policy con- has been argued that this view is not gener- straints, coupled with a high population ally valid since many export crops tend to be growth rate, led to the expansion of cultiva- less erosion-prone than food crops.14 tion into marginal areas and a long-term Most export crops are usually tree crops decline in soil fertility. or perennials that provide land cover and The authors then assessed the impact of more stable root structures. Examples are reforms implemented in the 1980s. The coffee, cocoa, rubber, palm oil, and bananas. study examined both the estate and small Citing data for West Africa, Repetto (1989) farm sectors, and evaluated policy impacts concludes that where tree and bush crops are in terms of changes in four environmental grown with grasses as ground cover, soil aspects: the extensive frontier of cultivation, erosion rates form tree and bush crops may intensity of production, product mix, and be up to three times less than the rates for production technique. In an effort to respond crops such as cassava and maize. Thus, to changes in producer prices and maintain trade-oriented reforms could have beneficial real incomes, smallholders intensified pro- implications not only for export growth but duction of food in marginal lands. However, also for decreased environmental damages estates were more responsive to improved from soil erosion. trade conditions and export incentives. It was noted that the environmental effect of Agricultural Inputs production changes depended on the crop being adopted and cultivation methods Irrigation being practiced. The study concluded that, on balance, product mix had been the most com tone smes haveibeeual main sensitive to changes in prices and incentives, cmpn po many agricturaeveop- Land used for maize declined responded to ment programs, and for a variety of reasons, thed usedeclinei foretun maized relatved to including the compensation farmers require thexportlcrops Whenum epor maincentives i- due to government intervention in product markets, they have also tended to be heavily proved, the output of groundnuts and beans subsidized. There are indications, however, rose. Since the production of groundnuts that much of this subsidy has been unneces- and beans is probably more beneficial to soil sary, and instead has discouraged efficient fertility, relative to maize farming, the envi- water use and conservation. Repetto (1986) ronmental effect may have been positive. These observations on Malawi indicate that the particular characteristic of crops that '4Repetto 1989, pp. 71-72. 3. Sectoral Policies 35 examined the consequences of water under- Beyond the current concerns with ineffi- pricing in terms of the resultant inefficient cient use of increasingly scarce water re- performance of public irrigation systems in sources, there remains the long-term prob- developing countries and in the United lem of declining productivity of irrigation States. In this study, it was found that only systems due to environmental degradation. 10 to 20 percent of the investment and Up to the early 1970s, the tradeoffs between operating cost of irrigation systems in many current demands to expand irrigated areas poor countries is actually charged. Both versus the long-term effects of irrigation efficiency and distributional effects were were not considered a priority. Thus, many negative since the subsidies led to excessive projects in the past 25 years were economi- water use and the primary beneficiaries cally justified because expensive compo- tended to be the better off farmers. nents such as drainage systems were not Changes in the water table and increasing included (Barghouti and Le Moigne 1991). land salinity are the most common environ- Since such systems may eventually suffer mental results of excessive water use. For from declining yields due to waterlogging example, irrigation subsidies were intro- and salinization, irrigation programs may duced in Peru in the 1970s to offset the have contributed to the general pattern of decline in land improvements associated transferring the costs of development from with the land reform program. Most public the present to the future. investments were directed at large irrigation projects in the Costa region (versus the Pesticides and fertilizers Sierra and Selva). Low water fees and inade- Subsidies for pesticides and fertilizers are quate maintenance of these systems led to r inefficient water use. The resulting soil usalyasmed toabe detrimental todthe * * * r . ~~~~~~~environment because they favor the produc- salinization caused a loss of productive tion of crops with high nutrient require- agricultural land. It is estimated that about ments, and they cause water pollution from 40 percent of agricultural land in the Costa runoff. Subsidies for pesticide use are sub- region has been affected by salinity. stantial in many developing countries. Mea- In many instances, such subsidies may sured as a proportion of pesticide retail cost, not be really needed. This is suggested by the subsidies for eight countries studied studies of privately supplied irrigation wa- have ranged from 19 percent in China to as ter. In Bangladesh, farmers normally pay 25 much as 89 percent in Senegal.6 Subsidies percent of their entire dry season crop reve- for chemical fertilizers have also been nues to nearby tubewell owners who supply linked to possible environmental problems. them with irrigation water. In Nepal, assess- Repetto has argued that such subsidies ments of farmer-owned and managed irriga- 'ificially reduce the incentives to practice tion systems have found that farmers are soil conservation and have made farmers willing to contribute substantial amounts of adopt short-sighted output-oriented strate- cash and labor to pay for the costs of system gies. In the 1960s such subsidies may have operation and maintenance. For example, in been important factors in promoting the use six hill systems, the average labor contribu- of "green revolution" technology, but the tion was about 50 man-days per hectare per o year, and monetary contributions averaged raed of tie ust ehas moredthan qar about the equivalent wages for one man- pled in the last two decades. Subsidies in the mbonttheof lqvab5 1980s normally constituted 50-60 percent of month of labor.a "World Bank 1 993i. I6Repetto I1985, Table 2, and pp. 19-27. 36 VOLUME I delivered cost and reached 80-90 percent in conditions and dramatic declines in produc- some countries.'7 tivity are indicative of the extent of the As in the case of crop pricing policies, the problem. For example, in western Africa environmental implications of input subsi- serious problems of pasture degradation due dies need to be evaluated on a case-to-case to overgrazing are reported in Togo, Camer- basis. In instances when fertilizer use is very oon, Guinea, and Cote d'Ivoire. limited and soils are not productive, there One of the best known examples of gov- may be a case for subsidy. An OECD study emient failure in this sector was the policy for Nigeria argues that fertilizer use in that of the Brazilian government of providing country is substantially below what would forest land, free of charge, for cattle ranch- be optimal (OECD"8). Similarly, in Malawi, ing (Mahar 1988). Additionally, generous soil fertility was declining due to population tax incentives were given for individuals to pressure, maize mono-cropping and re- engage in cattle ranching. This develop- stricted availability of organic manure ment-oriented policy proved to be unsuc- within the farming system. At the same cessful on both economic and ecological time, effective fertilizer costs were increas- grounds. The negative environmental im- ing rapidly, due to oil price rises and the pacts were dramatic since prospective ranch- closure of transportation routes. This led to ers were required to completely clear forest fertilizer, hectarage, and maize yields re- lands in order to stake out their claim. Un- maining static, and maize sales to govern- fortunately, the program was also uneco- ment agencies fell dramatically. The reintro- nomic since most ranching operations duction of a fertilizer subsidy in 1987 ap- turned out to be unsustainable owing to the pears to have been environmentally benign fragile conditions of Amazonian soils. Re- under these circumstances, as it reduced the form in this area is clearly a "win-win" long-term decline in soil fertility that would policy, the present one failing fiscal, effi- otherwise have resulted (Cromwell and ciency and environmental tests. Winpenny 1991). Indeed, some authors take In an analysis of govemment livestock a much more positive view of the long-term policy in Botswana, Perrings et al. (1988) contribution of agricultural chemicals. demonstrate that a mix of policies constitute Stryker (1989), in a paper on the arid and the underlying causes of rangeland degrada- semiarid tropics, proposes the retention of tion. The incentive structure prevailing in fertilizer subsidies in countries where soil the country at the time of the report encour- depletion is a significant concem.'9 aged inefficient stocking and farm manage- ment decisions, resulting in rangeland deg- Livestock radation. These included the prices paid to producers, the system of subsidies, the tax The decline of traditional tenure systems structure, and the nature of property has resulted in open access conditions and rights-all of which made the overstocking subsequent land degradation in many graz- of grazing land privately rational even ing areas. Actual measurements of soil though the social costs in terms of degraded erosion and land degradation are seldom lands and unsustainable livelihoods were available. However, changing land cover very high. Rangeland degradation results from the combined effects of soil erosion, "See, for example, Repetto 1989. depletion of soil nutrients, increasing soil aridity, and other factors, particularly '"Fontaine and Sindzingre 1991. drought. "9In Leonard (ed.) 1989. 3. Sectoral Policies 37 Livestock and crop prices were at artifi- Aside from labor and capital, fishery cially elevated prices due to the influence of production is crucially dependent on the high prices in the EEC countries and in existing fish stock (or biomass). Since it is a South Africa. Simultaneously, real input biological resource, it experiences net prices for livestock and food crops were growth through fertility or recruitment and reduced due to domestic agricultural assis- mortality. The employment of labor and tance programs. The impact of these price capital in the fishery (usually termed "ef- incentives was compounded by the presence fort") not only produces the catch but may of macroeconomic incentives to direct for- also lead to an increase or reduction of the eign investment, such as maintaining an biomass available for the next fishing pe- undervalued exchange rate. All of these riod. The biomass will increase or decline, factors contributed to the incentives to add depending on whether catch is less than or to herd sizes. To address the problem, the greater than the net growth for that period. authors conclude that a comprehensive set The concept of sustainable yield therefore of remedial policies will be required, includ- goes beyond the conventional notion of ing: (a) the introduction of a range levy, (b) long-run production since the long-term charges for water use, (c) modification of trend in the level of biomass is directly tax benefits available on livestock, (d) set- affected by short-run harvesting activity. In ting producer prices at high enough levels to the short run, any catch is theoretically encourage an increase in offtake, and (e) feasible up to the level of available biomass, subsidizing voluntary herd reductions in but this catch is not sustainable if biomass severely degraded areas. left over for the next period is already too limited. Fisheries Fishery biologists have long known that there is usually a maximum sustainable In fisheries, government programs have yield that is possible from a fishery, and this been primarily motivated by production is associated with a given level of biomass goals. There were attempts in the 1970s to and fishing effort. In some fisheries, the duplicate the green revolution approach in biomass level is primarily dependent on agriculture by providing credit for boats, environmental conditions and not on the motors, and improved fishing nets and gear previous year's level so that with increasing (Lockwood and Ruddle 1976). However, in fishing effort, catch may just stabilize in- fishing areas where there was already signif- stead of decrease (Anderson 1980). In either icant fishing effort and harvest was near the case, average catch will tend to decline, and fisheries' maximum sustainable yield, such this has been the basis for the standard "blue revolution" programs merely served to recommendation in capture fisheries for increase overfishing. This process is docu- limiting effort. Thus, conventional fishery mented in San Miguel Bay, one of the tradi- management activities focus on restricting tional fishing areas of the Philippines, where allowable gear or in limiting fishing area or increasing fishing effort in the late 1970s season. Minimum net mesh size rules to was associated with declining yields by the protect immature fish is a common example early 1980s (Cruz 1986). The growth of of the first approach. Enforcing both types communities dependent on the fishery, the of schemes, however, is extremely difficult open-access nature of the resource, and the due to the large jurisdictions concerned as production-oriented policies adopted by well as the number of fishermen involved. government contributed to overexploitation Limited entry schemes have therefore been of the fishery. proposed in attempts to minimize the need 38 VOLUMEI for comnmand-and-control approaches by served, while allowing for continued agri- addressing the open access problem that cultural growth. dominates the incentive structure in fishing. Since most forest lands in the developing The basic economic argument for control- world are under some form of government ling fishing effort is that the open access to ownership and management, government the resource dissipates the rent that may be policies significantly affect the rate of forest potentially generated by resource use, as exploitation as well as the conversion of ever increasing numbers of fishermen forest lands to agriculture (Hyde, Newman, overexploit the fishery. Limiting the amount and Sedjo 1991). There is considerable need of fishing activity and allocating these quo- for institutional and sectoral policy reforms, tas will therefore prevent overfishing. In including control of logging operations and addition, those who are assured of the rights capture of economic rents from forest con- will have an interest in actively promoting cessionaires, and measures to curb the fishing regulations and enforcing the quota, highly inefficient use of wood for fuel. since the fishery as an asset will become Continuing policy and institutional failures more valuable to them.20 The difficulty, of are associated with forest resource underval- course, lies in how to allocate rights to fish. uation and inadequate systems of forest land Nontransferable quotas or licenses to fish tenure, and these result in tangible economic have been the traditional approach, but there losses, including lost export earnings from is increasing experimentation in making forest products, foregone government reve- these licenses transferrable and then auction- nues, soil degradation and reduced agricul- ing them off to allow the management au- tural productivity, and flooding. thority to capture resource rents. Some form Repetto and Gillis (1988) have analyzed of limiting entry will clearly be preferred to the deforestation implications of the under- the current open access situation since har- valuation of timber resources. While gov- vests can increase and be sustainable. ernments claim substantial social value of forests, the stumpage fee or charges for Forestry harvested timber is often nominal. Logging concessionaires can therefore capture enor- Policy for efficient and sustainable for- mous rents since they are able to export estry in many developing countries is in its timber at a very high price. Because of this infancy since the multiple economic and incentive structure, loggers are often moti- environmental services provided by forests vated by rent-seeking to acquire as much have only recently become widely recog- timber harvesting concessions as possible, nized. Multiple uses and competing de- resulting in ever increasing pressure on mands characterize forestry resources in timber resources (Cruz and Delos Angeles many developing countries. The main forest 1988). products users are loggers and fuelwood Aside from logging, the other crucial gatherers. Agriculturists seek to convert source of deforestation is the conversion of forests into upland farms or pastures. Fi- forests to agricultural activities. In general, nally, government attempts to coordinate this process is the result of increasing de- these conflicting demands so that the protec- mand for farm land from a growing popula- tive and amenity values of forests are pre- tion. The problem is exacerbated by the failure of centralized management systems, both in keeping new settlers from forest 20Having no restrictions on entry is formally lands and in providing those who have equivalent to an extreme undervaluation of the already colonized such lands with the insti- economic contribution of the fishery asset. 3. Sectoral Policies 39 tutional structure that can encourage with population pressure there will be a shift conservation-oriented farming practices. to the most productive (lowland agricul- This perspective has motivated continu- tural) areas. However, this may be misdi- ing evolution in the World Bank's forestry rected to forest or frontier lands by disease, policy. In its 1978 Forestry Policy Paper the economic policies, and inequitable land emphasis shifted from industrial forestry and distribution. timber utilization toward social and rural A second study looks more generally at development issues and environmental the "nexus" of trends in population growth, forestry. This followed from the recognition agricultural stagnation, and environmental of the problem of timber undervaluation, a degradation in Africa (Cleaver and common policy distortion in many develop- Schreiber 1991). They find that shifting ing countries, as the source of deforestation cultivation and grazing in the context of and inappropriate land conversion. The limited capital and technical change cannot problem of encroachment in forests, associ- cope with rapid population growth. At the ated with poverty and degradation, was also same time, the traditional technological fix identified in the 1978 policy paper although from the development of high yielding crop this was not emphasized. This major change varieties are not available. Thus, they iden- in sectoral priorities led to efforts at "new tify the need for a mix of responses in terms style" forestry projects that incorporated of reforms to remove subsidies for inappro- watershed management and environmental priate land uses, improve land use planning, activities. recognize property rights, provide better The 1991 World Bank forest sector policy education, and construct appropriate rural paper (World Bank 199 lb) shifted the focus infrastructure to promote production incen- further and identified the relationship be- tives. tween deforestation and poverty and popula- With respect to the pattern of poverty and tion pressure as the primary resource man- degradation, more work remains to be done agement concern. The need for zoning and on the problem of encroachment of forest regulations, correct economic incentives, lands by displaced farners. Providing and the role of public investment and re- tenurial security is a key aspect of the prob- search were the other priorities identified in lem. For farmers already in forest areas and the policy paper. Although the 1991 policy marginal lands, providing security of tenure paper emphasized the problem of agricul- through a land reform program is the first tural extensification and migration to forest step in encouraging conservation-oriented land, analytical work that can improve farming. In most instances, land reform is current understanding of the mechanisms by politically difficult to implement (Anderson which poverty and population affect defor- and Thampapillai 1991). However, the estation have been limited. Two notable problem of encroachment will often occur in initiatives in this area are in Africa. As part public lands instead of private agricultural of the Managing Agricultural Development lands. Thus, alternative land reform in the in Africa (MADIA) program, Lele and public domain might be more workable. Stone (1989) focus on a post-Boserup con- One of the most comprehensive work cept of policy-led agricultural intensifica- done to date on the requirements for sustain- tion. Demand-led agricultural intensification able forestry management was the assess- (in the induced innovation tradition of ment of Philippine forestry presented in Hayami and Ruttan 1971) has apparently not World Bank (1989a). This study, undertaken been as effective in Africa as in Asia and in cooperation with the government's De- Latin America. The authors hypothesize that partment of Environment and Natural Re- 40 VOLUME I sources, identified the sectoral pricing and development projects. They indicate that taxation reforms needed for improved com- more care must be taken to recognize the mercial forestry management as well the variety of local circumstances and resources institutional reforms needed to address the that could be affected by the program. problem of population pressure on public Planned resettlement efforts, as in Indonesia, forest lands. Philippine forest lands have unfortunately seldom evolve as planned. declined from about half of the country's The long-term sustainability of new re- land area in the 1950s to less than 25 per- sources that are opened up for exploitation, cent. Timber stumpage undervaluation, as in Zambia, is often sacrificed for immedi- which provided substantial potential rents ate returns. Formal industrial investment for loggers, for many years created exces- projects, as in Carajas, will often attract sive demand for control of forest conces- spontaneous ancillary activities, some of sions. At the same time, rapid growth of which may lead to environmental problems. migrant communities contributed to the Unfortunately, few government implementa- conversion of forest lands to agriculture. tion agencies are capable of responding in a The study concluded that parallel reforms in relevant and timely manner to such prob- timber pricing and in introducing lems. community-based or decentralized approaches to forest land management Global Environment Implications should form the key components of any of Sectoral Policies strategy for sustainable management. Sectoral policies in the energy sector, Regional Aspects such as power pricing and choice of genera- of Sectoral Policies tion technology and inputs, have crucial environmental implications that go far be- Regional development programs, which yond national boundaries. In turn global for our classification purposes fall some- environmental concerns will normally tran- where in between sectoral and macroeco- scend the interests of individual countries. nomic influences on the environment, often This can be illustrated by GHG emissions. have massive and largely unanticipated Scientific and economic uncertainties, diffi- consequences for the environment. This may culty of valuation, and the fact that global be illustrated by reference to a number of climate change is determined by policies programs, some of which have been highly and activities outside their borders, make it publicized, such as the outer islands trans- reasonable for developing countries to take migration program of Indonesia, Carajas in the position that they will not take measures Brazil, and Narmada in India. Because to address the GHG issue unless it is in their regional development projects substantially own economic and social interest to do so. modify settlement and resource use patterns Where, as in the case of GHGs, long-term within their scope of influence, their envi- benefits of control might be in conflict with ronmental effects are often considerable. urgent poverty alleviation objectives, this is However, in many instances, these effects a particularly powerful consideration. like social and institutional constraints are The diagram below illustrates the situa- not anticipated in the design of projects and tion facing a single country. (See Figure eventually contribute to problems in the 3-2.) The MAC curve refers to the net long term. The examples above illustrate the marginal abatement cost to the country of variety of environmental effects that are each new method of reducing (or sequestra- often associated with large-scale regional tion of) GHGs. MAC is the sum of the costs 3. Sectoral Policies 41 of introducing policy reform or emissions- Sectoral Policies and General reducing investments, minus any benefits Market Imperfections which result from such expenditures, and therefore represents the net costs of alterna- This chapter has provided a flavor of the tive measures. (Alternatively, therefore, up kinds of sectoral policies which might have to point A, MAC could be mirrored by the an adverse environmental impact, but which dotted curve MBC, or net marginal benefit also merit reform in their own right. Numer- to the country concerned). Clearly, countries ous obstacles obviously have to be over- intending to reduce GHG emissions should come if policy reform is to be achieved; select the most efficient (i.e., cost-effective) reduction in long standing subsidy programs options first. MAC therefore increases, the or increases in the prices of goods and ser- greater the percentage reduction in carbon vices supplied by government, or over dioxide emissions. The portion of MAC which government has control, is notori- lying in the negative range (0-A) represents ously difficult. In addition, economic theory opportunities for "win-win" actions by the itself often suggests that immediate pricing country. reform in a particular sector should be Point A represents the level at which it is treated with caution. First, in the short run, no longer in the interest of the country to demand may be inelastic, requiring consid- reduce GHGs any further, i.e., at that point erable increases in prices to bring about the costs of so doing exceed the benefits change. Price reforms may also be politi- accruing to the country. However, there is a cally unacceptable, and therefore ultimately benefit to the world at large from such counterproductive. reduction. The global optimum emissions Second, reform of pricing or introduction level therefore requires a greater emissions of what may appear to be, at first sight, a reduction than for the country alone. A move toward economic efficiency in any global marginal benefit curve, MBG, would particular sector of the economy may in fact intersect MAC to the right of level A, i.e., at be a move away from it if optimal condi- B. This would represent the global optimum, tions do not prevail elsewhere; i.e., a "sec- i.e., where global marginal benefits equal ond best" policy may be called for. For global marginal costs. example, the introduction of economic Assuming that all "win-win" opportuni- incentives in a sector-perhaps dominated ties are taken by the countries concerned, by parastatals-may in fact be an inferior using conventional financing sources, GEF substitute for command and control, if financing should in principle be restricted to economic incentives in general do not pre- the range A-B. Beyond that, further reduc- vail in that sector. Or, as noted earlier, a tax tion in CO2 emissions would not be justified on commercial energy may simply result in even when global considerations are in- switching consumption to untaxed fuels, and cluded. In view of the massive costs of elimination of agricultural input subsidies arriving at the global optimum (as noted in may have undesirable environmental and the previous chapter), it is clear that any economic side effects. hope of moving significantly in this direc- A major constraint is therefore imposed tion will depend heavily upon the imple- by general market imperfections. Bringing mentation of sectoral policy re- about reforms at the sector level may be form-justified in their own right-at the counterproductive in the absence of major country level. economic policy reforms in the rest of the economy. As illustrated in subsequent chap- ters, the second best issue is a pervasive 42 VOLUME I problem in the developing world, especially the direction of social cost pricing. The in China and in Central and Eastern Europe. latter requires analysis of divergence be- General market imperfections might reduce tween market and social costs and benefits, the effectiveness of sector-specific policies, which can involve severe measurement in particular when they rely upon market- problems. These arise not only because it is based instruments. Their introduction will inherently difficult to place monetary values therefore often best be phased to conform on environmental impacts,2' but also be- with general trends in market liberalization. cause prediction of the physical impacts However, the relationships between such themselves is fraught with uncertainty. For wide-ranging policies and the environment example, subsidization of pesticides may are much less well understood than sectoral have both positive and negative environ- policies. mental effects, and socially and environ- For example, numerous exogenous mentally efficient energy pricing may be influences-political, economic, and envi- difficult to determine in practice. However, ronmental-determnine the appropriateness while precision may be difficult to achieve of general agricultural policy. Over time, in such assessment, the general direction of governments have introduced an array of needed reform will often be intuitively clear. economic and other policies to react to these The magnitude of underpricing is often so influences, and these measures have often large that refinement of social cost calcula- created constituencies supporting the status tions is of purely academic concern. quo, and which create obstacles to reform. Indeed, while raising prices certainly They also give rise to the "second best" raises various administrative problems (e.g., problem, which runs through the reform evasion of payment), the structure for recov- process, and is illustrated extremely well in ering costs of water and electricity consum- the case of agriculture. Thus, proposals to ers already exists. Moreover, reduction in reform, say, irrigation pricing, must be subsidies actually involves a dismantling of addressed in light of the whole range of the administrative structure involved. distortions that characterize agricultural Achievement of social cost pricing for key markets. resources is therefore a feasible policy in both industrial and developing countries. Conclusions Governments also often have the means to effect approximate adjustments for external There is ample opportunity for "win-win" cost-e.g., by raising gasoline taxes to policies, but formidable obstacles to their account for vehicle air pollution, congestion implementation abound, largely because of and noise. Tariff levels and structures for the incidence of the costs and benefits of water supply and energy are, in an adminis- reform measures. It is to be hoped that trative sense, quite possible to adjust. In policy reforrns which are justified on their general, therefore, while considerable re- own merits might gather additional support search still needs to be done in this area, it is when environmental concerns are weighed reasonable to expect policymakers to incor- in the balance, and this coordination of porate environmental considerations more conventional and environmental goals systematically into decisionmaking at cur- should be a central objective not only of the rent levels of knowledge. Lack of precise countries themselves but also of donor information should not be an excuse for agencies. inaction. Getting to market prices is in many cases a necessary first step in correcting distor- tions, to be followed by further correction in 2tSee Munasinghe 1993a. 3. Sectoral Policies 43 It is also administratively quite straight- they are also the bluntest of instruments, and forward to introduce complementary blunt impact on all aspects of life. The key admin- instruments, to cover the costs of sewerage, istrative issue here is to develop the institu- or of the damage done by utilization of high tional capacity-within Ministries of Envi- sulfur coal or gasoline. Finally, while mac- ronment as well as of Ministries of Fi- roeconomic policy reforms may be the most nance-to understand the various linkages powerful of instruments, in view of their between economic policies and the environ- countrywide and cross-sectoral impacts, ment. 44 VOLUME I Figure 3-1. Marginal Opportunity Cost Pricing. Natural Resource Prke, Cost MOC (Non-tradeable) P - ----------- - Border Price (MOC for tradeables) Po C~~~~~~~~~P P2 P3 - - - - - - - P4 Ps Qr Q2 Q3 Q Qs Natural Resource Quatity Figure 3-2. Marginal Costs and Benefits of Reducing C02 Emissions. S/ton of C02 MBG A MAC > A \ < ~~~~B (UnjudfRed) 9% Reducdon inDC02 4 Macroeconomic Policy and the Adjustment Process As WE HAVE NOTED, ENVIRONMENTAL DEGRADATION appears to be an increasing threat to sustainable economic growth and development, and therefore assumes macroeconomic propor- tions. At the same time, the impacts of policies at the macroeco- nomic level appear to be of major significance. In short, the environment is no longer to be thought of as something distinct from economics; indeed it should be central to it. This does not merely imply concern at the project or sector level, but arguably even more importantly, at the macroeconomic level. 45 46 VOLUME I National Income Accounting accounts are basically indicators of the vol- ume of economic activity. They are deficient The general principles now accepted as part in many respects as an indicator of human of the "new" environmental economics recog- welfare, and adjusting for one defi- nize the environment as integral to develop- ciency-major though it is-does not change ment policy, but much still needs to be done to this. Nevertheless, development of a parallel refine understanding of the macroeconomic set of physical resource accounts would un- importance of environmental problems, and in doubtedly be an important adjunct to con- particular to be able to assess the extent to ventional national income accounts. which economic growth is likely to be sustain- Recent work on the treatment of environ- able. The shortcomings of national income ment in national income accounts has, how- accounts in the treatment of the environment ever, highlighted one critical aspect of the are now fairly well known. (See Box 4-1.) relationship between economic policy and the Pollution abatement or mitigation costs-for environment. Virtually all definitions of example, cleaning up after an oil spill-are "sustainable development" imply the need to counted as additions to national income. Of pass on a stock of capital to future generations special relevance to many developing coun- at least equal to that available for the use of tries is that there is typically no accounting for the present generation. It is now widely ac- the drawing down of the stock of those cepted that "genuine savings" must be posi- resources that, in principle, are renewable, but tive: in turn, this requires that the sum of which in practice, because of overexploitation, natural and man-made capital must be main- are rapidly depleting. If compensating invest- tained intact, or indeed, increased in real ment is not made, growth based on such a terms, if economic growth is to be continued process is not sustainable, and conventional into the future.2 national income measures provide a mislead- ingly favorable impression of economic prog- Adjustment and the Environment ress. It has been suggested that treating natural In recent years, changes in macroeconomic capital depletion in a similar manner to depre- policies in the developing world have gener- ciation of human-made capital would provide ally been associated with the process known a more realistic indicator of economic prog- as adjustment. While in principle, the adjust- ress. Indeed, environmental accounting studies ment process is merely a special case of mac- have been completed for a number of develop- roeconomic policy change, in practice it is ing countries, as well as for certain industrial sufficiently important to use adjustment as a countries.' These exercises are aimed at creat- proxy for macroeconomic policy reform in ing an awareness of environmental issues at analyzing the consequences for the environ- the macroeconomic level and to identify sus- ment, at this level of decisionmaking. Indeed, tainable development strategies. There are, most of the analytical studies and virtually all however, arguments against reforming ac- the polemical ones on this subject have con- counts in this way. To do so could lull pol- centrated on adjustment rather than on macro- icymakers into a false sense of security, since economic policy in general. many of the most significant environmental Adjustment-related reforms have wide- issues are not susceptible to measurement in ranging effects on economic incentives, and monetary terms. Moreover, national income this has been recognized in a growing litera- ture on their impacts on sectors of the econ- 'Repetto et al. 1989; Solorzano et al. 1991; Cruz and Repetto 1992. 2Pearce et al. 1993. 4. Macroeconomic Policy and the Adjustment Process 47 Box 4-1: Environmental Accounting Economic performance is generally measured by the growth in gross domestic product (GDP). While GDP is a fairly accurate measure of market activity, it does not reflect the depletion of natural resource stocks and the degradation of the environment which often are not valued by the market. Lutz and Munasinghe (1991) identify three specific shortcomings in the current framework: Natural and environmental resources are notfully included in balance sheets. National accounts represent limited indicators of public well-being since they do not have the capacity to measure changes in environmental and natural resource conditions. Conventional national accounts fail to record the true costs of using natural resources in economic activity. The depletion or degradation of natural capital, which occurs in the course of productive activity (for example, through mining, fishing, or use of water) is not included in terms of current costs or depreciation of natural wealth. This leads to underestimation of the market value of resource-based goods-the lower the value added, the larger is the extent of underpricing of the final product (Dasgupta and Maler 1990). Also, there are no estimates of the "hidden costs" associated with the export of primary products, suggesting that the contribution of the external sector in many devel- oping countries is overestimated. Cleanup or abatement activities (for example, those that result in expenditures incurred to restore environmental assets) often result in overestimation of the national income because the offsetting environmental damages are not considered. For example, losses from environmental damage are not included from national income accounting. However, when damage occurs, cleanup or restoration costs serve to increase the measures of income. The deficiencies in the accounting techniques employed at present have suggested the need for a system of national accounts which permit the computation of an environmentally adjusted net domestic product and an environmentally adjusted net income. It has been proposed that a supplementary environmentally adjusted System of National Accounts (SNA) and corresponding performance indicators would encourage the reassessment of macroeconomic policies in light of environmental concerns and would help to trace the links between economywide policies and natural resource management (Muzondo and Miranda 1991). omy that were not the original objects of the Many of these sector-specific reforms (of reform programs. The initial focus of this the kind discussed in the previous chapter) are literature was on the social aspects of adjust- in fact commonly found in sector adjustment ment (Cornia, Jolly, and Stewart (eds.) 1987), operations, as noted below. Resource use, and but concern for the environmental implica- therefore the environment, may also be af- tions of adjustment soon followed. fected via the income distributional conse- Although generally aimed at achieving quences of adjustment measures. These in- macroeconomic stability and reducing domes- clude reforms aimed at reducing aggregate tic and foreign debt, the side effects of adjust- demand, with special focus on public expendi- ment on the environment may be considerable, tures in key economic sectors such as agricul- and take a variety of forms. These include ture/forestry, energy, and industry, or, more changes in incentives governing resource use typically, the social sectors (education and and conservation which may stem from eco- health). nomic reforms affecting the relative prices of The linkages between economic policy and macroeconomic or sectoral variables. Included the environment become increasingly complex in this category is pricing resources in accor- the higher the level of decisionmaking, and dance with full economic costs, removal or the more pervasive the effects of changes in reduction of subsidies for agricultural and policy. This is exemplified by the various industrial inputs, and reduction in trade barri- routes by which economic policy impacts ers. These changes may also stem from insti- upon incentives at the sector level, as illus- tutional reforms, such as the privatization of trated in the previous chapter. The adjustment public enterprises, the distribution of forest process, therefore, might be expected to exert concessions, or the promotion of land titling. an even more circuitous influence upon re- 48 VOLUME I source use, and therefore, by definition, upon tion, reduction of government subsidies, or the environment. This is consistent with energy pricing reforms-will affect a range of findings regarding the influence of the macro- environmental issues. economic context for agriculture, as shown by The results would also be useful from the the classic studies of Johnson (1973) and viewpoint of environmental policymakers, Schuh (1974). More recently Krueger, Schiff, such as officials charged with preparing the and Valdes (1991) have compiled detailed national environmental action plans. For them, country examples suggesting that economy- the key question is which of a bewilderingly wide factors may in fact be more important wide range of economic policies (current or than sectoral policies in agriculture. These proposed) would substantially affect a high- studies point out that when a broader assess- priority environmental issue. Certain types of ment perspective is adopted, direct output policies can be expected to exert an impact price interventions by government often have upon particular environmental issues (Table less effect on agricultural incentives than 4-2). For example, if air pollution is a major indirect, economywide factors, such as foreign concern, then the relevant policy would in- exchange rates and industrial protection poli- volve energy prices; for deforestation, foreign cies. exchange and agricultural price policies; for Some of the complexities in identifying water availability and quality, domestic price relationships between economic policies and policies; and for energy efficiency, trade and the environment are illustrated in Table 4-1, exchange rate policies that influence interna- the first column of which lists a number of tional fuel prices. However, while there is strategic policy areas. The policy reforms in reasonable consensus that relationships exist, the second column are usually designed to their precise nature and even their direction is address these issues, with the specific eco- usually much less clear. nomic development objectives or direct im- pacts in the third column. Examples of General Equilibrium Approaches second-order, unanticipated impacts are listed in the last column. It will be noted that the Ideally, the impact of the adjustment pro- environrmental effects could be either positive cess on the environment would be addressed or negative. To properly evaluate such re- by considering not only the immediate, first forms, therefore, possible tradeoffs between round effects, but the subsequent their contribution to conventional develop- consequences of feedbacks. In short, a general ment objectives and their environmental equilibrium approach would be desirable. effects will need to be assessed. Relevant Indeed, the systems effects that characterize modifications-to prevent or reduce negative relationships between economics and the effects or to augment potential environmental environment has prompted a growing interest benefits-can then be analyzed for each pol- in the use of computable general equilibrium icy. (CGE) models which attempt to take account In a country specific context, a more de- of both behavioral and physical variables. tailed matrix based on Table 4-I would be CGE models can be useful by capturing the very useful from the viewpoint of macroeco- market failures which lead to environmental nomic and sectoral decisionmakers, especially problems, thereby providing policymakers those involved in national economic planning with an indication of the direct and indirect in the ministry of finance, ministry of plan- effects of their policies. Additionally, they ning, or key sectoral ministries. For them, the might help to provide the structure within crucial question is how a specific economic which national income accounting and envi- policy-such as devaluation, price liberaliza- ronmentally aware policy analysis could be performed. 4. Macroeconomic Policy and the Adjustment Process 49 Early applications of CGE models to envi- Neoclassical macroeconomic models usu- ronmental concerns were undertaken in indus- ally incorporate capital and labor inputs in trial countries. Alfsen, Glomsrod, and Hanson production sectors, generally ignoring the role (1987) incorporated environmental compo- of natural resources. In the Philippine CGE nents in a multisectoral growth model of model, land inputs were included to allow an Norway. The Central Bureau of Statistics of assessment of land use changes associated Norway has also used a CGE model in con- with policy reforms. Simulations with the junction with an emissions forecasting model. model concluded that reforms to improve Various types of emissions are analyzed (e.g., access to agricultural lands could contribute to carbon dioxide, sulfuric oxide), together with reducing population pressures on forest lands four processes: stationary combustion, mobile by increasing labor absorption in lowland combustion, process, evaporation. In this farms. Other simulations indicated that do- modeling work, the CGE model is run and mestic resource mobilization based on in- then the environmental impacts are calculated. creasing resource rent and energy taxes could Other modeling work in developed coun- lead to significant "win-win" outcomes. This tries include a study on energy and economic could reduce the balance-of-payments deficit growth in Sweden by Lars Bergman (1989). and expand employment, while controlling Sherman Robinson (1990) constructed a CGE environmental degradation. model with an explicit pollution component, Another early modeling effort was under- but utilized only hypothetical data. The ap- taken by Panayotou and Sussangkarn (1991) proach included putting pollution and abate- for Thailand. This utilized a ninety-sector ment results from the CGE model into a social CGE macroeconomic model, using as a data- welfare function, which was then optimized in base a Social Accounting Matrix (SAM) of a nonlinear programming model (with the the Thai economy. Five structural adjustment- CGE equations serving as the constraints). type policies were simulated, namely a reduc- CGE models have been increasingly used tion in export taxes on rice and rubber; an over the last fifteen years in addressing prob- increase in domestic oil prices; an increase in lems in developing countries. Recently, their labor-intensive manufactured export growth applicability to environmental concerns has trend; an increase in tourism growth trend; also been explored. An early application was and a reduction in real public sector invest- by Cruz and Repetto (1992), which described ment. how postwar government policies in the The authors estimated that the increase in Philippines penalized lowland agriculture and agricultural production that would result from subsidized an increasingly inefficient indus- a reduction in export taxes, would lead to (a) trial sector. As a result, and compounded by intensification of rice production and hence rapid population growth, rural poverty wors- increased use of agro-chemicals; switching of ened and the capacity of the economy to land from upland crops to rice as well as absorb a rapidly growing labor supply severely increased investment in land improvement and lagged. The onset of the economic crisis in the soil conservation; and (b) extensification of early 1980s and the contractionary nature of rubber cultivation onto higher slopes and the stabilization policies intensified poverty consequent deforestation and soil erosion. The and unemployment. The lack of livelihood increase in domestic oil prices would cause opportunities in lowland agriculture and GDP to decline in all sectors, but there would industry stimulated to the migration uplands, be a reduction of energy-related emissions due accelerating the deforestation of upper water- to energy efficiency and conservation, and a sheds. shift at the margin from more energy-intensive to less energy-intensive activities. 50 VOLUME I The increase in labor-intensive manufac- better partial equilibrium models. These will tured growth trend would have both negative serve as the building blocks required for and positive environmental impacts. Labor- improved understanding of economy-environ- intensive industries tend to be more intensive ment linkages. In other words, a general equi- in local natural resources, and may intensify librium approach, based upon partial equilib- depletion. Some labor-intensive industries rium models, is, given the state of the art and such as tanneries and slaughterhouses would the lack of information, the appropriate strat- lead to increased water pollution. As labor is egy in most countries. attracted out of services, an increase in wastes In the case studies described in Volume II, and emissions may occur. However, attracting the Costa Rica and Morocco studies do apply labor out of agriculture could lead to reduced a CGE modeling approach, but most of the deforestation rates, and a move away from other studies done to date use a partial equilib- heavy industry would reduce atmospheric rium approach. The ones that are mentioned pollution. For the most part, increased tourism below also tend to emphasize certain aspects would lead to destruction of coastal lands, and of the adjustment process or macroeconomic an increase in marine and air pollution policy on the environment, most of them (through increased energy use). However, a being restricted to a particular sector or shift to less erosive high-value crops such as subsector, and addressing a specific determi- fruit and vegetables would be environmentally nant of environmental behavior, such as insti- beneficial. The model indicated that the envi- tutional factors, poverty and income distribu- ronmental impact of a reduction in real public tion, or debt and trade issues. sector investments would be an increase in natural resource depletion, forest encroach- Institutional Aspects ment and agricultural pollution. There would of Economic Reforms be a reduction in urban and industrial pollu- tion since these sectors would shrink. A number of studies have attempted to The quantitative results of this exercise trace through the effects of the adjustment clearly should be interpreted with great care. process at the sector level, emphasizing the Data problems are pervasive, not least because importance of institutional factors. One of the much of the data went back to 1984. Since earliest was a study of policy reform and then there has been a period of extremely natural resource management in Sub-Saharan rapid economic growth in Thailand, during Africa (Stryker et al. 1989). The study evalu- which all parameters have doubtless changed ated the stabilization and structural adjustment significantly. However, this important effort prograrns adopted by Sudan in 1978, with highlights the kind of information needed to respect to implications for deforestation. The be able to anticipate with any accuracy the structural adjustment program included the environmental consequences of policy reform. liberalization of foreign exchange transactions Of particular relevance for our purpose, and a devaluation of the exchange rate. These however, is that in the Philippines and Thai- were combined with other measures such as land studies the parameters linking economic the removal of price controls and the removal variables and their environmental impacts, as of consumer subsidies and were aimed at well as the economic impacts of environmen- increasing production of cash crops (particu- tal change were not integrated into the macro- larly cotton). economic model. The difficulty of generating The study considered various implications the data needed for explicitly incorporating of these reforms on forest resources. The first environmental processes in CGE models effect would be land clearing and this would suggests that the priority now is to develop directly result in forest depletion. Second, if 4. Macroeconomic Policy and the Adjustment Process 51 crops such as cotton were grown without practices as a response to higher prices. adequate fertilization, soil erosion and fertility It is clear from Stryker's work that while depletion would increase, thereby adding to price-related changes are of great significance, the problems caused by deforestation. Third, they do not work in a vacuum. Their eventual the removal of subsidies on petroleum would impact depends upon a host of other factors, lead to increased demand for wood as fuel not least of which is the institutional structure substitutes, limiting the effectiveness of poli- within which they operate. Examples include cies to protect forested areas. Finally, cuts in the problems caused by insecurity of land government expenditure were expected to tenure which reduces the incentives for re- reduce funding of forest protection and refor- source conservation, or inequitable access to estation programs. land, which worsens population pressure on The authors do not arrive at definitive marginal resources, leading to deforestation conclusions about the impacts of these poli- and soil erosion. cies that result from structural adjustment The direction of changes in resource use programs. However, they support implementa- will depend to a large extent on the nature of tion of direct measures being pursued by the intervening institutional factors. Thus, there is Sudanese Government to address the potential no simple relationship between price-related environmental problem. Within the forestry policy reforms and the environment. For sector itself, these measures include restricting example, if potential economic returns fron the rate of commercial exploitation and en- crops increase, this will lead to increased couraging replanting and agro-forestry. With cropping activity and therefore more land respect to the intersectoral fuel aspect, they exploitation. The implication for land conser- propose government-sponsored programs to vation, however, will be very different, de- improve the allocation of fuel supplies. pending on whether croplands are protected by The study also looked at the reform process secure rights or not. In the first case, increased in Senegal and the implications for irrigation potential returns may lead to parallel invest- management. In this case, it was expected that ment in the land resource. However, in the the shift in decisionmaking towards a greater second case, improved crop prices will result role for irrigation associations and individual in "mining" the land resource or in opening up farmers, would improve irrigation manage- new lands for cultivation, regardless of the ment, and limit problems of oversalinity and implication for declining productivity. waterlogging caused by current practices. A number of other studies have recognized In Nigeria, the study considered the poten- the environmental relevance of institutional tial environmental impacts of the structural factors, an important example being the work adjustment program undertaken in 1986. The of Perrings et al. (1988) on the problem of policy reforms-currency devaluation and overgrazing in Botswana. This study demon- trade liberalization-were associated with strates that the lack of clearly defined property increased prices of most agricultural products, rights resulted in individual herders putting as in particular internationally tradeable ones. many cattle as possible on the range, leading Most subsidies were removed. Although to overgrazing, bush encroachment, erosion fertilizer subsidies were retained, budgetary and local desertification. constraints did not allow for adequate financ- Cruz and Gibbs (1990) analyze the problem ing, and market prices rose steeply. Small of population pressure on forest lands in the farmers were affected the most. Nevertheless, Philippines and Nepal. They propose that lack the authors conclude that the reforms will of secure property rights and the presence of have a positive impact overall as farmers will substantial population pressure on marginal be encouraged to invest in soil conservation resources require that policy reform efforts 52 VOLUMEI should also attempt to modify the rules gov- An early study of Thailand illustrated the eming access to and use of natural resources. importance of complementary measures to Development agencies have also increas- ensure that successful economic growth poli- ingly been challenged to respond to the need cies do not conflict with environmental objec- for institutional reform in the interest of envi- tives.3 For example, in the absence of clear ronmental goals (Holmberg 1991). A study by delineation of property rights, increased incen- the United Nations Economic Commission for tives induced farmers to overexploit fragile Latin America and the Caribbean (ECLAC) lands; while industrial growth, unaccompa- focused on the role of land concentration nied by adequate regulatory or economic issues and the environmental implications of instruments, was associated with major envi- the debt crisis in Latin America (ECLAC ronmental damage. Although the quantitative 1989). In this study, concentration of agricul- results of this exercise should be interpreted tural land is identified as a factor leading to with care (because of data constraints), they income inequality and pressure on marginal make a useful contribution and, in agreement resources, even in areas where physical popu- with others, highlight the kind of information lation densities are not excessively high. needed to be able to anticipate with greater Other studies have recognized how institu- accuracy, the environmental consequences of tional factors can interact with the effects of policy reform.4 price changes. For example, open-access Finally, institutional change at its most overexploitation of fishery resources results dramatic-involving massive changes in the from the absence of property rights that allows whole system of incentives countrywide-is anyone to harvest the resource. Since individ- currently under way in both Eastern Europe ual resource users cannot benefit from con- and China. As the above studies suggest, the serving such open access resources, the ratio- assessment of the impact of economic incen- nal choice is to harvest as long as average tives in isolation from institutional returns from fishing are positive. This same change-or vice versa-would be a totally overfishing situation will result even if there artificial exercise. were secure fishing rights, if discount rates are extremely high (Clark 1976). In Cote d'Ivoire, Income Distribution, Poverty, the effects of government pricing policies and the Environment were believed to have led to deforestation, but to a lesser extent than the lack of a consistent Two specific distributional concerns have and secure land tenure system (Reed (ed.) arisen with regard to the adjustment process. 1992). The first focuses on the decline of environ- Lopez (1991) directly addresses the interac- mental services associated with the govern- tion between the effects of price changes and ment spending cuts mandated by many stabili- the institutional factors governing resource zation and adjustment programs. The second ownership and management in Cote d'Ivoire. deals with the more general relationships Using both household economic data and between adjustment reforms and their impact remote sensing information on agricultural on poverty and the environment. and forest resources, Lopez finds that in- The early view of the environmental impli- creased output prices may contribute to pres- cations of the distributive impacts of sures for agricultural extensification. How- adjustment-related reforms paralleled con- ever, if producers have secure tenure and can internalize the implications of excessive resource exploitation, these pressures can be 3Panayotou and Sussangkam 1991. significantly reduced. 4Devarajan 1990; Robinson 1990. 4. Macroeconomic Policy and the Adjustment Process 53 cerns raised about the social impacts of adjust- funding of environmental activities. Recent ment. Since the 1970s, the redistribution of case studies attributed increases in air pollu- wealth and the recognition of the importance tion problems in Thailand and Mexico to of fulfilling basic human needs, was given reductions in expenditures for adequate infra- increasing currency among international structure (Reed (ed.) 1992). development agencies, and reflected in World While the argument that government cut- Development Report 1980.5 The 1960s em- backs undertaken as part of adjustment auster- phasis on economic growth as the key to ity efforts may undermine the funding for development and poverty reduction had given environmental initiatives sounds a reasonable way to the view that more direct poverty one, empirical assessment of its actual impor- programs and investments in human resources tance is difficult. Decomposing government were crucial in any attempts to address pov- expenditures to shed light on what constitutes erty.6 environmental activities is not feasible with- Concern with the social aspects of adjust- out a major data-gathering and interpretation ment was motivated by the apprehension that exercise. In one effort that was undertaken to adjustment programs being implemented by assess the social consequences of adjustment the IMF and the World Bank would revert to lending in Africa, it was found that although a growth focus, at the expense of distribu- there have been declines in government ex- tional objectives. Its predominant focus was penditures, the budget proportion going to how reform programs had failed to protect social expenditures and agriculture actually social expenditures as fiscal austerity was increased during the adjustment period.7 imposed to stabilize the economy. This meant The results of studies focusing on social that the poor, who would be most vulnerable safety nets during adjustment programs con- to the effects of macroeconomic contraction, firm that pursuing fiscal discipline and macro- would also be deprived of "safety nets" as economic stability need not take place at the social services were cut. cost of increased hardship for the poor. In Similarly, the early adjustment and environ- much the same way, specific environmental ment literature focused on cuts in government concerns can be incorporated in stabilization spending and their implications on environ- efforts. For example, it has been reported that mental protection services. For example, a in many countries in Sub-Saharan Africa, study undertaken by ECLAC (1989) con- forestry departments and their activities have cluded that adjustment policies pursued in always been severely underfunded.8 Thus, Latin America in the 1980s led to cutbacks in targeted efforts to support forestry manage- current expenditure allotments for managing ment activities could, with reasonable cost, be and supervising investment in sectors such as included in reform packages as part of a energy, irrigation, infrastructure, and mining. proactive environmental response. In brief, This limited the funds available for environ- both critical environmental and social expen- mental impact assessments and the supervi- ditures could be protected if government sion of projects to control their environmental budget cuts are made judiciously. impacts. Muzondo and Miranda (1991), in an Emphasis has recently shifted to another IMF survey, recognized this problem and mechanism through which distributive poli- suggested that high levels of government cies might affect the environment. Thus, expenditure in other areas had led to reduced widespread poverty in conjunction with rapid 5World Bank 1980. 7World Bank 1994a. 6See Cornia, Jolly, and Stewart (eds.) 1987. 8Stryker et a]. 1989. 54 VOLUMEI population growth has been linked to increas- (Reed (ed.) 1992). In another study, using ing pressure on marginal agricultural econometric models with cross-country defor- resources. (See Box 4-2, Poverty and the estation data, no consistent statistical relation- Environment.) For example, Cleaver and ship was found between debt and forest deple- Schreiber (1991) identify this poverty, popula- tion (Capistrano and Kiker 1990). tion, and agricultural extensification nexus as In fact, many factors are at work, and pri- the critical environmental challenge for Sub- mary commodities such as timber exports do Saharan Africa. Since unemployment and not exhibit any simple trend during the debt poverty may be exacerbated by short-term crisis and adjustment periods. For example, in contractionary effects of stabilization pro- the early 1980s, primary commodity exports grams, there will correspondingly be impor- were subject to falling international commod- tant implications for population pressure on ity prices. Thus, production, domestic absorp- marginal resources. Moreover, Cruz and tion, and price effects need to be assessed for Gibbs, as noted above, also show that in specific commodities and countries (Reisen addition to inadequate economic policies, and Van Trotsenburg 1988). Indeed, since the poverty, population growth, and institutional debt crisis was associated with falling export factors all conspire to threaten sustainable prices and domestic economic contraction for environmental management in the Philippines. many developing countries, it would not be unreasonable to expect that in some countries Debt and the environment the rate of resource extraction, instead of increasing, would have actually declined Theoissed ow igh lievpels of d ofen during this period. Ultimately, what really asctbudgetdefwithustained periodsofngov matters is what debt is used for. Ideally, coun- ment budget deficits, and macroeconomic cainta h instability) and its implications for environ- tries go into debt with the expectation that the mental degradation have frequently been benefits from the productive activities to be raised. For example, the Brundtland Report funded will more than pay for the loan. In (WCED 1987) noted that: debt that cannot be practice, projects that are funded by external debt may be unsuccessful. Worse the capital amortized forces raw material-dependent myb ietdt te ss n h onr countries in Africa to deplete their fragile may be diverted to other uses, and the country counriesin Aricato dplet ther frgile is left with accumulated debt, and little eco- soils, with the result that good land is turned ic improvemen to bho for it.lInethe into desert. The perception was that many nonmentalmcntet, debt-for-nture countries reacted to the external shocks during the economic crisis years of the early 1980s by Jects represent an effort to directly channel exploiting natural resources unsustainably. debt (or in this case its converse, debt relief) However, evidence from country case studies to beneficial environmental activities. In . . . ~~countries, such as Costa Rica, debt relief and from cross-country statistical exercises ' programs have allowed environmental agen- cies to fund forest or biodiversity protection For example, a World Wildlife Fund report, .i.v. based on case studies for Cote d'Ivoire, Mex- anitiatives. ico, and Thailand, conclude the there is no direceHansen (1990) has also questioned the simpl reltionhip etwee extrnaldebt direct link proposed between natural resource slevelan ionment al det I .th degradation, specifically deforestation, and the levels and environmental degradation. In the detcii.Emlynbaimcreomc , . ~~~~~~~debt crisis. Employing basic macroeconomic case of Cote d'Ivoire the research team found analysis, Hansen points out that capital im- that although the country's deforestation rate ports out thatgcal im - was one of the highest in the world, external mnports could include technological improve- deb di no.fetevrnmnaerdto ments that would enable better management of *ingnot afoect in garticular the resource base, as easily as they could lead in general or the forestry sector in particular 4. Macroeconomic Policy and the Adjustment Process 55 Box 4-2: Poverty and the Environment The struggle to overcome poverty, daunting in itself is made more difficult in the face of increasingly apparent environmental constraints. A critical question for policymakers thus becomes whether the environmental aspects of poverty can be alleviated by modifying existing approaches, or if a wholly new strategy is required. A brief look at what is known about the reinforcing interplay of poverty and environmental degradation provides some clues. The Environment's Impact on the Poor Health problems. The poor are the most vulnerable in terms of exposure to certain types of pollution, such as unclean water that carries infectious and parasitic diseases. They (especially women and children) also suffer disproportionately from indoor air pollution that results from burning unclean, but accessible, bio-fuels. For example, smoke in household kitchens in poor rural areas of The Gambia, India, Kenya, and Nepal routinely have suspended particulate matter concentrations exceeding World Health Organization peak guidelines by four to five times. Lower productivity. Environmental degradation depresses the poor's income by diverting more time to routine household tasks such as fuelwood collection and by decreasing the productivity of the natural resources from which the rural poor are most likely to wrest a living. A study of Nepalese hill villages with severe deforestation concluded that time devoted to fuelwood collection was diverting nearly a quarter of household labor normally devoted to agricultural activities, resulting in income loss and declining consumption and nutrition levels. How Poverty Affects the Environment Constrained time horizons. The very poor, struggling at subsistence levels of consumnption and preoccupied with day-to-day survival, have limited scope to plan ahead and make natural resource investments (for example, soil conservation) that give positive returns only after a number of years. Such short time horizons are not innate characteristics, but rather the outcome of policy, institutional, and social failures. Constrained risk strategies. The poor's use of natural resources is affected by their facing greater risks, with fewer means to cope. These risks range from misguided policy interventions in input and output markets to evolving land tenure systemns that favor those with greater political clout. The rich array of traditional means for coping with crises-selling stored crops or goods, migration of household members, increasing wage labor, borrowing for consumption, calling on mutual assistance traditions or patron-client understandings-are often unavailable to the poor or are weakening as social norms. This means that the poor will have little choice but to overexploit any available natural resources. Moreover, the poor, especially the women, typically lack access to formal markets for credit, crop insurance, and informnation (for example, extension services) that provide advice on risk-reducing agricultural practices. Source: Mink 1993. to further exploitation of the natural resource amount was exceptionally large because of the base. He concludes that unless there were a unusual worldwide interest in Costa Rica's shift in domestic production to the forestry forestry and biodiversity resources, and the sector as a result of debt-servicing, or a shift process is probably not replicable in most to a more hazardous forest extraction technol- indebted countries. It also has been noted that ogy, there would be no automatic increase in some awareness-raising gains might follow deforestation because of the debt crisis. from such debt-for-nature campaigns (Pearce Regarding debt-for-nature campaigns, one and Warford 1993). However, such efforts of the most successful applications of this may not make any significant dent in the level strategy was in Costa Rica, where the govern- of outstanding debts for most countries. Fur- ment managed to purchase about US$70 thermore, the process does not directly address million of debt (5 percent of its commercial the critical need for policy and institutional debt) from debt-for-nature grants (World reforms in the resource and environmental Resources Institute 1989). However, this sector. 56 VOLUME 1 To directly address the policy relevance sector-specific distortions that encourage issue, Cruz and Repetto (1992) have proposed overexploitation. There should be better the more general link: debt, deficits, and recognition that macroeconomic reforms are resource degradation are all forms of asset being introduced and are affecting resource decline or increased liability, leading to deteri- use decisions in a context where there are oration of future income to maintain current long-standing incentive distortions. Clearly, consumption. Economywide policies and the impact of reform programs that alter incentive distortions, motivated by myopic macroeconomic prices will also be contingent macroeconomic objectives, are the common on existing distortions at the sector level. deterrninants of this process of declining national wealth. Trade and environment This perspective is consistent with the As noted by the 1992 World Development observed correlation between debt and degra- Report on development and the environment dation. More importantly it leads to fruitful presriptons or mcroconoic plicyre- (World Bank 1992k), the concern with envi- prescriptions for macroeconomic policy re- romnaiplctnsftadivlesbh forms. For example, resource accounts for the ronmental implications of trade ivolves both .. . .. ......................the domestic implications of policy reforms as Philippines demonstrate a general decline in well as the global environmental dimension of resource assets during the 1970s and 1980s. interational trade agreements. Although This was associated with the shortfall in liberalizing reforms generally promote more savings, low returns on investments, and the efficient resource use (including use of envi- continued increase in external indebtedness ronmental resources), in practice there is no that shifted resources to current uses at the clear-cut reason to expect that trade liberaliza- expense of future income. Tariff and exchange tion will be either good or bad for the environ- rate policies encouraged resource extraction rate policies encouraged resource extraction ment. The reason is that trade reforms may be and disinvestment in the primary production undertaken, but the presence of pre-existing sector, thereby reducing the sustainable yield market, policy or institutional imperfections in from the resource stock. Thus, macroeco- the environment sector may lead to adverse nonmiic policy variables are explicitly identified environmental impacts. The following discus- and linked to the general problem of myopic sion illustrates various environmental initia- economic management and the specific prob- tives that will be needed to complement re- lems of increasing national liabilities (from forms in the trade sector. debt) and decreasing assets (from degrada- Regarding national or domestic trade re- tion).eadgntlnlo oesl rd e Dn sh pforms, early concerns about negative effects Developing such policy relevant were raised regarding the North American approaches will require more research, espe- Free Trade Agreement tNAFTAr and pollu- cially in terms of constructing models and . . S tion in Mexico. Similar concerns Involved testing these against specific country experi- cassava exports and soil erosion in Thailand, ences. These efforts need to be coordinated and exchange rate depreciation and deforesta- with studies that are also being undertaken in . . v H several countries on two related themes. The tio in Ghana. However, more recently there firs reers o nturl reoure acouning As has been increased recognition that the links first refers to natural resource accounting. As btentaeadteevrnetaemc note earier,to cmprhendmacreconmic between trade and the environment are much more complex since economic expansion from trends in resource decline there is a need for a trade IS characterized not only by growth but macroeconomic measure of resource degrada- also by changes in the intersectoral composi- tion. Secondly, research on macroeconomic tion of output, in production techniques and policy-environment links also have to build on input use, and in location of economic activ- the results of studies that evaluate resource- or ity. 4. Macroeconomic Policy and the Adjustment Process 57 For example, if liberalized trade fosters expansion of cash crops, in fact, does not tend greater efficiency and higher productivity, it to reduce food production (Braun and Ken- may also reduce pollution intensity by encour- nedy 1986). This complementarity rather than aging the growth of less polluting industries competition has been observed in countries and the adoption of cleaner technologies. In where initial productivity is low and is partly Mexico, Grossman and Krueger (1991) con- explained by technology spillovers from cash clude that increased specialization due to crop activities that also enhance food crop NAFTA-related trade liberalization would production. result in a shift to labor-intensive and agricul- The more pressing question is whether tural activities that require less energy inputs these export crops displace forests. In Sudan, and generate less hazardous waste per unit of Stryker et al. (1989) found that trade and other output than more capital-intensive activities. adjustment-related reforms resulted in signifi- Similarly, in the Indonesia case study (Vol- cant deforestation because increased producer ume II), both pollution and energy intensity prices encouraged woodland clearing for crop declined due to such shifts. Pollution impacts cultivation. However, recent studies have probably declined as well, due to the disper- shown that in such cases, deforestation pres- sion of industry away from Java. However, the sures are due to prevailing distortions within rapid growth of the industrial sector in recent the forestry sector, such as very low stumpage years has also meant an increase in total pollu- prices or poor forest management capacity that tion in spite of reduced pollution intensities. are not corrected with the trade reforms. This needs to be addressed aggressively with Inadequate land tenure and land clearing as a a combination of regulations and economic requirement for tenure, prevent more efficient incentives. exploitation of existing agricultural lands, and On agriculture and forestry, contrary to have also contributed to the problem. For popular perceptions, a shift in cropping pat- example, in Cote d'Ivoire, the effects of price- terns towards export crops expansion does not related policies were believed to have led to necessarily imply increased erosion. Repetto deforestation, but to a lesser extent than the (1989), using examples for Sub-Saharan lack of a consistent and secure land tenure Africa, concludes that many export crops tend system (Reed (ed.) 1992). The Ghana study to be less harmful to soils. In West Africa, tree also analyzed the interaction between effects and bush crops are grown with grasses, and of price changes and the institutional factors erosion rates are 2-3 times less than similar governing resource ownership and manage- areas planted for locally used food crops such ment. Using both household data and remote as cassava, yams, maize, sorghum, and millet. sensing information on agricultural and forest In Malawi, Cromwell and Winpenny (1991) resources, the study found that increased crop found that adjustment led to changes in prod- incentives have contributed to pressures for uct mix and production intensity instead of deforestation. However, if producers had changes in cultivated area or production tech- secure tenure and could internalize the impli- niques. Soil improving crops were adopted cations of excessive land exploitation, these and agricultural intensification helped absorb pressures would have been reduced signifi- a rapidly growing population on less land. cantly.9 Also, contrary to popular belief, export crop With regard to the global environmental expansion has not generally occurred at the dimension of international trade, the debate cost of reduced food crop output, with subse- has revolved around the issue of whether freer quent potentially negative social and environ- trade is beneficial to global and national mental effects. However, in a study of 11 developing countries, it was found that rapid 9See the Ghana case study in Volume II. 58 VOLUME I environmental conditions and whether it gimes, regulations, management capacity) should be used to influence national and leading to conversion of forest land to agricul- international environmental standards and ture has played the larger role. In general, an agreements. Studies arising from a recent appropriate combination of domestic environ- General Agreement on Tariffs and Trade mental and agricultural policy measures, (GATT) symposium have concluded that combined with trade reforms, will result in expanding global production and consumption both welfare gains and in environmental does not necessarily cause greater environ- quality (Harold and Runge 1993). On the mental degradation (Anderson and Blackhurst international front, however, the challenge is 1992). Indeed, with appropriate ntational to initiate coordinated international action on policy reforms greater trade would generally domestic reform measures that will counter contribute to environmental gains. In the case the environmentally threatening scale effects, of coal, trade liberalization and the removal of because any country attempting to implement price supports in richer countries would re- domestic reforms in isolation will loose in- duce coal output, lead to higher international come and jobs to its neighbors. prices, and consequently decrease coal con- On the effect of freer trade with different sumption. This would be beneficial for the national environmental standards between environment. In the case of food production, North and South, an early view was that dirty the reduction of agricultural trade protection industries would migrate to poor countries, in rich countries would lead to a relocation of where environmental standards were either production to poorer countries, leading to less strict or nonexistent (Leonard (ed.) 1989). greater incomes, and reduced agricultural Recent work indicates that pollution abate- pollution in developed countries. In poorer ment and control expenditures by firms do not countries, it is recognized that the incentive to appear to have had a significant effect on produce more will probably increase fertilizer competitiveness in most industries since these and pesticide use. However, maintaining high expenditures represent a modest share of total levels of agricultural protection in rich coun- costs. For example, environmental costs tries is an inefficient way of protecting the generally comprise only .5 percent of output environment. value and only 3 percent for the most pollut- Domestic tax incentives and regulations ing industry (Low (ed.) 1993). Thus, environ- would be a better way of lirniting environmen- mental costs are not the dominating factor in tal degradation. (Anderson and Blackhurst decisions for locating new industrial invest- 1992; Lutz 1992). The same general conclu- ments. In fact, trade openness which may sion is reached in recent studies on bio- promote newer technologies may tend to have diversity and forestry. For example, the over- positive environmental effects since most new exploitation of biodiversity and wildlife for technologies are also cleaner (Birdsall and international trade plays a minor role in spe- Wheeler 1992; Huq and Wheeler 1993). cies extinction since the major cause is habitat These findings also suggest that there is no destruction (Burgess 1991). Thus, attempts to pressing reason for requiring national environ- ban wildlife trade will have limited benefit mental standards to be made identical. Pat- plus large cost; proper trade mechanisms such terns of resource exploitation and pollution are as taxes and subsidies would be better at primarily affected by economic and social encouraging conservation. With respect to conditions, with environmental regulations or global deforestation, Barbier et al. (1991) standards (especially in poor countries) play- found that the timber trade has not been the ing a minor role. Promoting acceptance of major source of deforestation. The domestic similar environmental principles, such as factors (distorted prices, subsidies, tax re- requiring that polluters pay for the damages 4. Macroeconomic Policy and the Adjustment Process 59 Box 4-3: Environmental Concerns and Adjustment Lending For many years now, the World Bank has advocated integrating environmental concerns into economic reforms, and as a recent study shows, the rhetoric is being translated into action. A review of Bank adjustntent lending operations over the period FY88-FY92 found that about 60 percent of the sampled loans explicitly included environmnental goals or loans conditionalities addressing environmental concerns in agriculture, forestiy, energy, trade, and industry. This was up sharply from only 37 percent during the FY79-FY87 period. Moreover, the recent loans encompassed a much wider range of policy instruments or sectoral strategies (e.g., from energy and resource pricing reforms to institutional capacity building). For the study, the Bank selected 81 loans, which represented about 65 percent of total adjustment lending during the FY88-FY92 period. This included 47 structural adjustment loans and 34 sectoral adjustment loans in 58 countries spread throughout the developing world. The rest of the loans were excluded, because they were mostly financial sector adjustment programs considered to have no direct-or traceable-implications for the environment. One caveat, however: It is important to note that such lending operations have specific, fairly short-run objectives, and the loans are meant for rapid disbursement. While environmental objectives can, and increasingly are, built into loan conditions, there are many other environmental goals that require long-term institutional and capacity reform and for which adjustment lending is not an appropriate instrument. Source: Warford et al. 1994. they inflict or incorporating environmental mental issues. The paper stresses that in ad- values in cost-benefit analysis, will probably dressing the linkages between adjustment be more effective as well as politically more lending and the environment, it is important to acceptable. bear in mind that such lending operations have Further work in this field should include specific, fairly short-run objectives in mind, efforts to establish more clearly (a) the condi- and the loans are intended for rapid disburse- tions leading to intensification as opposed to ment. The following assessment indicates that extensive land use at the agricultural frontier; while environmental objectives can, and (b) the extent to which pollution from indus- increasingly are, built in to loan conditions, trial growth may undermine declining pollu- there are many other environmental objectives tion intensity effects from trade reforms; and that require long-term institutional and capac- (c) whether trade measures should be resorted ity reform and for which adjustment lending is to as "second best" policies when international a singularly inappropriate instrument. coordination on removal of domestic distor- The adjustment process is facilitated not tions fail. merely by adjustment lending operations, but also by the whole range of sector and project World Bank Adjustment activities in which the Bank, other develop- Lending Operations ment agencies and, of course, the countries themselves are engaged. In fact, many of the The World Bank has for several years policy reforms contained in the adjustment advocated the integration of environmental process-particularly in sector adjustment concerns in economic reforms as a key prior- lending-are far from new. Reforms, such as ity, and has made significant steps in building rationalization of electricity pricing or re- this into its own operations. A World Bank moval of subsidies for pesticides, have been paper (Warford et al. 1994) examines the standard elements of project and sector lend- relationships between the adjustment process ing for many years. Whether they have been and the environment and, in particular, about related or not to adjustment lending, macro- the extent to which World Bank adjustment economic dialogue as well as lending and lending activities adequately address environ- policy work in a variety of sectors-ranging 60 VOLUME I from energy to population-may have pro- However, it is important that those responsible found impacts not only upon the adjustment for economic and sectoral management should process but also on the environment. be aware of the nature of the linkages between During the early to mid-1980s, environ- these variables. They should be prepared to mental issues were limited considerations in take appropriate measures either to use the adjustment lending, although there were often leverage of such policies to bring about perva- potential complementarities between adjust- sive environmental improvement, or at least ment policies and environmental objectives. In be prepared to take compensatory measures to the last several years, by contrast, adjustment avoid potentially adverse social or environ- programs include more than just a nominal mental consequences of those policies. treatment of the environment. Environmental In conclusion, while critics may have been issues have become an important aspect in correct in the past about how the environment adjustment lending by the Bank. (Refer to Box was not being systematically integrated into 4-3.) There are now more adjustment loans World Bank adjustment lending, that is cer- with components or conditionalities that are tainly not true now. Even in the past, when openly environmentally motivated. Indeed, there was limited concern over the environ- environmental programs have in some cases ment, the resulting neglect was not necessarily been the primary objective of adjustment bad. On the contrary, good economics, partic- operations. ularly as it emphasizes efficient use of re- This assessment of the evolution of adjust- sources, is often good for the environment too. ment is at odds with the criticism that adjust- As this review has stressed, there remain, due ment operations ignore environmental con- in large part to government policy failure, cerns. On the contrary, adjustment is a neces- many opportunities for policies that satisfy sary, if not sufficient, condition for sound both economic and environmental objectives. environmental management. Certainly stabil- It should continue to be a primary strategic ity, "getting prices right," and public sector objective of individual countries as well as of reform have virtually unambiguous-and development institutions such as the World beneficial-impacts on the environment. Bank to search out such opportunities, and to Trade reform, in enhancing efficiency and give them priority in their investment pro- employing the principle of comparative ad- grams, and institutional and economic policy vantage, will also tend to do so. In each case, measures. however, there may be unanticipated effects, which require complementary or compensa- Conclusion tory interventions. This might be especially apparent in the case of trade policy: encourag- Most of the work referred to in this chapter ing exports, if not accompanied by adequate has focused on the relationship between spe- pricing or institutional policies in the country cific adjustment-related reforms and the envi- concerned, could lead to overexploitation of a ronment. This experience demonstrates that natural resource, such as forest products. there is an important interface between However, freer trade itself would not be the economywide policies and the incentives culprit, but failure to address the "second governing natural resource use. However, best" conditions prevailing elsewhere in the more work needs to be done to weigh the economy would be. implications of these links and to design It is recognized that environmental prob- effective policy modifications or alternatives. lems and their solution tend to be location- This will typically require a distinction to be specific and heavily dependent upon the made between (a) the short-term stabilization prevailing culture and physical environment. components and (b) the longer-term incentive modifying aspects of adjustment programs, 4. Macroeconomic Policy and the Adjustment Process 61 since these categories of reform tend to differ or intersectoral issues, and in particular, the in their environmental implications and there- influence of site-specific physical, institutional fore call for different remedial actions. and cultural variables, need to be explicitly The short-term effects work primarily considered. Adjustment programs, insofar as through the aggregate demand contraction they advocate economywide reforms that associated with stabilization efforts. These remove distortions from inappropriate macro- effects may substantially differ from the ef- economic policies, are needed in many devel- fects of longer-term changes that modify oping countries. However, when there are production incentives for resource use and major environmental externalities involved or pollution. For example, a reduction in govern- when sectoral government or institutional ment expenditures or increased unemployment distortions exist for specific resources, it is not from contractionary policies may increase clear that better macroeconomic prices will deforestation pressures through the poverty lead to more efficient resource use. For exam- route. However, contractionary policies will ple, in the case of forestry higher export prices also reduce domestic absorption and may from adjustment efforts couple with continu- therefore decrease deforestation from com- ing sectoral timber underpricing constitute the mercial logging. By contrast, reforming the main ingredients for more deforestation. This structure of incentives may have longer-term means that for this class of adjustment-envi- implications for various sectoral activities that ronment linkages both macroeconomic re- differ from the short-term effects. An example forms and sector-specific aspects will need to of these longer-term effects is how foreign be considered. exchange liberalization will generally expand While the studies and experience reviewed the traded goods sector, thus encouraging above tend to reinforce the general notion that resource-based exports such as timber. economic policy is a potentially important tool The modifications to adjustment programs to be used in environmental management, it in response to the short-term negative environ- also suggests that generalizations are difficult mental effects of stabilization are conceptually to make. What may appear to be identical more straightforward-though not necessarily policy reforms may have dramatically differ- easier to implement. The contractionary ef- ent impacts in different situations, depending fects of adjustment, although they can clearly on such things as the prevailing institutional increase unemployment and poverty, are arrangements, prices of other goods, and the sometimes justified on the argument that physical and cultural environment.' Policy excessive inflation or loss of international reforms that might intuitively be expected to credit are far more costly. However, there is be environmentally benign, may in fact have growing recognition that unemployment and the opposite result. Increased prices of com- poverty can be directly addressed by targeted mercial energy might stimulate overuse of programs and changing the emphasis on biomass and deforestation; reducing pesticide stabilization instruments can additionally subsidies may also reduce the production of cushion indirect social costs. (See, for exam- otherwise environmentally benign crops, and ple, Blejer and Guerrero 1990.) Environmen- so on. tally oriented modifications could mostly The evidence produced so far is fragmen- parallel these changes that have been proposed tary and incomplete, and it is necessary at this to reduce the short run social costs of adjust- stage to produce more case material to illus- ment. trate the range and nature of the interrelation- The required response to the environmental ships between countrywide (macroeconomic implications of longer-term incentive changes are more complex. For these reforms sectoral '"World Bank 1989c. 62 VOLUME I or sectoral) policies and the environment. raising living standards, particularly in light of Such case material should involve more atten- the high population growth rates in the poorest tion than in the past to the importance of other countries, is immense. So is the gap between (noneconomic) variables influencing out- rich and poor. The prospects for continued comes, as well as explicit attention to the economic development will rest heavily upon policy choices. Thus, after all "no regrets" human capacity to adapt to natural resource options have been exhausted, environmental depletion, on technical progress, and the measures may conflict with other legitimate ability to substitute natural for human-made objectives-growth, development, poverty capital. A major challenge for economists is to alleviation-case studies are required in develop strategies that smooth the transition to which economic policy and the environment a sustainable society, by means of policies are placed firmly in an overall development which satisfy both short-term economic objec- context. tives and which are also environmentally Finally, it will be observed that this book benign. Clearly, economic policy instruments does not consider the implications of growth will be indispensable means of restricting itself for the environment. Clearly some im- wasteful, environmentally destructive use of provement follows increased income per resources. In this sense, reconciling sound capita. However, there are reasons to doubt, as environmental management with economic Herman Daly constantly reminds us, the adjustment is essential. feasibility of sustainable economic growth into the indefinite future."' The challenge of "See, for example, Daly and Cobb 1989. 4. Macroeconomic Policy and the Adjustment Process 63 Table 4-1: Critical Environmental Links for Economic Planners Direct Objec- Indirect (Environmen- Policy Issues Policy Reforms tivestEffects tal) Effects 1. Trade deficits Flexible exchange Promote exports; re- Export promotion may rates duce imports lead to more deforesta- tion for export, but it could also lead to sub- stitution of tree crops for annual crops. In addition, industrial job creation may reduce pressures on land re- sources 2. Food security and Agricultural intensifi- Increase crop yields May reduce spontane- unemployment cation in settled lands and acreage; absorb ous migration to eco- and resettlement pro- more rural labor logically fragile areas. grams for new areas However, there is po- tential for overuse of fertilizers and chemi- cals 3. Lack of industrial Reduction of tariffs Promote competition More openness may competitiveness and special incentives and industrial effi- lead industry to adopt ciency more energy-efficient or less pollution-prone technologies. How- ever, it may also lead to influx of hazardous industries 64 VOLUME I Table 4-2: Critical Economic Policy Linksfor Environmental Planners Resource / Environ- mental Management Issue Sectoral Economic Characteristics Relevant Policy Reforms 1. Agricultural expan- Many small, competitive decision- Reduction of taxes and subsidies sion and deforestation makers are involved Exchange rate and trade reforms Outputs, inputs are mostly interna- tionally traded Poverty and income distribution policies Government implemrents substantial production subsidies and trade inter- Property rights reforms vention 2. Water depletion and Supply side is dominated by govern- Intersectoral pricing degradation ment or monopolies; bulk of re- source use goes to large commercial Reduction of subsidies and intro- enterprises and irrigation systems duction of charges for resource degradation Resource is not internationally traded but sectoral use and produc- tivity for main user groups substan- tially differ Prices are highly regulated 3. Energy use and air As with water, supply side domi- Exchange rate reforms pollution nated by government and monopo- lies Reduction of cross-subsidies Inputs (coal, oil) are generally Privatization programs for generat- traded; output broadly linked to all ing and distribution activities production activities Sectoral investment and pricing highly centralized 5 Linkages Between the Environment and Economywide Policies: Recent World Bank Experience THIS BOOK FOCUSES ON THE ENVIRONMENTAL IMPLICATIONS of economywide policy reforms undertaken at the sectoral or macroeconomic level. Economywide policies involve a variety of economic instruments, ranging from pricing in key sectors (for example, energy or water) and broad sectoral taxation or subsidy programs (for example, agricultural production subsi- dies, industrial investment incentives); to macroeconomic policies and strategies (exchange rate, interest rate, or wage policies; trade liberalization, privatization, and so forth). Economywide policies are packaged often within programs of structural adjustment or sectoral reform, aimed at promoting economic stability, efficiency and growth, and ultimately, human welfare. 65 66 VOLUME I Our focus is on the linkages between eco- The studies themselves reflect a wide range nomic policies and the environment; other key of country situations and environmental prob- social objectives like popular participation, lems. Thus pollution issues are addressed with empowerment and the rights of indigenous reference to industrial pollution in Poland. peoples fall outside its scope. Nevertheless, Environmental aspects of energy use are the generic findings and approach presented addressed in the Sri Lanka case. A variety of here could be useful also in systemically natural resource related issues are covered in identifying some of the underlying economic the other studies: deforestation and land and environmental causes of a wider range of degradation in Costa Rica, deforestation in the social, institutional and legal impacts, and Philippines, degradation of agricultural lands therefore suggest directions for policy reform. due to overgrazing in Tunisia, fertility losses Although macroeconomic and sectoral due to extension of cultivated areas in Ghana; policies are typically not directed explicitly water resource depletion in Morocco; and towards influencing the quality of the natural wildlife management in Zimbabwe. Some of environment, they may, nonetheless have the examples mentioned in this chapter are major impacts upon it, either positive or summarized more extensively in Chapter 6 of negative. This chapter provides evidence from this book and Volume II. a number of studies to indicate that there are The case studies utilize a variety of analyti- significant payoffs in attempting to better cal methods to illustrate the different ap- understand such impacts and to act upon them. proaches available for identifying the environ- Positive impacts of economywide reforms on mental implications of economywide reforms. the environment can be used to build constitu- These methods range from those tracing the encies for reform. Potential negative impacts links between economic incentives and re- need to be analyzed, monitored and mitigated. source use through direct observation, to In some instances the direction of environ- others relying on more complex economic mental impact stemming from economywide modeling of policies and their environmental policy reform is fairly straightforward. The effects. In all the studies, however, the analyti- extent of the impact, however, invariably cal approach uniformly requires identifying requires empirical analysis. In more complex key environmental concerns and relating these cases, even the direction of the impact is to the agenda of priority sectoral and macro- ambiguous. In view of their location-specific economic reforms under consideration. The nature, and the complexity of economic, analysis underscores the formidable difficul- physical, ecological, institutional and cultural ties of developing a general methodology to variables involved, there is a clear need for trace all possible environmental impacts of a more case study material to enhance our package of adjustment reforms and until understanding of these relationships. recently there has been relatively limited Building upon the experience of previous empirical work on this subject.' Nonetheless, work, this chapter reviews some recent experi- the case studies offer evidence that careful ence in the World Bank in this regard. Such case-specific empirical work may help identify experience has been obtained both from lend- better ways to deal with potentially serious ing operations and sector studies as well as impacts of specific economywide policies on from specific, in-depth, research efforts. high priority environmental problems. This Although the case studies have been labeled as chapter also indicates the considerable scope "research," they have been highly applied, and primarily carried out by staff with operational responsibilities within the Bank. 'Exceptions include Reed (ed.) 1992; Mahar 1988; Cruz and Repetto 1992; Panayotou and Sussangkarn 1991. 5. Linkages Between the Environment and Economywide Policies: Recent World Bank Experience 67 for developing better analytical tools to trace economywide implications (such as subsi- environment-economic policy linkages. dized energy prices). In either case, economy- General findings from the World Bank case wide policies that are not designed for envi- studies and other experience are summarized ronmental purposes may have substantial below. One recurring theme is that the poten- effects on the level and conduct of tial for achieving parallel gains in conven- environment-related activities, suggesting that tional economic, social and environmental correcting such price-related distortions will goals is often present whenever economywide also result in environmental gains. Among the reforms attempt to improve macroeconomic broadest remedies are those correcting the stability, increase efficiency, and alleviate foreign exchange rate and taxes that distort poverty. However, in important cases these trade. More sector-specific reforms seek to potential gains cannot be realized unless shift key relative prices-for example, setting complementary environmental and social efficient prices for energy or water (which measures are carried out. The results are have pervasive effects), and removing taxes or elaborated below under the following head- subsidies on particular commodities or factors ings: of production. Efficiency Motivated Policies Macroeconomic reforms 3 Other Policy, Market, or Institutional Im- At the level of "macroeconomic" pricing perfcections policies, the Zimbabwe study illustrates how Macroeconomic Stability foreign exchange reforms associated with Longer-Term Poverty and Income Distri- adjustment efforts can support a key environ- mental sector. Wildlife-based economic activ- ities in Zimbabwe, including ecotourism, safaris, hunting, and specialized meat and hide The main feature of most policy reforms production, constitute some of the fastest directed at various levels of economic growing sectors. Wildlife-based tourism alone decisionmaking are price changes which are grew at the rate of 13 percent in 1991, com- designed to promote efficiency and reduce prising 5 percent of GDP. From the environ- waste. The findings of this report reinforce the mental perspective, wildlife-based activities view that such programs which address price- (unlike cattle ranching which competes for related distortions ("getting prices right"), can limited land resources), are better suited to the contribute torboth economic andenvironmen- country's semiarid climate and poor soils. tal goals. Economically viable systems can be main- In many developing countries, misplaced tained with lower stocking rates and a reduced efforts to promote specific regional or sectoral environmental burden, compared to cattle growth and general economic development ranching and pastoral activities. Equally have created complex webs of commodity, important is the indirect environmental benefit sectoral, and macroeconomic price distortions, associated with wildlife management goals of resulting in economic inefficiency and stagna- conserving a natural habitat that appeals to tion. Often, these economic distortions also visitors. lead to unanticipated changes in production There is much interest in wildlife develop- and input-use that promote resource over- ment in Zimbabwe, with emphasis placed on exploitation or pollution. Such economic its potential role as a more sustainable land distortions may arise from a macroeconomic use system than cattle ranching or conven- policy (such as the overvaluation of the local tional agriculture, in semiarid zones. Wildlife currency) or from a sectoral policy with enterprises currently account for 15 percent of 68 VOLUME I land use on commercial and communal lands. accounts for 92 percent of the country's mar- Wildlife on which ecotourism is based com- keted water use. At the same time, irrigation petes with beef production-in terms of land charges cover less than 10 percent of the use, rather than meat output. Despite its eco- LRMC, while the corresponding figure for nomic and environmental advantages, sectoral urban water tariffs is less than 50 percent. land policies have generally discouraged Given these policies, it is not surprising that a wildlife activities since these are still per- water deficit is projected for Morocco by the ceived as "underutilizing" land. Livestock year 2020, notwithstanding the fact that by the marketing and pricing policies have also same year, water sector investments would traditionally subsidized cattle ranching. account for 60 percent of the government More importantly, for many years, the budget. The study, however, goes beyond the government's foreign exchange and trade traditional sectoral remedy of proposing an policies severely penalized this sector. The increase in water tariffs. It links sectoral Zimbabwean dollar was overvalued by 50 to policy reforms with ongoing macroeconomic 80 percent from 1981 to 1990. This meant that adjustment policies, involving the complete export-oriented sectors were implicitly taxed, removal of nominal trade tariffs, and analyzes among them wildlife and nature tourism the overall effects of both sets of reforms. concerns. Foreign exchange earnings were In the CGE simulation, liberalization of diverted to other sectors, depressing incomes trade alone leads to a marginal rise in real and investment in wildlife. In 1990, the gov- GDP. Household incomes and consumption ernment introduced an adjustment package, post significant gains as import barriers are including measures aimed at boosting the reduced, exports become more competitive, level of exports. The currency was devalued domestic purchasing power rises and by 25 percent, and more liberal access to resources are allocated more efficiently across foreign exchange was allowed. These moves the economy. The two major drawbacks, were beneficial on both economic and ecolog- however, are that elimination of tariffs leads ical fronts. Exports increased. At the same to budgetary deficits, and domestic water use time, the profitability of the wildlife sector increases substantially due to the expansionary improved, leading to a significant increase of effects of liberalization. In the second sce- wildlife in commercial farmlands. nario, only water price reforms are considered. While the Zimbabwe study above illustrates The results indicate (as expected) that, other how relatively straightforward and unambigu- things being equal, doubling water prices ous links between macroeconomic reforms reduces water use significantly-by 34 percent and specific environmental effects can be in rural areas and by 29 percent for the econ- traced and measured, in other cases the effects omy as a whole. This static efficiency gain, of policy change are more indirect. Such however, is acquired at a price-real GDP indirect or system effects of economic policies falls by about 0.65 percent relative to what it on the environment have prompted some would have been, and incomes and real con- interest in the use of computable general sumption of both rural and urban households equilibrium (CGE) models. decline by approximately 1 percent. This approach has been used in the study of In the final scenario, the trade liberalization Morocco, which employed a CGE model continues to stimulate growth, but simulta- linking agricultural water use to trade policies. neously reforming water prices induces sub- Low water charges (coupled with ineffective stantial reductions in agricultural (and collection of these charges), have artificially economywide) water use, unlike in the sce- promoted production of water intensive crops nario involving price reform alone. To sum- such as sugar cane. Thus, rural irrigation water marize, the macroeconomic policy reform 5. Linkages Between the Environment and Economywide Policies: Recent World Bank Experience 69 (trade liberalization) alone resulted in more ment, such as promoting the use of energy- efficient allocation of resources and expansion saving fluorescent lights. Of course, a combi- of exports, but also led to environmental stress nation of both pricing and technical measures through increased water use. When comple- provided the best results. mentary water price increases were simulta- This emphasis is reflected in two recent neously undertaken with trade liberalization, World Bank policy papers for the energy the beneficial expansionary economic effects sector.3 As noted earlier, one of these reports of the latter were largely retained, but now estimates that developing countries spend with substantial reductions in water use as more than US$250 billion annually on subsi- well (due to the higher water prices). dizing energy.4 The countries of the former U.S.S.R. and Eastern Europe account for the Sectoral reforms bulk of this amount (US$180 billion), and it is More specific or restricted policies affect- estimated that more than half of their air ing major sectors, such as industry and agri- pollution is attributable to such price distor- culture, or key resources, like energy, are also tions. Removing all energy subsidies would addressed in programs of economywide policy produce large gains in efficiency and in fiscal reforms. For example, the potential gains from balances, and would sharply reduce local price reform in the energy sector may be pollution and cut carbon emissions by as enormous. In fact, all recent energy projects much as 20 percent in some countries, and by supported by the World Bank have involved about 7 percent worldwide. Similarly, electricity prices in developing tional arrangements and price efficiency In countries are, on average, barely more than each case efforts were made to promote ratio- one-third of supply costs. As a result, consum- nal pricing policies, improve institutional ers use about 20 percent more electricity than effectiveness, and achieve greater transpar- they would if they paid the true costs of sup- ency and accountability in the provision of ply. Moreover, recent evidence shows that far energy. from correcting this distortion, many govern- Energy. sector reforms can contribute to ments have been slow to adjust electricity botheconergysectrd refvronms ntribut toal. Itariffs to reflect higher costs from inflation, bot ecnmcadevrnetlgas.1 fuel, and interest charges. A review of elec- Sri Lanka, for example, as in most develop- g . ing countries, electricity prices have been well tricity tariffs in 60 developing countries has below the incremental cost of future supplies, shown that average tariffs declined over the belw te mremnta cst f ftur supl1s. period 1979-88 from US$0.052-US$0.038 Many studies show that eliminating power peri k 1988 from Us).52Ths$spri8 subsidies by raising tariffs closer to the LRMC per kWh (1986 U.S. dollars). This is particu of power generation, will encourage more larly troubling as energy demands are ex- efficient use of electriCity.2 In projecting pected to grow, and will probably double in future electricity requir t in Si Lthe next 15 years. Achieving commercial futur eletricty rquirment in ri Lnka, pricing policies is, therefore, central to achiev- the study found that the economic benefits of ing en ergficency tand ecnomi setting electricity prices to reflect LRMC is ing energy efficiency and economic supplemented by an unambiguously favorable sustainability. Consequently of the 24 energy impact on the environment. In addition, pric- and power sector loans approved by the World ing reforms were found to have better eco- nomic and environmental impacts than purely technical approaches to demand-side manage- 3World Bank 1993b, World Bank 1993k. 4World Bank 1993b. 2Munasinghe 1990. 5World Bank 1993k. 70 VOLUME I Bank in fiscal year 1993, 16 contained specific also increased by 5.7 percent in the same requirements to adjust energy prices. period. Aside from the beneficial environmen- The negative environmental effects of tal aspects of removing such subsidies, there industrial protection policies also suggest the will also be direct fiscal implications. Energy win-win potential of industrial policy reforms. subsidies are generally costly, and must be This is illustrated in the experience of Mexico financed from government budgets that are from 1970 to the late 1980s. Between 1970 to often in deficit. In Mexico, broad subsidies for 1989, industrial pollution intensity (per unit of fuels and electricity absorbed US$8-US$13 value added) in Mexico increased by 25 per- billion, or 4-7 percent of GDP, from 1980 to cent, induced by government investments and 1985. (See Box 5-1.) subsidies in the petrochemical and fertilizer industries. The energy intensity of industry Box 5-1: Fiscal Policy and Air Pollution in Mexico A recent study addressed the environmental consequences of industrial growth in Mexico, in terms of air pollution and changes in energy intensity of industrial output. The impact of industrial development on the environment has been substantial. Industrial production increased by a factor of 10 between 1950 and 1989. With respect to pollution, the study results suggested that the environment did not only deteriorate as a result of the growth of manufacturing output but also due to a considerable shift towards the more polluting subsectors leading to an increase in the pollution intensity, that is the arnount of emissions per unit of manufacturing output. Between 1950 and 1970 the pollution intensity of the manufacturing industry (calculated with fixed emission coefficients) increased by 50 percent. The growing participation of the production of highly polluting intermediates in total manufacturing output was the main cause of this increase. The study also showed that industrial pollution intensity increased by another 25 percent from 1970 to 1989, particularly in the second half of this period. This increase is almost completely explained by the growth of public sector investments from 1978 to 1982 in the petrochemical and fertilizer industries. The pollution intensity figures used in the study were derived from U.S. emissions data for 1987 using fixed pollution coefficients by subsector. Thus, changes in the estimates of total industrial pollution intensity are completely produced by structural shifts in the composition of manufacturing output. Neither the possibility of technology choice nor the influence of economic policies, for example trade policies, on this choice were taken into account in the estimates. To complement this analysis, the energy intensity of Mexican industry in relation to energy pricing policies between 1970 and 1990 was exarnined. It was found that energy pricing policies led to annual implicit subsidies for energy products (that is, petroleum fuels, gas, and electricity) of between US$8 billion and US$13 billion, or 4 to 7 percent of GDP, from 1980 to 1985. Associated with this, the energy intensity of Mexican industry increased by 5.7 percent from 1970 to 1990 while industrial energy intensity in OECD countries decreased by 35.3 percent over the same period. An increase in petroleum fuel and electricity intensity appears to be almost exclusively attributable to technological and other changes within subsectors, and not to structural shifts in production towards more energy intensive sectors. To some extent, the failure of Mexican industry to follow the trends towards energy saving adopted by the OECD countries after the oil price shocks of 1973 and 1979 could be attributed to the government policy of keeping energy prices far below international levels in the late 1970s and early 1980s. The more recent reduction of implicit subsidies to energy is expected to induce a lower increase of energy demand during a period of renewed economic growth. The study found no evidence to support the view that foreign trade policies were to blame for the growth in industrial pollution. Pollution has resulted mainly from structural changes, such as the increasing importance of intermediates and public investment in the heavily polluting petro- and agro-chemical industries, and also from the low pricing policies for publicly provided petroleum fuels and electricity. By contrast, foreign trade policies have been strongly biased in favor of the less polluting consumer good industries. 5. Linkages Between the Environment and Economywide Policies: Recent World Bank Experience 71 Box 5-1. continued. In addition to environmental aspects of industrialization for the whole country, studies have also addressed the specific problem of air pollution in Mexico City. Exacerbated by low fuel prices, air quality in Mexico City has steadily declined in recent years. Efficient air quality management requires, inter alia, that pollution reductions be obtained from the least costly source. Taxing pollution directly would conform with this prescription, since it would provide incentives to firms and individuals to pursue emissions reductions in the least costly manner. However, because Mexico City's sources of pollution are many and varied (buses, taxis, and private vehicles, all of varying ages), each vehicle's emissions cannot be monitored continuously, so it is not feasible to tax emissions directly. This suggests the need to develop indirect instruments, which target proxies for emissions (for example, indicators of how clean the car is and how much it is used). These indicators could be influenced by regulations such as emissions standards, and market-based tools such as fuel taxes. The latter are particularly relevant where, as has traditionally been the case in Mexico, fuel prices are well below their opportunity costs. In fact, the general conclusion stemrning from this study is that the appropriate policy for combating vehicular air pollution consists of two elements, namely, policies aimed at making vehicles and fuels cleaner, and policies aimed at reducing demand for trips. To reduce emissions by modifying fuels and vehicles, some measures will be best implemented by regulation, others by market-based instruments. But when it comes to reducing demand, taxation is immensely more effective than regulations, which often limit choices unnecessarily. The study in fact concludes that by combining such an environmental tax instrument with regulatory approaches, targeted emissions reductions can be obtained with savings of at least 10 percent of the cost of "regulation-only" approaches. The inadequacy of reliance upon regulatory methods was exemplified by Mexico City's one day-a-week driving ban, a measure that could have been effective on a temporary basis, but which proved ineffective when applied permanently. Gasoline taxes, in contrast-now being forcefully applied in Mexico-manage demand by screening out only the least essential trips. They also have the advantage of raising public revenues, as well as reducing road congestion and accidents. Source: Ten Kate 1993; Eskeland 1992, 1993. Energy subsidies are not the only form of funds could be used to alleviate poverty more policy-induced inefficiency. Many natural directly. resources are subsidized, leading to distorted Experience in the water and sanitation investment decisions and removing competi- sector illustrates the limitations of direct tive incentives to use them efficiently. Unfor- government provision and indiscriminate tunately, subsidies tend to create powerful subsidization of household services. Despite beneficiaries who come to regard their subsidy progress in developing affordable engineering as a right, creating challenging political and solutions, the delivery and maintenance of institutional obstacles to full cost pricing. A services have often been disappointing. Subsi- recent Bank Operations Evaluation Depart- dies are often captured by wealthier custom- ment (OED) review of experience in urban ers, and in most situations resources are inade- water supply and sanitation projects between quate to maintain a high quality of service or 1967 and 1989, for example, found that bor- to extend facilities to low income areas. Sub- rowers often fail to comply with covenants, sidies may be justified in specific situations especially those on pricing and financial (rural water supplies in low income areas and performance. Another OED review of com- sewage treatment in urban areas), but these are pleted irrigation projects, found that cost most effective when targeted and explicit. recovery was unsatisfactory in 73 percent of Thus, water and sanitation projects approved the 107 projects surveyed. The Bank has taken by the World Bank are increasingly emphasiz- steps to strengthen cost recovery mechanisms ing cost recovery. because benefits from removing subsidies can The negative effects of underpricing re- be substantial, economically, environmentally sources can also be seen in the agricultural and socially-especially when such subsidies sector. In Tunisia, the government's concern benefit large-scale users of a resource and the with ensuring sufficient supply and afford- 72 VOLUME I ability of livestock products has resulted in a other constraints that have passed unnoticed in web of pricing and subsidy interventions. A the initial screening, often cause envirounen- variety of subsidies has promoted livestock tal harm. Paralleling the way in which the production intensification in certain parts of social consequences of adjustment should be Tunisia, while in other regions they have handled, such potential adverse environmental encouraged herd maintenance at levels beyond consequences due to remaining inefficiencies rangelands' carrying capacity. Particularly or inequities in the economic system may during dry years, subsidized feed imports have therefore require additional measures to be substituted for natural pasture, and have avert- introduced, to complement the original ed herd contraction. This failure of herds to economywide policies. respond to diminished feed availability in natural pastures, however, has contributed to Policy distortions that remain need to be significant rangeland degradation primarily in addressed to ensure environmental gains the central and southern regions of the coun- Reforms in energy prices will help the try. This has direct effects on livestock pro- environment, but remaining policy distortions duction, and long-term, indirect implications elsewhere may reduce the beneficial effect. for the entire agriculture sector. This is exemplified in the Poland case study, In the past few years, several further ex- where energy intensity and excessive pollution amples of the adverse environmental effects of have been caused by not only the undervalua- these types of economywide policies have tion of coal in the centralized price system but been examnined. Bank studies on Brazil have also the entire system of state ownership that demonstrated the role of sectoral policies suppressed market signals and incentives. subsidizing frontier land clearing and use that Previous research had already shown how have exacerbated deforestation in the Ama- zon. 6 economywide adjustments, luding increases in energy prices, contributed to improvements in energy use and pollution in Other Policy, Market, or Poland.8 The current study indicates, however, Institutional Imperfections that energy intensity and excessive pollution in Poland is due not only to the undervaluation While liberalizing policies typically help of coal in the centralized price system but both the economy and the environment, unad- more importantly, to the entire system of state dressed policy, market and institutional fail- ownership that encourages output maximiza- ures may undermine the beneficial environ- tion rather than cost minimization. This means mental effects of economywide reforms. The that price responsiveness is blunted, since reform process is typically handled in stages, financial losses are simply absorbed by the with the initial adjustment package aimed at public budget, or passed on to consumers in the most important macroeconomic issues. the form of higher output prices. Some distortions that policymakers intend to The Poland study points out the special address later in the adjustment process, or challenges that the Former Soviet Union and other countries of Central and Eastern Europe face as they attempt to restructure their econo- 6Mahar 1988 and Binswanger 1989 have analyzed mies and make a rapid transition to the market the role of subsidies to agricultural expansion as the key factor leading to deforestation. Schneider 1993 system. All of these economies are more focuses on institutional barriers at the economic frontier that prevent the emergence of land tenure services, such as titling and property rights 'Munasinghe, Cruz, and Warford 1993. enforcemnent, and thus undermines the potential for sustainable land use. 8Hughes 1992. 5. Linkages Between the Environment and Economywide Policies: Recent World Bank Experience 73 material intensive than market economies, as The same generic set of issues is encoun- soft budget constraints and centralized plans tered in China, with specific reference to lead to maximization of output and resource sustainable agriculture. Dramatic reformns have use, rather than cost minimization. The high included reductions in subsidies for chemical energy intensity endemic to all socialist econ- fertilizers and pesticides, increases in energy omies is manifested in Poland's case through prices, lifting of quotas for key agricultural excessive reliance on coal. The study also products, and reduced intervention in product indicates that, especially in the case of econo- markets. A new study focused on farm-level mies in rapid transition, regulations, institu- decisionmaking in Dafeng County, Jiangsu tions, and so forth, should not be allowed to Province, where rapid industrialization is lag too far behind economic restructuring. occurring and the opportunity cost of labor has In 1990, Poland initiated an economic increased considerably in recent years. (See transformation program that led to the privat- Box 5-2.) Application of crop and animal ization of many enterprises. The program was residues as fertilizer (a labor-intensive activ- adversely affected by recession and the col- ity) has been discouraged by current trends in lapse of trading arrangements linked to the labor costs, thereby stimulating excessive Council of Mutual Economic Assistance demand for chemical fertilizer which may be (CMEA). Furthermore, the process of privat- less environmentally desirable. Increases in ization proved to be more complex and leng- commercial energy prices may also result in thy than initially expected. The government burning of biomass. Another potential prob- has therefore introduced an enterprise and lem arises from the fact that one major agri- bank restructuring program to assist in the cultural input, namely land, is still subject to restructuring of state-owned enterprises command and control and, in some communi- (SOEs) and in reducing their debt-servicing ties, arbitrariness in its allocation. In such constraints. circumstances, the uncertainty about land Despite these changes, SOEs will continue allocation tends to encourage short-run profit to be major players in the Polish economy, at maximization and exploitation of land at the least in the short term. Of particular relevance expense of sustainability in agricultural is the decision by the government to retain prouction. Land access issues are also relevant ownership in the energy, mining, steel and in the institutional reforms discussed below. defense sectors in the medium term, and to decide on privatization on a case-by-case basis Market failures may lead to over the next three years. Thus, energy sector environmentally costly patterns of growth restructuring efforts have focused on creating the institutional and legal framework to facili-Asdfrmeitnpocyitrin,th tate competition and greaternprivte sector absence of price signals for environmental tate competition and greater private sector services can undermine the contribution of participation in the future. Coupled with efficiency- and growth-promoting reforms. aggressive energy pricing reforms, this strat- However, recent studies on high-growth egy appears to be making some headway. For economies indicate that addressing environ- example, a recent survey of large state-owned mental concems early in the transition to manufacturing concerns found that even winucthutrivatgzationcSOems arend thalreay agrowth may allow countries to limit the ad- jithout .tanSorsato proam. a verse environmental impacts of expanded particular, the transur foumatond thatral fI economic activity. For example, a recent study parecular, the survey found that allsfan on mitigating pollution and congestion im- ueduced theircnit mption ofsales.alsand pacts in the high-growth economy of Thailand energy per unit of sales. concludes that environmental effects are not solely determined by the scale of economic 74 VOLUME I Box 5-2: Economic Transition and Sustainable Agriculture in China Chinese significant transformations are taking place in agriculture in the context of rapid evolution in the economy. Dramatic, economywide changes have taken place in the relative prices of relevant farm inputs, including reduction in subsidies for chemical fertilizers and pesticides, and increases in the price of energy, and the opportunity cost of labor. Changes in other government policies also affect environmental behavior, via their influence on prices. Among these are lifting of quotas for key agricultural products and substantial reduction in intervention in product markets. Other important changes relate to policy and practice regarding government support for eco-farrning and security of land tenure. Using farm-level data from communities in Dafeng County, Jiangsu Province, an ongoing assessment of sustainable agriculture illustrates the vast range of variables that determine environmental behavior. The area has been experiencing rapid industrial development, and the opportunity cost of labor has increased rapidly in recent years. This trend in labor cost discourages the application of crop and animal residues to the land-a labor-intensive activity. Increases in commercial energy prices may also result in the diversion of biomass for fuel, thereby stimulating demand for chemical fertilizer. Alternatively, where cotton is produced (perhaps to meet a government quota), cotton waste, which has little environmental value, may be burned instead. In assessing the environmental policy implications of changes in the prices of key inputs, the study makes it clear that "second best" problems abound. For example, one major agricultural input, namely land, is still subject to command and control and, in some commnunities, arbitrariness in its allocation. In such circumstances, the uncertainty about land tenure generated by this system has encouraged short-run profit maximization and exploitation of land at the expense of sustainability in agricultural production. Surveys of farmers' reaction to changes in strategic prices and policy variables suggest ways in which they might react in the future under various scenarios of price and other policy reform. Based on the assumption that farmers are profit maximizers, farm models are being designed to simulate reaction to various scenarios of future changes in the prices of inputs and outputs, for example, by crop switching, reducing scale of operations, changing mix of inputs, or going out of business. The environmental implications of these reactions, and therefore the need for possible remedial action, will then be assessed. Policies are rapidly evolving, but the relevance of this study, location-specific though it is, is in illustrating the leverage exerted by macro-level and sectoral policies on farmers' behavior and therefore, by definition, upon the environment. It also suggests that while market liberalization is a necessary condition to encourage farmers to operate efficiently and thereby to ensure that neither producers nor consumers use resources wastefully, it is far from a sufficient condition for sound environmental management. Market reforrs need to be accompanied by various forms of public intervention. This may take the form of education and training to bring farmers up to date with latest techniques. However, where modem techniques and the changes in the relative prices of key agricultural inputs yield unsatisfactory environmnental by-products, the study illustrates the kind of situation in which government should be prepared to step in and compensate for market failure. Above all it demonstrates that policy reform in the environmental area, while urgent, has to parallel overall trends in market liberalization in the Chinese economy. Source: Hu and Warford 1994. activity-the "structure of the economy, the tion in Indonesia. In this case, adjustment efficiency of input use (especially in energy reforms which are successful in the traditional and industry) and the types of production sense of stimulating industrial growth may technologies in use all matter in determining have adverse pollution consequences because the environmental impacts" of economic of market failure-no price signals prevent growth.9 excessive buildup of pollution. Accelerated The specific role of market failure in industrial growth, while clearly desirable for influencing the environmental implications of poverty reduction, could therefore bring with economic reforms is illustrated in the case of it increased pollution. (See Box 5-3.) liberalization policies and industrial promo- The Indonesia case shows how reforms can mitigate some of the pollution problems associated with growth. In terms of emissions 9World Bank 1994c. 5. Linkages Between the Environment and Economywide Policies: Recent World Bank Experience 75 per unit of output, or pollution intensity, the production incentives, while efforts to reduce study found that processing industries (for the government wage bill tend to increase the example, food products, pulp, and paper) tend pool of unemployed. Thus, the adjustment to be dirtier than assembly (for example, process helps to stimulate production of ex- garments and furniture) industries. Liberaliza- port crops, and combines with rapid popula- tion in the 1980s promoted a surge in assem- tion growth and lack of employment opportu- bly industries, thereby reversing the 1970s nities outside the rural sector to create increas- pattern of more rapid growth in "dirty" pro- ing pressure on land resources, encroachment cessing sectors. Projections indicate that the onto marginal lands, and soil erosion. This share of basic processing industries in total effect on resource use is influenced by the industrial output will fall from 72 percent in allocation of property rights. Whether in 1993 to about 60 percent by 2020. relation to the security of land tenure of peas- In addition, industry expanded rapidly ant farmers, or to the right to extract timber by outside densely populated Java, reducing the logging companies, uncertainty normally health impact of industrial concentration. results in environmental degradation. In However, industrial output growth has been so Ghana, as in many regions of Africa, agricul- rapid that general pollution levels have never- tural lands are governed by traditional land theless increased. Thus, while decreases in use institutions, and farms are communally pollution intensity and industrial decentraliza- owned by the village or tribe. These common tion have helped to limit pollution, formal property regimes may have been sufficient in regulations will need to be strengthened also, allowing sustainable use of agricultural lands to avoid health and environmental damage in when populations were much smaller, and the future. sufficient fallow periods could allow land to regain its fertility. However, such traditional Pervasive institutional constraints may arrangements would be overwhelmed ulti- undermine potentially beneficial mately by economywide forces, resulting in environmental impacts of policy reforms reduced fallowing, loss of soil fertility and The nature of macroeconomic effects on environmental decline. The foregoing suggests the environment is also contingent upon that better clarification of property rights may .. . . . . ~~~~~hele to resist externall induced pressures. prevailing regulations or institutions govern- y ing resource use. The current case studies In the China case study discussed earlier, in ethat institutional constraints are a economywide pricing reforms in output mar- indvasice problem, and that they take many kets have not been accompanied by similar pervasive problem, and that theyetak may reforms on the input side. Land resources are, forms. For example, the eventual mpact of course, aong the major agricultural in- economywide reforms (such as those affecting ut n neti a ritaotftr inteatioal ad doesti ters oftrad) on puts, and uncertainty may persist about future international and domestic terms of trade) on '' ' the incentives facing farm households will be rights to farm individual plots of land in many influenced by intervening institutional factors localities, even as agricultural markets in (which are themselves determined by cultural, general are being liberalized. This could economic, and politcalactoworsen the incentives for short-term thoseafen ic, access and polticl uts)ertsp veia overexploitation of land resources, leading to those affecting access and use rights over derato.SeBx52 agricultural resources such as land and water. degradation. (See Box 5-2.) The role of institutional constraints in Relevant laws and regulations governing resource access should be reviewed when incthecana cefsuy In tis example, economywide reforms are planned, especially tradhe liberalization, bdy. rdIng thestaxation when there is evidence that key resource ofade aiclral e rtsulea to increase sectors such as land, forests, minerals, or of agricultural exports leads to increased 76 VOLUMEI Box 5-3. Industrial Growth and Pollution in Indonesia The trade liberalization experience in Indonesia shows that while economic policy reforms can promote less pollution intensive industrialization, the rapid expansion of the scale of industrial activity points to the urgent need for regulation as a complement to economic policy reforms. A recent study decomposed industrial pollution in Indonesia by breaking it down into three dimensions: (a) the pollution intensity of output, (b) its location relative to human populations and fragile ecosystems, and (c) the increase in absolute levels of pollutants due to the expansion of output. Using industrial data from 1975 to 1989, the likely impact of continuing reforms on the scale and structure of pollution was then projected to the year 2020. Secondly, the sectoral characteristics of pollution-intensive activities were examined, by classifying them according to indicators of air, water, and toxic pollution per unit of output. Materials processing industries (for example, food products, tobacco, pulp and paper, basic industrial chemicals, petroleum refineries, iron and steel) were generally found to score higher on these indicators than assembly type industries (for example, garments, furniture and fixtures, printing and publishing, metal products, office and computing machinery, transport equipment). For example, the ratio of air pollution intensities in assembly to processing industries ranged from 2.4 to 6.1. Finally, the impact of liberalization on all three dimensions of pollution and on the pollution characteristics of different industrial sectors were assessed. The analysis showed that liberalization in the 1980s promoted a surge in relatively clean assembly processes, reversing the 1970s pattern of more rapid growth in "dirty" materials-processing sectors. Projections indicate that the share of basic processing industries in total industrial output will fall from 72 percent in 1993 to about 60 percent by 2020. In addition to changes in composition of output, within Indonesia liberalization efforts were also associated with differentially rapid growth of "dirty" sectors outside the densely populated island of Java, thereby reducing the health and productivity impact of pollution on population centers. On Java, assembly industries have grown faster than processing activities, and will probably be larger than the latter by the year 2020. However, processing industries outside Java will continue to account for about 80 percent of industrial output. While reforms contributed to rnitigating the impact of pollution from these two sources, industrial growth has been so rapid that the scale effect domninates current patterns and future trends in industrial pollution. Industry has responded very strongly to liberalization; manufacturing output has doubled in volume every six to seven years during the 1970s and 1980s, so that in 1990 manufacturing value added was about eight times its 1970 level in real terms. This accelerated growth, while clearly desirable for poverty reduction, has nevertheless undermined the positive impacts of liberalization on reduced pollution intensity and the relocation of "dirty" industries. Thus, Indonesian industry in the aftermath of liberalization has a much-improved sectoral and locational profile from an environmental perspective. However, accelerated growth has pushed pollution to new heights almost everywhere. Efforts to augment the reform program with institutional support and regulation will clearly be required if Indonesia is to avoid severe pollution problems in the future. Source: Wheeler and Martin 1993. marine resources will be affected. A useful Another common institutional problem example of how such programs could incorpo- relates not to the rules and regulations them- rate legal reforms for environmental purposes selves, but rather to the government's capacity is the recent adjustment operation undertaken to establish and enforce such rules. Regulating in Peru. In this example, it was determined large numbers of potentially environmentally that economywide reforms to promote eco- degrading activities is especially difficult, nomic recovery could potentially increase even for industrial country governments. harvesting pressures on Peru's overexploited Substantial reductions in institutional and fisheries. Thus, the complementary new fish- monitoring needs may be achieved with the ing regulations to protect various fishing use of indirect measures or modified pricing- grounds were incorporated directly into the regulation approaches. This is illustrated, for adjustment program.' example, by the Mexico City air pollution study which shows that while, in principle, pollution taxes are the most accurate means of 'World Bank 1993g. S. Linkages Between the Environment and Economywide Policies: Recent World Bank Experience 77 achieving reductions in pollutants, in practice, the prices of the country's main exports), the administrative feasibility demands that less result is macroeconomic instability of crisis refined instruments such as taxes on consump- proportions. tion of fuels may have to be used. While The relationship between environmental recourse to blunt instruments will help, the issues and policy reforms is fairly straightfor- magnitude of the institutional capacity-build- ward at this general level. Macroeconomic ing challenge nevertheless remains clear. instability is not only disastrous for the econ- Building the relevant institutional capacity in omy, but also frequently detrimental to the developing countries therefore should be environment. For example, high interest rates underscored, and appropriate resources should associated with economic crises can severely be made available early in the adjustment undermine the value of sustainable produc- process to assist country governments in this tion, as resource outputs in the future lose task. most of their expected value. Thus, to the extent that adjustment policies can help re- Macroeconomic Stability store macroeconomic stability, their impact will be unambiguously beneficial for long- Sustainable resource management term natural resource management and envi- requires economic stability ronmental concems. This link is illustrated in One broad objective of structural adjust- the Costa Rica case study, which used a ment lending is to help restore stability in macroeconomic model incorporating timber countries beset by economic crises. A recent harvesting activities, to examine the deforesta- example involves the Sub-Saharan countries, tion implications of various macroeconomic where aaksud ocudsNeofactors. Simulation results demonstrate that where a Bank study concludes: "No economy loeinrstaessoctdwthatbe can function well for long if it has rampant lower interest rates associated with a stable inflation, an overvalued exchange rate, exces- economy allow the logging sector to correctly sive taxation of the agricultural sector, scarce anticipate benefits from future returs to supplies of needed inputs, regulations on forestry, thereby leading to a decline in current prices and production, deficient public ser- logging activities. -vices, and limited financial services."X1' The Other studies have indicated that low and vices*andimite fin a s s."" Tstable discount rates favor the choice of sus- causes of macroeconomic instability often tainable farming rather than short-term culti- arise from imbalances created by long-stand- vation practices.' This is important since ing, internal policy failures and aggravated by "mining" of agricultural land resources is adverse external conditions. For example, amingofarclullndesresS hiverstoryeof potemalciswic r h exaplowe in- often the prevailing form of resource use in creased domestic spending without parallel many tropical areas. Frontier farmers have to crae doetcsedn* wtotprle choose between a sustainable production growth in production eventually leads to cose betw a iable producin inflation or current accounts deficits or both. system with stable but low yields and When unfavorable external credit or trade conditions arise, the result is macroeconomic instability. Under these conditions, both gov- '2The effect of inadequate tenurial security over emnment budget deficits and international trade the resource (and future benefits from it) parallel the balances progressively deteriorate. When an results for high discount rates. This corresponds to the well-known result in renewable resource exploitation external shock occurs (such as an increase In models that the effects on economic behavior of open- the prices of imported energy or a decline in access resource conditions are formally equivalent to those of having secure property rights with infinitely high discount rates. "World Bank 1994a, p. 37. '3Southgate and Pearce 1988. 78 VOLUME I unsustainable practices which initially have policy is that indirect resource allocation high yields. Using farm models and data from effects are important and may dominate the Brazil,'4 a recent Bank study found that if more direct effects of some price or income interest rates are very high, farmers would policy changes. In the Costa Rica study, the tend to choose less sustainable methods. For economic and environmental implications of example, at interest rates of 40 percent (the wage restraints in structural adjustment are prevailing real interest rates at the time of the examined with the use of a CGE model which study),farmers would pursue unsustainable highlights the economic activities and factors agricultural practices that yielded high initial affecting deforestation in Costa Rica. The returns but led to subsequent annual declines model differs from standard approaches in two in productivity of 10 percent. This explains important respects. First, it can simulate the why agricultural land "mining" is so prevalent effect of introducing property rights on forest in the Amazon-since most sustainable farm- resources, thus allowing the private valuation ing technologies available to Brazilian farmers of future forestry returns to contribute to cannot provide such high incomes. The criti- sustainable management. Second, it also cal macroeconomic implication of this result includes markets for logs and cleared is that attempts to resolve the land degradation land-loggers deforest to sell timber to the problem solely by focusing on providing forest industry and squatters clear land for better agricultural technologies would proba- agricultural production and for sale to the bly be ineffective. To arrest land degradation, agriculture sector (as the latter expands and macroeconomic reforms which reduce the real requires more land). interest rate would be needed. The importance of indirect effects in Costa Rica is demonstrated in the analysis of Longer-Term Poverty and Income economywide policy changes, such as an Distributional Effects increase in the wage rate. Because the role of intersectoral resource flows is incorporated in In addition to the short-term concerns the CGE model, the effects of changes in discussed earlier, the crucial long-term links wages are different from partial equilibrium between poverty and environmental degrada- results. If the wage of unskilled labor were tion in developing countries are increasingly increased due to, say, minimum wage legisla- being recognized (Refer to Box 4-4, on Pov- tion, the model predicts that deforestation erty and the Environment.) Growing evidence could worsen rather than decline. Although of the relationship between reducing poverty logging declines due to increased direct costs, and addressing environmental goals points to this is more than made up by the indirect the need to undertake poverty and population effect of intersectoral flows since the indus- programs as part of environmental efforts. The trial sector (where minimum wage legislation need to break the cycle of poverty, population is more binding) is much more adversely growth, and environmental degradation has affected by the higher labor costs. Labor and also been identified in a recent report of the capital thus tend to flow from industry to International Development Association as a agriculture, leading to greater conversion of key challenge for sustainable development."5 forest land for farming. An important result of examining the This simulation exercise suggests the need general equilibrium effects of macroeconomic for caution in attempting to "legislate" income improvements by increasing minimum wages. Introducing higher wages initially improves '4Schneider 1993. labor incomes but a resulting contraction of industrial and agricultural employment leads '5International Development Association 1992. 5. Linkages Between the Environment and Economywide Policies: Recent World Bank Experience 79 not only to more unemployment but to envi- high yielding crop varieties is not available. ronmental degradation as well. The increase in Thus, the study identified the need for a mix unemployment results in greater pressures for of responses in terms of reforms to remove expanding shifting cultivation in forest lands. subsidies for inappropriate land uses, improve Beyond pricing and intersectoral environ- land use planning, recognize property rights, mental linkages that can be identified in gen- provide better education, and construct appro- eral equilibrium approaches, another set of priate rural infrastructure to promote produc- studies has looked at the environmental impli- tion incentives. cations of rural poverty and unemployment Among the current Bank research, the within the broader context of the social and Philippines case study evaluates the policy demographic problems of inequitable land determinants of long-term changes in rural access and rapid population growth.16 Import poverty and unemployment that have moti- substitution, industrial protection, and regres- vated increasing lowland to upland migration. sive taxation are some economywide policies This process has led to the conversion of that have historically been associated with forest lands to unsustainable agriculture and lagging employment generation, income has been identified as a key mechanism con- inequality, and poverty. Unequal distribution tributing to the deforestation problem. The of resources and inappropriate tenure are inability of the government to manage forest institutional factors that also contribute to the resources is an important direct cause of problem. In the context of inequitable assign- deforestation, but there is increasing recogni- ment of endowments and rapid population tion that economic policies, both sectoral and growth, the resulting unemployment and economywide, also significantly contribute to income inequality force the poor to depend the problem. For example, the study links increasingly on marginal resources for their lowland poverty to agricultural taxation, price livelihood. The result is pressure on fragile controls, and marketing restrictions, and uses environments. This effect can be analyzed in an econometric model to demonstrate that the conjunction with the assessment of large poverty contributes significantly to migration migration episodes. These may occur as part pressures on forest lands. of direct resettlement programs or may be Trade and exchange rate policies have also induced by inappropriate policies, such as land played important roles in the Philippines and colonization programs. have been dominated by an urban consumer With regard to sustainable agriculture and industrial sector bias. The agricultural concerns, the World Bank study of the Popu- sector was implicitly taxed by an average of lation, Environment and Agriculture Nexus in about 20 percent for most of the 1970s and Sub-Saharan Africa explicitly links the related early 1980s. Because the industrial sector did problems of rapid population growth, agricul- not provide an alternative source of growth, tural stagnation and land degradation in Af- poverty generally has worsened and rural rica. 7 The study found that shifting cultivation incomes in particular have suffered. The study and grazing in the context of limited capital results indicate that the main mechanism by and technical change cannot cope with rapid which these economic problems affect the population growth. At the same time, the environment is through migration and the traditional technological solution of relying on conversion of forest lands to unsustainable agriculture. Population pressure already evi- dent in the 1970s worsened during the 1980s. "Feder et al. 1988; Cruz and Gibbs 1990; Lele and The net upland migration rate grew from 3.4 Stone 1989. to 9.4 percent between 1970 to 1975 and 1978 to 1980, and increased substantially to 14.5 "Cleaver and Schreiber 1991. 80 VOLUME I percent between 1980 and 1985. Conse- specific conservation programs are needed, quently, upland cropped area grew at annual economywide policy reforms could be as rates exceeding 7 percent from 1971 to 1987. important in arresting the process of deforesta- These results suggest that while forestry tion. 6 7 Case Study Summaries HIGHLIGHTS OF THE STUDIES forming the World Bank research program on the linkages between economywide policies and the environment are presented below. These studies have been carefully selected to reflect a wide range of country situations, and of environmental problems. The very diversity of the cases considered is intended to dem- onstrate the generality of the overall theme-which is the actual or potentially major impact that economic policies have on the environment. 81 82 VOLUME I The cases include countries in Latin approaches in two important respects. First, America (Costa Rica); Sub-Saharan Africa it can simulate the effect of introducing (Zimbabwe and Ghana); North Africa (Tuni- property rights on forest resources, thus sia, Morocco); Asia (Philippines and Sri allowing the private valuation of future Lanka); and Eastern Europe (Poland). Vari- forestry returns to contribute to sustainable ous results from these case studies have management. Second, it also includes mar- been included in this book, as examples kets for logs and cleared land: loggers defor- pertinent to specific policy issues. (For est to sell timber to the forest industry and continuity of presentation, some of the squatters clear land for agricultural produc- points mentioned in the main text are repeat- tion and for sale to the agriculture sector as ed in the country summaries.) For the reader the latter expands and requires more land. wishing to obtain further information, these The model retains features that are fairly studies are contained in Volume II. standard in most CGE models. The tradable sectors-forestry, agriculture, and indus- Costa Rica' try-are price takers in the world market, while infrastructure and services produce While the other studies described in this nontraded output. To focus on the natural chapter (except the Morocco study) gener- resource sectors, the domestically mobile ally adopt a partial equilibrium approach in factors include, aside from capital and labor, addressing the environmental consequences cleared land and logs. The supplies of both of economic policy, it is clear that general labor and capital are exogenous. The de- equilibrium effects are important. Indeed, mand for these factors arises from the pro- failure to protect the environment may have ducing sectors (agriculture, industry, and so serious feedbacks and may constrain eco- forth) and from the deforestation activity of nomic development. To capture this whole loggers and squatters. The supply of economy perspective a study of the linkages "cleared" land is initially based on Costa between economic policies and the environ- Rica's total land area that has been defor- ment in Costa Rica uses a computable gen- ested. However, additional cleared land is eral equilibrium (CGE) model. The model made available from increased deforestation. pays special attention to deforestation, This rate of land clearing depends on the which is proceeding at a rapid pace in Costa definition of property rights as well as on Rica. Together with soil erosion, it has been taxes (or subsidies) that affect the forest and identified as the main environmental prob- agricultural sectors. In addition, the expan- lem of the country. sion of squatting activities augments the Even conservative estimates of remaining cleared land factor. Agricultural production forest cover forecast that if current defores- provides the demand for cleared land. tation rates continue, the commercial forests The results of the CGE simulations sup- of Costa Rica will be exhausted within the port the conventional view that establishing next five years. To evaluate how sectoral property rights tends to decrease deforesta- and economywide policies can help control tion. The reason is that such rights allow the deforestation, the study constructed a CGE logging sector to capture the future benefits model that highlights the economic activi- of reducing excessive logging damage on ties and factors affecting deforestation in residual stands. Initially, this loss is pre- Costa Rica. The model differs from standard sumed to be 28 percent of the value of the residual stand. Using an interest rate of 10 percent, the simulation indicates that defor- 'Researchers: Annika Persson and Mohan estation is dramatically reduced to 5 percent Munasinghe. 6. Case Study Summaries 83 of the base level as both the logging and Finally, both these last two examples squatters sectors internalize the losses asso- suggest the importance of pursuing sectoral ciated with deforestation. Significant reduc- reforms in the context of growth. Without tions in deforestation occur even when the alternative employment opportunities, re- estimate of logging damage is substantially ducing logging activities will tend to direct reduced. The CGE results on the deforesta- labor and capital resources toward agricul- tion effects of discount rate changes also ture, industry and other sectors. Expansion parallel the predictions of partial equilib- of some of these sectors may lead to a sec- rium models: higher interest rates promote ond round of effects on forestry which could deforestation while lower interest rates actually result in more deforestation. contribute to conservation. Beyond augmenting the analysis of partial Ghana2 equilibrium models, an important contribu- tion of the model is in illustrating how the In Ghana, socioeconomic and land-map- direct impacts of forestry sector-specific ping data were combined to analyze the policies are modified once the indirect effects of ongoing trade liberalization and effects arising from intersectoral linkages public employment reduction on agricultural are accounted for. For example, partial productivity and land use in the country's equilibrium analysis predicts that stumpage western region. A key empirical result un- price increases will reduce logging. How- derlying the policy simulations is that the ever, the model shows that, while deforesta- main source of supply response in agricul- tion from logging will indeed decline, total ture is the expansion of cultivated area deforestation nevertheless increases. The rather than agricultural intensification. It reason is that the contraction of the logging was estimated that biomass, measured in and forest industry sectors causes a shift of terms of the proportion of land under forest resources toward agriculture. As agriculture cover, is an important factor of production, expands, deforestation increases. contributing 15-20 percent of the value of The importance of these indirect effects is agricultural output. This is close to the also demonstrated in the analysis of contribution of "conventional" factor inputs: economywide policy changes, such as an 26 percent for land cultivated, 25 percent for increase in the wage rate. Because the role labor, and 26 percent for capital. Since the of intersectoral resource flows is incorpo- share of agricultural output in national GDP rated in the CGE model, the effects of is about 50 percent, this means that the changes in wages are different from partial contribution of biomass to national income equilibrium results. If the wage of unskilled is about 7.5 percent. Thus the stock of bio- labor were increased due to, say, minimum mass is an important determinant not only of wage legislation, the model predicts that agricultural production but also of GDP. deforestation could worsen instead of de- In the agricultural system prevalent in the clining. Although logging declines due to area, a large proportion of the land available increased direct costs, this is more than in the village is reserved exclusively for the made up by the indirect effect of use of villagers. The system is consistent intersectoral flows since the industrial sector with shifting cultivation since the individual (where minimum wage legislation is more has exclusive rights on the land actually binding) is much more adversely affected by being cultivated, but once the land is left the higher labor costs. Labor and capital idle in fallow it can be reallocated by con- thus tend to flow to agriculture, leading to the conversion of forest land for farming. 2Researcher: Ramon Lopez. 84 VOLUMEI sensus and consent of the village chief. how the existing water allocation system has Under these conditions, biomass is already led to suboptimal and unsustainable patterns being overexploited through a more than of water use. Specifically, low water charges optimal level of land cultivated. Fallow (coupled with ineffective collection of these periods appear to be too short, and the stock charges), have artificially promoted produc- of the environmental resource is below tion of water intensive crops such as sugar- socially optimum levels. cane. Thus, rural irrigation water accounts The study found that increasing agricul- for 92 percent of the country's marketed tural prices or reducing wages cause an water use. At the same time, irrigation expansion in the cultivated area, with the charges cover less than 10 percent of the direct effect of increasing output. For exam- LRMC, and the corresponding figure for ple, a 10 percent increase in land cultivated urban water tariffs is less than 50 percent. leads to a 2.7 percent increase in the direct Given these policies, it is not surprising that output effect. However, such an increase in a water deficit is projected for Morocco by cultivated area leads to a reduction in the year 2020. fallowing, and total biomass declines by The study, however, goes beyond the 14.5 percent. This, in turn, leads to a 2.5 traditional sectoral remedy of proposing an percent loss in sustainable agricultural pro- increase in water tariffs. It links sectoral ductivity. Thus, the net effect of expanding policy reforms with ongoing macroeco- area cultivated (2.7 percent direct output nomic adjustment policies, namely the effect less 2.5 percent biomass loss effect) is complete removal of nominal trade tariffs, still positive but only 0.2 percent-many and analyzes the overall effects of both sets times smaller than the direct effect alone. In of reforms. As a consequence of the trade addition to policy changes, other factors reforms, prices of sugar, cereals, oilseeds, contribute to expansion of cultivated area: meat and dairy products, among other large family size, availability of capital, and things, would decline to world levels from the presence of migrant populations in the their current protected levels. Further, a area. simultaneous introduction of trade and water The results suggest that, in general, pricing reforms would imply increased input economywide price and wage policy reforms prices and a decline in output prices. As in that do not include changes in land manage- the Costa Rica case above, a CGE model is ment practices will have limited impact on used to trace the impact of these reforms on national income, once the existence of land output, consumption, imports, exports, and quality effects is considered. This means the use of factors of production (including that sustainable development efforts would water), by the different sectors in the econ- be better served if such links between agri- omy. cultural production and environmental To separate out the effects of the sectoral degradation could be analyzed in the context and macroeconomic reforms, the study of economywide reform programs. considers three scenarios: water pricing reform only, trade reform only, and a combi- Morocco3 nation of the two. In the first scenario the only policy change is a doubling in the price The Morocco study focuses on the link- of rural irrigation water. Similarly, in the ages between macroeconomic policies and second scenario the only change is a com- plete removal of nominal tariffs (which in 1985 averaged 21 percent for the whole 3Researchers: Ian Goldin and David Roland- economy and 32 percent for agriculture). In Host. 6. Case Study Summaries 85 the final scenario the two policy reforms are problem. The inability of the government to combined. manage forest resources is an important The results indicate that, other things direct cause of deforestation, but there is being equal, reforming water prices alone increasing recognition that economic poli- reduces water use significantly-by 34 cies, both sectoral and economywide, also percent in rural areas and by 29 percent for significantly contribute to the problem. the economy as a whole. This is as would be These policies take the form of direct sec- expected. This achievement of static effi- toral interventions through agricultural ciency, however, is acquired at a price: real taxation, price controls, subsidies, and mar- GDP falls by about 0.65 percent, and in- keting restrictions. They could also be indi- comes and real consumption of both rural rect, working through exchange rate policies and urban households decline by approxi- and industrial protection. mately 1 percent. In the second scenario, The study shows that in general these liberalization of trade only has the opposite policies have tended to penalize lowland effect: there is a marginal rise in real GDP, agriculture in favor of industrial sectors. On and household incomes and consumption the one hand, this has resulted in the limited post significant gains as import barriers are ability of the agricultural sector to produc- reduced, exports become more competitive, tively employ a growing labor force. On the domestic purchasing power rises and re- other hand, trade and exchange rate policies sources are allocated more efficiently across have made the industrial sector inefficient the economy. and increasingly difficult economic condi- The two major drawbacks, however, are tions during the late 1970s and early 1980s that elimination of tariffs leads to budgetary further reduced its lagging capacity to ab- deficits and domestic water use increases sorb surplus labor from the agricultural substantially due to the expansionary effects sector. The net result has been growing of liberalization. In the final scenario, the unemployment and worsening rural poverty, expansionary effects of trade liberalization and these provide the "push" factors moti- are retained, but reforming water prices still vating migration to forest lands. Deforesta- induces substantial reductions in agricultural tion in the Philippines has exceeded 150,000 (and economywide) water use. Moreover, hectares per year of forest area for the last this reduction in water consumption occurs two decades. Conversion to agricultural land against a backdrop of growth in real GDP constitutes the largest form of land use unlike in the price reform only scenario. change from forest land. Between 1980 and 1987, for example, the cultivated areas on Philippines4 land with 18-30 percent slope alone in- creased by more than 37,000 hectares annu- The Philippines case study evaluates the ally. policy determinants of long-term changes in The study evaluates government interven- rural poverty and unemployment that have tions for key crops to illustrate the role of motivated increasing lowland to upland commodity specific policies in altering the migration. This process has led to the con- incentives for lowland compared with up- version of forest lands to unsustainable land agriculture. Policies on rice production, agriculture and has been identified as a key which dominates lowland agriculture, have mechanism contributing to the deforestation been governed more by the goal of main- taining low prices for consumers rather than assuring price incentives for producers. 4Researchers: Wilfrido Cruz, Herminia Francisco, Corn and coconut production, which togeth- and Gregory Amacher. 86 VOLUME I er make up the majority of agriculture in Poland5 sloping lands, have also fared differently from government intervention. Corn cultiva- The massive structural changes now tion has generally been encouraged while occurring in Eastern Europe and China coconut, a more environmentally stable clearly present even greater analytical chal- crop, has been excessively taxed. Corn, for lenges in predicting the environmental example, has received favorable protection impacts of economic reforms. The former while the copra export prohibition and the centrally planned economies of Eastern coconut levy kept producer prices below Europe are burdened by the twin legacy of world prices by more than 25 percent. The low energy prices and the absence of an net effect of these policies has been to re- incentive system that ensures efficient utili- duce the attractiveness of lowland compared zation of resources. This is exemplified in with upland agriculture and to encourage the Poland case study, which evaluates the upland farming households to shift from relationship between economic reforms coconut farming to more environmentally (including both price and institutional demanding corn production. changes) and energy and air pollution issues. In addition to commodity specific poli- The assessment proposes that energy inten- cies, trade and exchange rate policies have sity and excessive pollution in Poland is due also played important roles and have been not only to the undervaluation of coal in the dominated by an urban consumer and in- centralized price system but more impor- dustrial sector bias. The agricultural sector tantly to the entire system of state ownership was implicitly taxed by an average of about that encourages output maximization rather 20 percent for most of the 1970s and early than cost minimization. This means that 1980s. Because the industrial sector did not price responsiveness is blunted by the fact provide an alternative source of growth, that financial losses are simply absorbed by poverty in general has worsened and rural the public budget, or passed on in the form incomes in particular have suffered. An of higher output prices. econometric model of migration from low- In addition to the institutional constraints, lands to forest lands indicates that the main Poland also explicitly pursued a macroeco- mechanism through which these economic nomic strategy which emphasized rapid problems affect the environment is migra- industrialization in general and the develop- tion and the conversion of forest lands to ment of heavy industry in particular. Four unsustainable agriculture. Population pres- energy-intensive industries-energy, metal- sure already evident in the 1970s worsened lurgy, chemicals and minerals-tended to during the 1980s. The net upland migration dominate the sector. As a result, they were rate grew from 3.4 to 9.4 percent between also the most polluting sectors in industry 1970-75 and 1978-80, and increased sub- and made heavy demands on other natural stantially to 14.5 percent between 1980 and resources, such as water. While an industri- 1985. Consequently, upland cropped area alization strategy based on heavy industry is grew at annual rates exceeding 7 percent common to most centrally planned econo- from 1971 to 1987. These results indicate mies, in the case of Poland, where coal is an that while forestry specific conservation abundant resource, it also led to excessive programs are needed, economywide policy energy intensity. reforms are as important in arresting defor- estation in the Philippines. 5Researchers: Robin Bates, Shreekant Gupta, and Boguslaw Fiedor. 6. Case Study Summaries 87 Finally, it was not only the types of mation program. In particular the survey economywide policies pursued in Poland found that all firms reduced their consump- which historically promoted high levels of tion of materials and energy per unit of energy use. Environmental policy was not sales. used to offset adverse impacts of industrial- While progress in economic reforms has ization on the environment. To some extent, already produced some results, the timing this was due to the lack of price responsive- and speed of further change are matters of ness of state-owned enterprises, which considerable uncertainty in Poland. The case limited the effectiveness of an otherwise study therefore analyzed a number of sce- sophisticated system of pollution taxes. In narios to quantify the possible impact of addition, environmental inspection and audit various economic reforms on the environ- capabilities were weak and environmental ment. Projections of energy generation and statutes were not stringently enforced. For the associated emissions from three alterna- example, even by the end of the 1980s, only tive models indicate clear environmental a third of plants emitting air pollutants had gains from restructuring combined with emission permits. energy pricing reforms. Although there are In 1990, Poland initiated an economic improvements, the study also concluded that transformation program that led to the pri- economic reforms by themselves will not be vatization of many enterprises. The program enough to meet the medium-term environ- was beset by recession and the collapse of mental goals set by government in 1991. trading arrangements linked to the Council Specifically, the simulations suggest that of Mutual Economic Assistance (CMEA). sulfur and particulate emissions will not be Furthermore, the process of privatization sufficiently reduced unless complementary proved to be more complex and lengthy than environmental regulations are also adopted. initially expected. The government has therefore introduced an enterprise and bank Sri Lanka6 restructuring program to assist in the re- structuring of state-owned enterprises and in World Bank work has traditionally ad- reducing their debt-servicing constraints. dressed the problem of subsidies in key Despite these changes, SOEs will con- sectors such as energy and water, that result tinue to be major players in the Polish econ- in inefficient use of these services. In Sri omy, at least in the short term. Of particular Lanka, the study approached the assessment relevance is the decision by government to of policy reforms and environmental con- retain ownership in the energy, mining, steel cerns from two perspectives: by first investi- and defense sectors in the medium term, and gating the environmental implications of to decide on privatization on a case-by-case energy sector pricing reforms and then by basis over the next three years. Thus, energy evaluating the effectiveness of alternative sector restructuring efforts have focused on policy approaches in meeting specific envi- creating the institutional and legal frame- ronmental goals, such as reducing GHG work to facilitate competition and greater emissions which is mandated by the World private sector participation in the future. Climate Convention. The study focused on Coupled with aggressive energy pricing electricity price reforms as an example of a reforms, this strategy appears to be making sectoral policy change with broad economic some headway. For example, a recent survey and environmental implications and on of large state-owned manufacturing con- cerns found that even without privatization, SOEs are already adjusting to the transfor- 6Researchers: Peter Meier, Mohan Munasinghe, and Tilak Siyambalapitiya. 88 VOLUME I evaluating the effectiveness of levying With respect to meeting GHG reduction externality taxes on electricity compared goals, at present per capita carbon emissions with applying carbon taxes to meet GHG in Sri Lanka (0.06 compared with 4.9 tons constraints. per capita in the United States) are ex- The economic rationale for eliminating tremely low, due to the dominance of power subsidies or raising tariffs is docu- hydropower sources and the low energy mented in many studies, and covenants intensity of the industrial sector. However, between the Bank and its borrowers often beyond the year 2000, CO2 emissions will provide for tariff increases to generate suffi- rise very sharply as the generation mix cient revenue to meet self-financing or rate- moves toward fossil fuels. As generating of-return on equity targets. However, prob- capacity is increased, the study found that lems arise in evaluating the environmental imposing carbon taxes on fuels has a more consequences of such policies. For example, direct impact on greenhouse gas reductions higher electricity prices, based on the than adding the equivalent externality cost LRMC of power generation, may be ex- (an enviromnental tax) to the electricity pected to encourage more efficient use of tariff. The reason is that the fuel tax gives electricity. However, reduced consumption more direct signals for implementing a could also affect the least cost expansion power generation expansion path that re- path, such that the addition of more efficient duces the use of "dirty" fuels such as coal. generating units might be delayed, resulting in higher emissions. Tunisia7 The extent to which this effect would be offset by the lower generation requirement is In Tunisia, the government's concern an empirical question, which can only be with increasing the country's self-suffi- answered by investigating specific cases. In ciency in livestock products and with the projecting future electricity requirements in affordability of these products for its citi- Sri Lanka, the study found that the effi- zens has resulted in a web of pricing and ciency effect of setting electricity prices to subsidy interventions in the livestock sector. reflect LRMC dominates and there is a The environmental consequence of these significant and unambiguously beneficial measures, namely the degradation of Tuni- impact on the environment. The difference sia's rangelands, however, has rarely been a between tariffs based on average incremen- central consideration. A variety of subsidies tal cost of generation (as an approximation has promoted the intensification of livestock of LRMC) and one based merely on meeting production in certain parts of Tunisia, while financial covenants that require achieving a in other regions government subsidies and 10 percent return on equity is a 6 percent policies have encouraged the maintenance of reduction of greenhouse gas emissions by the national herd at levels beyond the carry- the year 2010, and a 10 percent reduction in ing capacity of the country's rangelands. the health effects associated with human Particularly during dry years, subsidized exposure to incremental ambient concentra- feed imports have provided a substitute for tion of air pollutants. In addition, pricing reduced grazing supplies, and have suc- reforms were found to have a more general ceeded in averting the large declines in impact than technical approaches to animal numbers often associated with demand-side management (DSM), such as droughts. This failure of livestock numbers promoting the use of energy-saving fluores- cent lights. DSM programs tend to be diffi- cult to implement and limited in scope. 7Researchers: Zeinab Partow and Stephen Mink. 6. Case Study Summaries 89 to respond to diminished feed availability in on rangelands in much of central and south- natural pastures, however, has contributed to em Tunisia has been negative. Failure of significant environmental degradation of the policies to distinguish between bioclimatic Tunisian range. This has direct effects on zones has thus contributed to the severe livestock production, and longer-term, degradation of the country's range re- indirect implications for the entire agricul- sources. The intention has been to protect ture sector. While important efforts at pas- herders in the southern and central regions ture improvement and reforestation are from major losses and wide income fluctua- underway, the positive impact of these and tions; this short-term objective has been other measures are often undermined by accomplished, but no durable solution has subsidy and pricing policies that fail to been found to alleviate the herd pressure consider or respond to environmental sig- that is slowly degrading the capacity of nals. rangeland to sustain herds and livestock Livestock policies have had different income. In addition, subsidies on feed con- environmental impacts in the north, center centrates have reduced the incentives for and south regions of the country. Govern- forage production. ment subsidies for feed, irrigation and fertil- While government policy may have had izers have promoted intensification of live- a small measure of success in social terms, stock production and integration with crop- these benefits threaten to be short-lived if ping activities in the north. This has oc- the environmental consequences of policies curred to a lesser extent in the central part of are not adequately considered. Income the country, where sheep herds have in- stabilization of small-scale herders will only creased without commensurate increase in be temporary if it is achieved through means feed production. Rangeland appears to be that result in the degradation of the range- degrading, exacerbated by stabilization of land upon which the incomes ultimately herd sizes in drought years through the depend. The long-term effects of environ- subsidized distribution of barley feed im- mental degradation will ultimately result in ports, and more generally through the mild the permanent reduction of rangeland pro- protection of domestic mutton production. ductivity and the consequent reduction of Following liberalization of mutton prices in herd size and incomes from livestock. In the late 1970s it became profitable to in- addition, the impacts of increased desertifi- crease use of feed concentrates for sheep cation and soil erosion will find their way production, but this has not been sufficient into the rest of the economy, affecting agri- to alleviate the pressure on Tunisia's central cultural productivity and infrastructure rangelands. (siltation of reservoirs through increased In addition, government policy encour- erosion). The challenge is to introduce less aged the conversion of marginal lands from environmentally destructive means to pastures into cereals, mainly barley. Not achieve the social objectives. only did this encourage land degradation Sweeping policy changes introduced through the removal of permanent cover, it gradually since the launching of structural also shifted some of the best pasture lands to adjustment reforms in 1986 will ultimately marginal cereal production, further shrink- have an important impact on how livestock ing the rangeland resources available to a activities affect rangeland. These policy growing livestock herd. Thus while subsi- changes were primarily driven by budget dies may have a beneficial effect when constraints and market strategies, with implemented in the north and perhaps in environmental consequences rarely taken certain parts of central Tunisia, their impact into account. The interaction of these poli- 90 VOLUMEI cies makes it difficult to predict the magni- the country's semiarid climate and poor tude of their impact on the various feed soils. The direct environmental advantage is sources, and their introduction is still too that economically viable systems can be recent for clear trends to be identifiable. It is maintained with lower stocking rates than probable that strengthening producer prices those associated with commercial cattle for beef will encourage growth in the cattle ranching and subsistence pastoral activities. herd after years of stagnation. This growth Equally important is the indirect environ- will be concentrated initially in the north mental benefit associated with wildlife where feed resources are more abundant, but management goals of conserving a natural a critical issue will be whether the derived habitat that appeals to visitors. demand generated by cattle herd growth will Thus, there has been much interest in help to maintain fodder and barley produc- wildlife development, with emphasis placed tion in the face of reduced subsidies on on its potential role as a more sustainable fodder crop inputs such as irrigation water land use system than conventional agricul- and fertilizer. In central Tunisia, the finan- ture in semiarid zones. Except for specially cial returns to sheep herding are likely to protected species, the 1975 Parks and Wild- decline with subsidies being eliminated on life Act and its amendment for communal feed concentrates, and some shift to beef areas allowed wildlife utilization by the production can be expected. The impact of private sector to expand rapidly. Wildlife such shift will depend on whether perma- enterprises currently account for 15 percent nent cattle herds are maintained, or whether of land use on commercial and communal incentives encourage a focus on reproduc- lands. The large wildlife enterprises are tion using seasonally available range feed found in arid areas where farmers concen- resources for sale to fattening operations in trate on extensive game or mixed game and the north. cattle ranching. Wildlife resources are gen- erally not used for meat production, and Zimbabwe8 most meat offtake is sold locally at prices well below beef prices. Nevertheless wild- The study of the impacts of economic life competes with beef production; not in policies on wildlife in Zimbabwe, like the terms of meat output but in terms of land Tunisia case, illustrates the opportunity for use. economywide reforms that also have envi- With respect to sectoral policies, govern- ronmental benefits. The wildlife-based ment land policies have generally discour- economic activities in this country, includ- aged private sector involvement in wildlife ing eco-tourism, safaris, hunting, and spe- activities since these are still perceived as cialized meat and hide production, consti- "underutilizing" land and therefore invites tute one of the fastest growing sectors of the future taxation or appropriation. Livestock economy. Wildlife-based tourism alone marketing and price policies have also grew at the rate of 13 percent in 1991 and traditionally subsidized cattle ranching. comprised 5 percent of GDP. The sector is Since 1985 subsidies directed to an ineffi- also important from the environmental cient parastatal marketing system have been perspective. Wildlife-based activities, unlike the main cattle sector policy instrument. cattle ranching, with which they compete for Industrial promotion and exchange rate limited land resources, are better suited to policies are two areas where there have been adverse effects on wildlife activities. Zimba- bwe followed a strongly interventionist 8Researchers: Kay Muir-Leresche, Jan Boj6, and policy regime and the structural adjustment Robert Cunliffe. 6. Case Study Summaries 91 program initiated in 1990 has only margin- comes and investment in wildlife. In 1990, ally moved the economy toward liberaliza- the government introduced an adjustment tion. The problem is that Zimbabwe inher- package, including measures aimed at boost- ited a highly centralized and regulated econ- ing the level of exports. The currency was omy at the time of independence. As re- devalued by 25 percent, and more liberal cently as 1990, the government budget access to foreign exchange was allowed. comprised 48 percent of GDP. This exces- Although further progress needs to be made, sive public sector role in the economy these moves have contributed on both eco- crowded out private initiative and contribut- nomic and ecological fronts. Exports in- ed to very low investment levels and pro- creased; at the same time, the profitability of ductivity. Government policy tends to chan- the wildlife sector increased, allowing an nel the limited private sector investment into expansion of land allocated for wildlife. the mining and manufacturing sectors, primarily through simplifying project assess- Scope of Economywide Policy- ment and approval procedures. In areas Environment Linkages where wildlife resources are still abundant, the establishment of commercial schemes While the case studies undertaken in this does not require major capital investment, program focused on a particular environ- and the sale of concessions for offtake or for mental issue for each country, the various viewing access can be used in initial devel- linkages between economywide policies and opment. However, even where wildlife a range of environmental concerns presented activities may be socially beneficial, they above may be of relevance in other develop- will not be successful if government policies ing countries. Table 6-1 presents the scope undermine their private profitability. the different findings from the case studies Foreign exchange controls, however, within a consolidated matrix. have played the more important role. For In fact, land degradation, deforestation, many years, the government's foreign ex- industrial pollution, and energy inefficiency change and trade policies have severely and water management problems could all penalized this sector. The Zimbabwean occur in the same country. By identifying dollar was overvalued by 50 to 80 percent the possible linkages between policies and from 1981 to 1990. This meant that export- such environmental concerns, the examples oriented sectors were implicitly taxed, drawn from these different country case among them wildlife and nature tourism studies may help guide future, more compre- concerns. Foreign exchange eamings were hensive studies of specific countries. diverted to other sectors, depressing in- Table 6-1: Scope of Economywide Policy-Environment Linkages Discussed in Case Studies Economic Policies and Other Measures Erosion and Land Degradation Deforestation Pollution Energy and Water Use Macroeconomic Policies Foreign exchange liberalization has increased Improved rural incomes and Financial sector reforms and Trade liberalization may profitability of ecotourism based on employment opportunities reduces privatization efforts impose promote economic expansion at environmentally friendly wildlife industry lowland poverty and population harder budget constraints on cost of increased water use (Zimbabwe) pressure on fragile, open access state-owned enterprises, (Morocco) forest lands (Philippines) allowing higher coal prices Agricultural price increases associated with to reduce pollution intensity liberalization lead to agricultural extensification High interest rates lead to increased (Poland) and decline of fallowing and yields (Ghana) deforestation; higher wage rates in industrial sector reduces employment and encourages expansion of both agriculture and deforestation (Costa Rica) Sectoral Policies Livestock promotion policies have discouraged Disadvantageous terms of trade of Low energy and fuel prices Marginal cost pricing of power wildlife resource-based activities (Zimbabwe) agriculture relative to industry encouraged use and promotes energy conservation penalized rural sector, aggravated aggravated air pollution (Sri Lanka) Agricultural subsidies have led to overgrazing of migration into marginal forest lands (Poland, Sri Lanka) arid and semiarid range lands (Tunisia) (Philippines) Underpricing of coal associated with excessive energy intensity Agricultural growth needed to of industry (Poland) reduce deforestation pressures (Costa Rica) Expicit Environmental Increased stumpage valuation Taxation of carbon content Subsidies for industrial and Policies reduces logging but may lead to in fuel use for energy leads agricultural water use expansion of agriculture into forest to less use of "dirty" fuels undermines conservation areas (Costa Rica) such as coal (Sri Lanka) (Morocco) 0 7 Policy Implications EFFEcrTVE DECISIONMAKIG FOR SUSTAINABLE development has been hindered by lack of knowledge about the complex links between economywide policies and the environment. From the economic side, the environmental implications of macroeconomic policies and the adjustment process typically inadequately explored, and from the environmental side, national environmental action plans (NEAPs) rarely contain careful economic analysis. As described below, several practical steps to facilitate the integration of environmental and economic decisionmaking emerge from the case studies. 93 94 VOLUMEI Integrating Environmental quencing of various economywide policies Concerns into Economic and complementary environmental mea- Decisionmaking sures, to minimize environmental damage. The best approach to avoid environmental The preceding discussion shows that the damage would thus be to identify, prioritize links between economywide policy reforms and analyze the most serious economic- and the environment can be complex and environmental linkages, and devise specific usually require country-specific analysis. complementary mitigating measures, when However, while impacts are often too di- economywide reforms are contemplated. verse to be comprehensively traced with Where data and resource constraints pre- precision, many key economywide reforms clude the accurate tracing of such links (ex have specific, identifiable, impacts on a ante), the preliminary screening and priori- much smaller subgroup of priority environ- tization of environmental issues could be mental problems. Some of these impacts followed by establishing contingency plans may be intuitively obvious, and many of and carefully monitoring these environmen- them, with some effort, may be traceable. tal problems, to deal with them if they wors- Even modest progress in this regard is help- en ex post (see the next section on Action ful because the proper recognition of the impact Matrix). environmental benefits of economywide policies will clearly help build support for Action Impact Matrix: A Tool for economic reforms. At the same time, broad- Analysis er recognition of the underlying economic and policy causes of environmental prob- In the context of the foregoing discussion, lems can enhance support for environmental economic and environmental analyses and initiatives-both in terms of environmental policies may be used more effectively to policies, as well as projects. achieve sustainable development goals, by Positive or negative linkages may arise linking and articulating these activities from relative price shifts-changes in the explicitly. Implementation of such an ap- pattern of taxes, trade duties, real wages, proach would be facilitated by constructing exchange rates, and so on. For example, an Action Impact Matrix (AIM)-a simple there are usually strong positive linkages example is shown in Table 7-1, although an between energy conservation and reforms in actual AIM would be very much larger and energy pricing. On the other hand, trade more detailed.' Such a matrix helps to pro- liberalization may encourage deforestation mote an integrated view, meshing economic or overfishing in some cases. Where such decisions with priority environmental and negative linkages exist, the answer is not to social impacts. delay stabilization or the adjustment pro- The first column of Table 7-1 lists exam- gram, but rather to devise specific measures, ples of the main development interventions such as sensible forestry and fishing laws, to (both policies and projects), while the first counteract the possible negative effects. In row indicates some of the main sustainable almost all cases the foregoing conclusions development issues. Thus the elements or will be appropriate. However, it is conceiv- cells in the matrix help to (a) explicitly able that in rare cases involving more severe identify the key linkages; (b) focus attention environmental degradation (especially on valuation and other methods of analyzing where ex ante analysis has carefully pre- the most important impacts; and (c) suggest pared the ground), special care may be required to orchestrate the timing and se- 'Munasinghe 1993a. 7. Policy Implications 95 action priorities. At the same time, the marginal costs to improve energy efficiency organization of the overall matrix facilitates and decrease pollution. Adding pollution the tracing of impacts, as well as the coher- taxes to marginal energy costs will further ent articulation of the links between a range reduce pollution. of development actions-that is, policies Increasing public sector accountability and projects. will reinforce favorable responses to these A stepwise process, starting with readily price incentives, by reducing the ability of available data, has been used effectively to inefficient firms to pass on cost increases to develop the AIM in several country studies consumers or to transfer their losses to the that have been initiated recently.2 First, data government. In the same vein, a major from NEAPs, environmental assessments hydroelectric project is shown in Table 7-1 (EAs), and so forth may be organized into as having two adverse impacts-inundation an environmental issues table that prioritizes of forested areas and villages, as well as one these problems, provides quantitative or positive impact-the replacement of thermal qualitative indicators of damage, and helps power generation (thereby reducing air identify underlying economic causes. Sec- pollution). A re-afforestation project cou- ond, the main economywide policies (cur- pled with adequate resettlement efforts may rent and intended) could be set out in a help address the negative impacts. The second table, together with a brief review of matrix-based approach therefore encourages the basic economic issues that they address the systematic articulation and coordination and potential environmental linkages. The of policies and projects to achieve sustain- information from these two tables is then able development goals. Based on readily combined to develop a preliminary action available data, it would be possible to de- impact matrix. (For an example of this velop such an initial matrix for many coun- process, refer to Tables 7-2-7-4, which first tries. present the environmental issues, then de- This process may be developed further to scribe various economywide policy reforms, assist in analysis and remediation. For and finally combine these two building example, more detailed analyses may be blocks to produce an illustrative Action carried out for the subset of main economy- Inpact Matrix for Sri Lanka.) wide policies and environmental impact One of the early objectives of the AIM- links identified in the cells of the prelimi- based process would be to help in problem nary matrix. This, in turn, would lead to a identification-by preparing a preliminary more refined final matrix, which would help matrix that identifies broad relationships, to quantify impacts and formulate additional without necessarily being able to specify measures to enhance positive linkages and with any accuracy the magnitudes of the mitigate negative ones. The more detailed impacts or their relative priorities. For ex- analyses which could help to determine the ample, in Table 7-1, a currency devaluation final matrix would depend on planning goals may make timber exports more profitable and available data and resources. They may and lead to deforestation of open access range from the application of conventional forest. The appropriate remedy might be to sectoral economic analysis methods (appro- strengthen property rights or restrict access priately modified in scope to incorporate to the forest areas. A second example might environmental impacts), to fairly compre- involve increasing energy prices toward hensive system or multisector modeling efforts. The former approach is used in many of 2For example, Ghana and Sri Lanka. The process the case studies mentioned above. The latter used in Sri Lanka is illustrated in Tables 7-2-7-4. 96 VOLUME I approach is illustrated by the Costa Rica project-level applications in the industrial and Morocco studies where computable countries.4 There is a growing body of case general equilibrium models were con- studies on the environmental valuation of structed that includes both conventional project impacts in the developing countries.5 economic, as well as environmental or However, considerable work is required to resource variables. At the moment, data and extend this experience to cover economy- analytical shortcomings are likely to pre- wide impacts. clude reliance upon general equilibrium or Other (noneconomic) indicators of envi- comprehensive system modeling ronmental and social well-being (both micro approaches. Current efforts constitute a first and macro) also would be helpful in step in this direction-their major contribu- decisionmaking, especially in cases where tion being to identify more precisely the economic valuation was difficult. Tech- information and data required for opera- niques such as multicriteria analysis (MCA) tional policy purposes, and test the strengths may be used to trade off among different and limitations of a general equilibrium economic, social and environmental indica- approach. tors, as a supplement to conventional cost- Thus far, the more successful attempts to benefit analysis. The Sri Lanka case study value environmental impacts in the macro- explores the MCA approach, in attempting economic context, have been based on their to analyze economic-environmental, as well effects on conventional economic output as environmental-environmental tradeoffs. which are priced in the marketplace (supple- The essential point is that even when envi- mented sometimes with shadow pricing ronmental valuation is not possible, tech- corrections). This approach may be linked niques exist that will help to better prioritize up more easily with commonly used market environmental and social impacts, thereby measures of well-being like gross national improving development actions. product (GNP). For example, the new United Nations handbook for the System of Identifying Economic- National Accounts (SNA), includes a pro- Environmental Links posal to supplement the conventional SNA with a set of satellite accounts that reflect As shown above, the better integration of pollution damage and depreciation of natu- environmental issues in economywide pol- ral resource stocks.3 icy analysis will help generate support for Some environmentally and socially cru- economic reforms. However, this can also cial impacts (for example, loss of bio- improve the policy context for environmen- diversity or human health hazards) may be tal initiatives. Implementation of projects as important in certain cases, and they may that have environmental objectives or com- require extension or adaptation of conven- ponents has always been a problem. This tional economic techniques. One step would stems from the fact that it may not be in the be to improve environmental valuation by narrow self interest of the borrowing entity using a wider range of methods which em- to adhere to loan conditions which are pri- ploy both market and on-market information marily of benefit to others in the country. At to indirectly estimate the economic value of the national level, enforcement of standards environmental assets (for example, travel cost or contingent valuation methods). Such techniques have been used quite widely in 4For a recent review, see, for exanple, Freeman 1993. 5For a recent review, see, for example, 3United Nations Statistical Office (UNSO) 1993. Munasinghe 1993a. 7. Policy Implications 97 and regulations often encounters severe port the EA process at the project or invest- institutional constraints. Part of the answer ment level. is to create conditions in which the interests The lessons from the case studies are also of the party causing environmental damage relevant from the viewpoint of those with coincide with the social good-integration explicit environmental responsibilities, of environmental concerns into sectoral and including preparation of National Environ- macroeconomic incentives is therefore mental Action Plans (NEAPs). These docu- required. ments have rarely responded adequately to Overall, the studies discussed earlier the growing need for greater understanding suggest that economic techniques of links between economic policies and the exist-and for most countries, so does environment, and to date none have appar- natural resource information-to improve ently conducted a systematic analysis of the the way environmental issues are addressed economic policies underlying environmental by policies at the sector and macro levels. degradation and, therefore, of the appropri- Although data problems remain, the studies ate ways in which the environment should illustrate the feasibility of carrying out better become part of countrywide economic analyses of the environmental impact not planning. only of projects, but also of economic In providing examples to those responsi- policies-and in particular-adjustment ble for environmental management of the operations. This will hasten the integration way in which economic policies may impact of the environment into the mainstream of upon the environment, the evidence con- economic policymaking. Where the environ- tained in this book demonstrates the kinds of mental impact of the adjustment process is opportunities available for achieving envi- potentially adverse, such studies would form ronmental objectives, not simply in a cost- the basis for identifying measures to coun- effective manner, but indeed often in ways teract these effects (both ex ante or expost); that impose no costs at all upon society. where on the other hand they are likely to be Such opportunities should receive system- positive, complementary measures might be atic attention in country environmental devised to maxirnize such beneficial im- action plans, which would then become pacts. much more operationally useful as inputs This approach is consistent with and into decisionmaking at the macroeconomic supports project environmental assessment or sector policy level. (EA) procedures that are already in exis- In summary, the specific findings emerg- tence in most countries. While the function ing from the case studies are presented of the EA as a proactive instrument of pro- below-grouped according to the principal ject preparation and design is clearly under- ways in which economywide policies inter- stood in theory, more could be done to act with the environment, highlighting how achieve this objective in practice. The "add- they might help in the design of better ad- on" nature of environmental concerns, the justment programs. lack of breadth in identifying relevant is- sues, the limited attention to alternatives and * Removal of major price distortions, pro- the weak mitigation plans in some projects motion of market incentives, and relax- show this to be the case. Clearly, the search ation of other constraints (which are for fundamental underlying causes of envi- among the main features of adjustment- ronmental degradation and the design of related reforms), generally will contribute economic and other instruments at the coun- to both economic and environmental try or sector level could substantially sup- gains. Reforms which improve the effi- 98 VOLUME I ciency of industrial or energy related toring and regulating the discharge of activities could reduce both economic industrial waste. waste and environmental pollution. Simi- larly, improving land tenure rights and * Measures aimed at restoring macroeco- access to financial and social services not nomic stability will generally yield envi- only yields economic gains but also pro- ronmental benefits, since instability un- motes better environmental stewardship. dermines sustainable resource use. For example, stability encourages a longer- Unintended adverse side effects may term view on the part of decisionmakers occur, however, when economywide at all levels, while lower inflation rates reforms are undertaken while other ne- lead to clearer pricing signals and better glected policy, market or institutional investment decisions by economic agents. imperfections persist. Indeed the very These are essential prerequisites for en- success of the adjustment process in couraging environmentally sustainable stimulating economic growth may place activities. pressure on the environment due to inad- equacies elsewhere in the economic, * The stabilization process also may have administrative, or legal system. Specific unforeseen adverse short-term impacts on additional measures that remove such the environment, in some cases. For policy, market and institutional difficul- example, while general reductions in ties may not only be generally environ- government spending are deemed appro- mentally beneficial in their own right, but priate, targeting these cutbacks would be also critical complements to broaden desirable to avoid disproportionate penal- economywide reforms. Typical examples ties on environmental protection mea- include: sures. Another important issue is the Policy distortions: Export promotion and short-term impact of adjustment on pov- trade liberalization might encourage erty and unemployment, which may ag- excessive extraction or harvesting of gravate existing pressures on fragile and natural resources if the latter were under- "open access" resources by the poor due priced or subsidized, for example, low to the lack of economic opportunities. In stumpage fees for timber. this case, appropriate measures designed Market failures. Economic expansion to address the possible adverse social induced by successful adjustment may be consequences of adjustment will be justi- associated with excessive environmental fied even further-on environmental damage, for example, if external environ- grounds. mental effects of economic activities (such as pollution), are not adequately * Economywide policies will have addi- reflected in market prices. tional longer-term effects on the environ- Institutional constraints: The environ- ment through employment and income mental and economic benefits of distribution changes. Several of the ex- economywide reforms could be negated amples confirm one predictable con- by unaddressed institutional issues. These clusion-adjustment-induced changes may include, for example, poor account- generate new economic opportunities and ability of state-owned enterprises; inade- sources of livelihood, thereby alleviating quate land titling; weak financial interme- poverty and reducing pressures on the diation; or inadequate capacity for moni- environment due to overexploitation of fragile resources by the unemployed. 7. Policy Implications 99 However, while growth is an essential the techniques and examples presented in element of sustainable development, it this chapter will be helpful in tracing the will necessarily increase pressures on simpler and more obvious links between environmental resources. Increasing economywide policies and the environ- efficiency and reducing waste, as well as ment. properly valuing resources, will help reshape the structure of growth and re- * Remedies: Where potential adverse im- duce undesirable environmental impacts. pacts of economywide reforms can be identified, targeted complementary envi- Practical Implications ronmental policies or investments should be implemented as soon as feasible-to While the relationships between mitigate predicted environmental dam- economywide policies and the environment age, and enhance beneficial effects. are complex and involve many economic Where linkages are difficult to trace ex and noneconomic variables, immediate steps ante, greater reliance will need to be can be initiated by decisionmakers to im- placed on preparing contingency plans to prove understanding and to start to address be invoked ex post (see below). some of these linkages. Proper recognition of the generally positive environmental * Follow-up: Afollow-up systemfor moni- consequences of economywide policy re- toring the impacts of economic reforn forms could help to build additional support programs on environmentally sensitive for such programs. At the same time, areas (identified earlier) should be de- broader recognition of the underlying eco- signed, and resources made available to nomic and policy causes of environmental address environmental problems that may problems can enhance support for environ- arise during implementation. mental initiatives. The following are key practical steps that can be taken: The complementarity of economic and environmental measures for sustainable * Problem Identification: More systematic development should be used to mobilize efforts are needed to monitor environ- more environmental support for economic mental trends and anticipate emerging reforms, and vice versa. However, the diffi- problems when policy reform proposals culties of analyzing the potential environ- are being prepared. The range of cur- mental impacts of proposed economywide rently available environmental informa- reforms (ex ante), should not be underesti- tion should be analyzed to help identify mated. Linking specific causes with particu- the highest priority pre-existing or emerg- lar effects is especially problematic in coun- ing environmental problems, and their tries where many conditions are simulta- sensitivity to policy measures. Recently neously changing. Nevertheless, many direct initiated work on environmental indica- linkages may be traced using existing meth- tors in the Bank would help supplement ods. Since the better incorporation of envi- existing data. ronmental aspects into economic policymaking could result in substantial * Analysis: Serious potential environmental gains (particularly in the context of adjust- impacts of proposed economywide re- ment operations), more analytical work is forms identified in the problem identifi- needed to better understand the complex cation stage should be subjected to care- links involved. Due to the significance of ful environmental analysis-to the extent social and institutional constraints to sus- that data and resources permit. Many of 100 VOLUMEI tainable development, more attention should focuses initially on the links among a rela- be paid also to the analysis of the social tively small subset of priority environmental impacts of economywide reforms. concerns and a few key economic policy This book has shown how the analytical reforms. In subsequent stages, the analysis process may be strengthened, starting from may be made much more comprehensive. In fairly simple considerations. The various view of its potential contribution as a policy relationships identified here, although based tool to link a wide range of environmental on country-specific work, have been used to processes with macroeconomic and sector develop a general, framework based on the policies, it is recommended that govern- concept of the Action Impact Matrix (AIM), ments give high priority to strengthening which more clearly identifies a country's and refining the building blocks of the Ac- environmental problems in relation to its tion Impact Matrices applicable to their own program of economywide policy reforms country circumstances. and major projects. This stepwise approach Tabk 7-1: Simpk Example Action Impact Matrix (AIM) MATRIX OF OTHER IMPACTS ON KEY SUSTAINABLE DEVELOPMENT ISSUES ACTIVITY/POLICY MAIN OBUECTIVE Land degradation Air pollution Resettlement Others (-H) *Exwhange Rate * Inprove Trade Balance and (deforest open-access I Economic Growth areas) (+M) * Energy Pricing * Inprove Economic and (improve energy Energy Use Efficiency efficiency) * Others * Market Basued ..* (poilution tax) Revrse Negaive Impac of Maket Failures and *Non-Moj*et Based ~~Policy Dist(ions (.iH) (i-M) * Non-farket Basedl i Distortions i (property rights) (public sector accountability) Proiect) (-H) (+M) (-M) * P-jecst I ffHyd-o Dam) . ,. (inundation) (displace fossil (displace people) *Use of Project Evauaton (Cost-Benefit Analysis, fuel use) Enviromnentad Assessments, MuliCritria C(+H) *Project 2 (RW-afforest) Analysis, etc.) . fo) s~~~~~~~~~~~~~ I * Project N i : i ._i Note: A few exanples of typical poices and projecs as well a key envimental and social issues are sbown. Some ilhtve but qualitative impact assestsa also indicated: thus + and - signify bwenicial ad bEmfal impacts, while H and M indicaft high and modrate severiy. The AIM proces focuse on the highest priority enviromental issue and related social c es Tabk 7-2: Exampk of Enviromnental Issues: Matrix Indicators and Causes of Sekected Environmental Problems in Sri Lanka Environmental areas Underlying causes: economic policies, prices, of concern Bio-physical indicators Socioeconomic indicators and institutions Soil erosion and Increasing pressure on land (land-man ratio has declined to 0.38 Productivity losses due to soil erosion estimated in the Land markets are very limited and the resource is degradation ha), as the economy continues to depend on land. range of Rs. 613 to 4,283 million annualy. severely underpriced. This leads to inefficient and distorted aDlocation decisions. Cultivation of marginal lands, particularly the shallow and Tea yields only 52-64 percent of yields in Indonesia, lateritic soils of the wet zone, results in erosion and landslides. India, Malawi, and Kenya Land tenure system results in disincentives for long- Forests have been removed from steep slopes for tobacco term soil conservation measures. This includes poorly cultivation. Erosion rates in neglcted tea lands (up to 30 percent Severe erosion has led to the PolgoDa reservoir silting managed state-owned tea and rubber plantations. of total area under tea) are as high as 40 tons/ha/yr, compared to up to 45 percent of its capacity within only 12 years of an achievable rate of 0.3 tons/ha/yr. operation, resulting in a loss of irrigated area, electricity Subsidies for erosive crops (e.g., potatoes). generation, as well as greater flooding. In the dry zone where land is flat, erosion is not a severe problem. In the case of gem mining, lack of environmental However, the longstanding practice of chena (shifting) cultivation charges or rehabilitation deposits encourages smal is now practiced with greater intensity: very short falow periods scale pit mining operations which do not reflect the have replaced longer ones that made the system sustainable. As a social cost of these activities. resul, soil is becoming inferile and about 1.2 million hectares of land (mostly in the dry zone) are now degraded. Severe land degradation due to gem mining in specific areas (mostly in Ratnapura district). Deforestation and Decline in forest cover from 55 percent of total area (1950s) to 28 Decline in sustainable timber yield due to deforestation Underpricing of timber (royalty only 10 percent of biodiversity loss percent (1980s). NEAP estimates forest area in 1989 at 1.58 is estimated at Rs. 300 million annually. The wood sales value) encourages maximization of current miDion ha (24 percent of total area), with closed canopy forest industry also has been forced to shift to lower quality extraction at the expense of future harvesting. down to 20 percent. Deforestation rate is estimated to be wood. In addition, conversion forest land to chena, 30,000-50,000 ha/yr. poorly managed plantations, or food crops results in Poverty and unemployment leads to encroachment of soil erosion amounting to 5-10 percent of GNP. forest lands (80 percent of which are state-owned, but defacto open access). Urban and industrial Less than 20 percent of the population of Colombo Metropolitan Diseases associated with pollution and poor sanitation Absence of user fees for municpal services results in pollution Area (CMA) is served by sewers. Less than half of CMA's daily constitute the number one cause of morbidity and financially weak municipalities that are dependent on solid waste disposal of 1,200 tons reaches landfills. mortality in CMA. govt. grants. Similar situation prevails in other urban areas as well. CMA is Nationwide, the rate of intestinal infections more than Lack of effluent/emission charges implies that the only urban area with a (partdal) sewer system. doubled to 1,025 per 100,000 population between activities that generate them do not internalize the 1965-84. costs of these damages. Tabk 7-2 (continued) Environmental areas Underlying causes: economic policies, prices, of concern Bio-physical indicators Socioeconomic indicators and institutions Water polution and Water shortage in areas other than the western part of the wet A disproportionate share of public investment has been Lack of effluent charges or enforceable standards. water shortage zone. aDlocated to irrigation, particularly the Mahawei project (pubfic expenditure on this project alone accounted for Fertilizer subsidies result in overuse. Sedimentation of reservoirs and canals in irmgated areas in the 7 percent of GDP in 1982). However, the returns have dry zone. Salinity and watelogging in downstream lands also a not been commensurate. Smal size of holdings (I ha) in Mahaweli, and the growing problem. incentives provided by subsidies, trade policy and Water use is inefficient (biased towards paddy research and extension contribute to excessive Fertilizer residues from paddy cultivation contaminate surface cultivation). Large volume of water is unaccounted for concentration on (water intensive) paddy cultivation, and subsurface water. Poor fertilizer storage is one of the main (39 percent in Colombo) due to leaks, faulty meters and as do land use and cropping restrictions. Area under causes of groundwater polution. illegal connections. high value added cash crops is limited in the Mahaweli, implying suboptimal use of irrigation Extensive water pollution in urban and industrial areas. Nearly The irrigation infrastructure is deteriorating water. 75 percent of Colombo's untreated sewage is discharged into prematurely: funds allocated for operation and the lower Kelani river. Water quality at the city's water intake at maintenance cover only 40 to 60 percent of the actual National water tariff is below marginal cost and the Ambatale often unfit for public water supply. requirement. collection system is relatively ineffective. Cross- subsidies (from low-cost to high-cost regions and from Greater Colomnbo to the rest of the country), discourage conservation. Marine and coastal One-third of the coastine (1,600 km) is subject to varying Potential sites for managed sand mining have largely Virtual open access to coral reefs and coastal fishery resource degradation degrees of erosion. Average annual rates on the southwestem disappeared. resources. and western coasts range from I to 7 meters. Coastal fisheries have declined. Excessive reliance on legislation and laws for the Extensive sand and coral mining aggravate erosion. The latter is protection of coastal resources. Mining of sea coral in most severe along southwestern coast, where approx. 7,700 tons Coastal tourism potential in sites such as Hikkaduwa the coastal zone (a punishable offence under the Coast of coral and coral debris are coDlected annually along a 60 km and Bentota is threatened by fecal pollution of beaches Conservation Act), continues unabated. Though the stretch. and coastal waters. (About 85 percent of tourist demand for coral is a derived demand for construction, revenue comes from facilties in coastal areas. About there has been no focus on economic incentives for Sedimentation and runoff from rivers and agricultural lands, 75 percent of graded hotels and over 80 percent of hotel reducing this (derived) demand by encouraging and inappropriate infrastructure also leads to coastal and marine rooms are located along the coast. Thus, tourism is altemative construction materials. degradation. There is a growing list of mangrove areas and threatened by (as weDl as a cause of) marine and coastal lagoons that have been seriously damaged by polution. resource degradation. In terms of agrochemical runoff, fertilizer and pesticide subsidies are a major cause of overuse. Energy shortage Fuelwood accounts for 70 percent of energy consumption, and Industry is relatively energy intensive, and households Electrcity tariffs are low. Even after a 30.5 percent is used for cooking by 94 percent of households. Puelwood generaDy do not practice energy conservation. Thermal increase in 1993, average tariff (6 cents/Kwh) is shortage forecast in the dry zone by 1995 and for the entire efficiency of traditional stoves is 10-15 percent. approx. two-thirds of the long run marginal cost country by 2000. (LRMC). Households consumers are cross-subsidized (some pay only 15 percent of LRMC). Uneconomic No domestic petroleum. Al large hydropower resources (50 rural electrification percent of hydro potential) already tapped. _3 Table 7-3: Current Economic Conditions and Proposed Reforms in Sri Lanka Macropolcies Current situation/policy regime Ongoing/proposed reforms Government Budget Deficit has crowded out the private sector and driving up real interest rates. Reduce overall deficit (excluding official grants) to 6.5 percent of GDP in 1994, It was 11.6 percent of GDP in 1991. However, in 1992, a I percent through improved revenue performance, consolidation of current expenditures, and reduction in current expenditure and a sharp drop in capital expenditure rationalization of the public investment program. Reduce deficit to 6 percent in the reduced deficit to 7.5 percent, well below the target of 8.6 percent. It went long run. up to 8.1 percent of GDP in 1993. (i) Govt. Expenditures Misallocated: large, unviable investment programs; inadequate maintenance Limit large village-level public works programs; administrative reform, including civil expenditures; excess spending on civil service salaries, defense and debt service reform; $600 million Airbus purchase by Air Lanka should be reconsidered. servicing. (ii) Public Enterprises Losing money: losses at 8 largest ones accounted for half of the deficit in Half of small/medium enterprises already privatized or divested. Complete the 1991; 2 state-owned banks with % of total assets of banking sector are privatization of small/medium enterprises, start with large ones (Air Lanka, sugar insolvent. factories, cement companies, tea plantations)-also see Industry below. However, no sign that hard budgets will be imposed on the ones that remain state-owned (e.g., Ceylon Electricity Board (CEB), Sri Lanka Railways (SLR) and Ceylon Petroleum Corporation (CPC)). CEB's tariffs are to be increased in 1994 & 1995 due to IDA pressure. SLR has been made into an autonomous corporation and an IDA-assisted restructuring program is under way. (May Day package announced by the President actually lowers electricity tariffs!) Scetoral policies (iu) Tax Policy Substantial reliance on indirect taxation (83 percent); arbitrariness A VAT was planned for 1994, but has been postponed by a year to April 1995. (proliferation of tax holidays, ad hoc tax concessions). Progress in computerizing returns continues to be slow. Corporate income tax reduced to 45 percent; elimination of export taxes; simplification of turnover tax (rate bands reduced from 10 to 3). -Infrastructure/Energy Transport, telecommunications, electricity generation are heavily Sri Lanka Telecom Dept. is now a public corporation. In addition, there is now a concentrated in the public sector; backlog of necessary rehabilitation and imited role for private services in this sector. Sri Lanka Railways has been converted maintenance works; inadequate cost recovery; regulatory framework from a govt. department to an independent authority. inhibits private sector entry. No increase in long-awaited tariff and fare revisions for CEB and SLR, respectively; no Ceylon Electricity Board (CEB) and Sri Lanka Railways (SLR) require indication that tariffs in the infrastructure sector in general will be increased towards tariff and fare hikes urgently. In former tariffs are well below long-run long rum marginal cost (LRMC). BOO/BOOT schemes are being actively pursued in marginal cost (LRMC). Level and structure of petroleum prices out of line the power sector. with border price relatives; public import monopoly of petroleum products. Private sector entry allowed in petroleum sector (e.g., blending plant and blending The massive Mahaweli project has been going on since 1970 (almost services privatized and divestiture of retail stations is ongoing). complete now) to provide irrigation and electricity. It is the govt's largest investment project: over 43 billion rupees had been spent by 1987 and the Inadequate operation and maintenance (O&M) is already causing premature total expenditure was then anticipated at 60 billion rupees (Sri Lanka's deterioration of the infrastructure. It is now necessary to focus on maintenance and GDP in 1987 was 200 billion rupees). rehabilitation rather than further investment. Studies by International Irrigation Management Institute (IIMI) indicate there is no economic justification to increase irrigated area such as through the Kalu Ganga project. Table 7-3 (conmin*wd) N Sectorolpe&ies Current situationlpoUcy regime Ongoinglproposed reformns *IndustrylAining Manufacturing most dynamic sector in the economy (grew at 9 percent in 1992). Private Privatization continues, and 23 state enterprises had been privatized by the end of 1992. sector grew at 20 percent and its performance overshadows the sluggish public sector. However, plans to privatize Air Lanka and the two banks have not taken off. Foreign investment remains strong. This should enable the economy to grow and diversify its industrial and export base. Following protests from local gem miners and environmentalists, the government in Januaiy, banned mechanized gem mining in aDl rivers and stream beds in Sri Lanka. Garment industry highly successful (partly due to import quotas in the EC and the United (Possible environmental impacts: destruction of river fauma, lowering of surrounding States). The government set up 200 nural clothing factories by the end of 1992 to promote water table, collapse of river banks leading to flooding in heavy rains.) job growth in rural areas and reduce the current concentration around Colombo-however, many may not be economicaly viable; also this is the only major nonagricultural Comprehensive new mining regulations introduced under an Act in 1992. All current manufactured export. A worrying development is that the United States has imposed a licensed and unlicensed operations involved in exploration, mining, processing, trading or countervailing duty of 3.06 percent on all garment imports from Sri Lanka w.e.f. October export of minerals must acquire new licenses under the act. The act does not cover gems 1993. This is a major blow since the United States accounts for 65 percent of all garment and hydrocarbons. exports. *Agriculture Sluggish growth and narrow export base due to (i) excessive govt intervention in pricing Insufficient political wiUl to implement meaningful reform, especially to relax legislated and trade; (ii) public expenditure excessively oriented toward self-sufficiency in food (free cropping and land use restrictions and to remove nontariff barriers. land and water inputs); (iii) poor O&M of existing irrigation infrastructure. Dominant crops are paddy, tea, rubber and coconut. Most of rubber and tea are exported. Export crop taxation, however, being phased out; rationalization of sugar industry (including privatization of factories); rice, wheat and flour markets partally deregulated; Tea: Output almost back to normal in 1993 after the drought-affected slump of 1992 (also tea and rubber plantations contracted out to private management companies (see below); due to privatization of plantation management). World demand is high and prices are firm. Mahaweli restructuring plan under preparation. There is an urgent need to modernize tea mdustry and increase output of CTC tea (Westem markets) as compared to crthodox teas. (In 1993 CTC tea accounted for only 3.4 The govt. is offering cash subsidies per hectare to tea smaDlholders as weD as rebates on percent of total output; the rest was orthodox tea-this could be a big problem in the fertlizers (environmental dilemma here-fertilizer subsidies bad for the environment, but future ) Tea growers also hampered by high interest rates. Another major problem is required to increase production); tea marketing system to be reformed; regulations on tea advanced age of tea bushes-in 1987 average age was approx 60 years. Only 15 percent of growing relaxed-growers do not have to register tea holdings with the Tea the area under tea had been replanted with HYVs. Low replanting m 1960s and 1970s Commissioner or obtain permits for planting and replanting, establishing nurseries or because high export taxes + low tea prices = low profits; also there was a risk of factories, or selling tea locally. nationalization. There is a proposal to conduct the Colombo tea auction in dollars rather than rupees Rubber- A large number of plantations suffer from old age and neglect; output and area (enabling planters to borrow working capital in foreign currency, at much lower interest have been declining since the 1980s. rates). Coconut: Like tea and rubber, suffers from inadequate replanting. Large proportion of Smallholders, who produce the bulk of the coconut output have not taken advantage of trees old and past optimum productivity levels. Output is on a declining trend due to several subsidy schemes that the govemment has offered to encourage coconut recurring droughts and withdrawal of fertilizer subsidies. production. *Forests Continuing deforestation and degradation of forests through illicit feling and The Master Plan envisages clearing aUl 1.3 million ha of dry zone forest (except 0.5 encroachments which are periodically "regularized"; lax implementation of statutes for milion ha set aside for national parks). The remaining forests are in the wet, intermediate limiting felling; lot of good plans on the books but not implemented. The Forestry Master and mnontane zones (278,000 ha). Of these 159,000 ha (57 percent) wiD be protected and Plan (1987) is the blueprint for this sector for the next two decades. (3 two types of the rest selectively cut. The Plan also recommends reintroduction of the cooperative forests: dry zone and aU other.) reforestation scheme (a highly successful program for raising industrial wood plantations in the dry zone). While a large reforestation program has been implmented, essental folUow-up silvicultural operations are freQuently negkcted. A five-year vrogiram to improve the forests' condition and management started in 1990. Tabk 7-4: Sn Lanka Action Impact Matrix Ecoy policy Agricultural land reform goaLinstrwnents Urban and industria Forest and biodiversity conversion and Energy generation and Water resources depktion Coastal resource polliuion protection degradation conservation and degradation degradation Sectoralfntersectoral price and instutoa reforms: r resource access rights [+] proptty fights [+] decenrizaon and [+] tenurial security wil [+1 introduction of and tenure allowing community- social forestry-type promote investment and community rights over based managnent of institutional support will improve land management fishing and mangrove coastal areas and coral reduce open-access (note: in some cases, resources would reefs could increase tde exploitation of forest and privatization may be encourage better resource incentives to reduce wild}ife resources extewnally imposed on management industrial and agricultual lands that are communally polltion managed, leading to a breakdown of traditional management systems) *pice and subsidy t+I removal of subsidies [+1 improving energy (+] intrducing higher reforms wiUl encourage more prices wil promote more industrial and irrigation efficient/reduced use of efficient energy water fees will encourage agriculturai chemicals generation and use efficiency in water supply and use Prfivaizatio * improve efficiency in [+1 reduce waste in [+] increase efficiency of [+] improve efficiency of [+] promote more use of resources (e.g., resource-based tea plantations, kading to generating plants; with efficient provision of with financial reforms manufacturing better land management pricing reforms (see urban and industrial water and hard budget (note: in lands that are below), it will also reduce supply constaints) governed by traditional energy intensity among conmunal systems, industrial users privatization may be associated with negative effects, as discussed under institutional reforms below) * note private [+] private investments 1+] alienating land for [+] may increase 1+1 new plants tend to be [ together with price investment tend to introduce less plantations or allowing investment in land energy efficient increases, this may reduce polluting technoogy sufficiently long-term improvement access to water by the leascs could promote poor plantation deveopment .CZ Table 7-4 (conminued) Economywide policy PoLlution: industriaL Forest and biodiversity Agricultural land Energy generation and Water resources depletion Coastal resource reform goals/ instruments urban, and coastal protection conversion and conservation and degradation degradation (including coral reefs) degradation Government deficit reduction. * cut expenditures, reduce [-] social and [-] protection efforts may [-] reduced agriculural [+1 reduced energy [+/-] reduced subsidies [-] coastal/coral reef subsidies environmental programs be reduced especialy in extension programs, subsidies also controls will discourage wasteful protection efforts may like urban polution forestry (e.g., Forest Dept. increasing problem of wasteful energy use, but water use but poor further decline (e.g., abatement (e.g., MEI) budget constraints) chena cultivation, soil may reduce access for the communities may have CEA, NARA budget are often the first to be erosion poor reduced access to safe constraints) cut; poorr conmunities supplies often at risk introduce resource rent [+1 reduce pressures on [+] taxation of idle or [+] encourage more [+] promote more taxation and user charges use of forests and neglected lands wiDl efficient use of water efficient use of coastal protected areas and raise encourage land sources resources funds to improve improvement community self- management or government protection services introduce environmental [+1 taxes or charges on [+1 reforestation deposits [+] introduce incentives to [+] tailings or discharge [+] charges or penalties taxes and fees (in contrast emissions or effluents could encourage reduce emissions or fee will reduce water would discourage coral to above instruments, wil increase incentives sustainable logging effluents in energy degradation problems reef and mangrove these are taxes on for abatement; may also generation degradation envirnmental reduce land degradation externalities) from mining 54 Table 7-4 (continued) Economywide poUcy Pollution: industrial Forest and biodiversity Agricultural knd Energy generation and Water resources depletion Coastal resource reform goaWinstrunents urban, and coastal protection conversion and conservation and degradation degradation (including coral reefs) degradation Trade promotion: * expot poo ad -xport stimulus may [+/-] both crop output and [-] outward-oriented foreign exchange increase timber cutting; input prices will be growth will increase liberaization depending on land tenure affected if they are energy generation needs and accountability this tradables; better land may worsen deforestation management is encouraged by higher crop prices if tenure is secure (see tenure issue below) reduce tariffs and other [1+] industria openness [+/-] may initially affect trade barriers is associated with new industrial output and and more efficient employment as inefficient technologies, but absolute firms fail to compete with pollution levels may imports; long-run increase with rapid improvements in resource sectoral growth allocation should increase employment and income, reducing pressures for marginal resource exploitation Industrial promotion: * redice specia indusry [+] special government [+] increased industrial l+] tourism promotion programs and investment industrial projects tend to employment may reduce could generate new jobs, subsidies favor industries pressures on marginal reducing pressure on (especially parastatals) lands coral mining and fishery that are often pollution overexploitation prone; 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ABBREVIATIONS AND ACRONYMS AFC average financial cost AIC average incremental cost AIM Action Impact Matrix BAT best available technology CAC command-and-control (measures) CEB Ceylon Electricity Board CEE Central and Eastern Europe CES constant elasticity of substitution CET constant elasticity of transformation CFC chlorofluorocarbon CFL compact fluorescent lighting CGC Caisse de Compensation General CGE computable general equilibrium (model) CIDIE Committee of International Development Institutions on the Environment c.i.f. cost, insurance, and freight CITES Convention on the International Trade in Endangered Species of Flora and Fauna CMEA Council of Mutual Economic Assistance CSC Cold Storage Commnission (Zimbabwe) DC district council (Zimbabwe) DHE district heating enterprises DNPWLM Department of National Parks and Wildlife Management (Zimbabwe) DSM demand-side management EA environmental assessment EAP environmental action plan EC European Community ECLAC U.N. Economic Commission for Latin America and the Caribbean PEER energy-efficient refrigerator EPRI Electric Power Research Institute ERS export retention scheme ESAP Economic Standard Adjustment Program ETP Economic Transformation Program FGD flue gas desulfurization f.o.b. free on board FY fiscal year GATT General Agreement on Tariffs and Trade GDP gross domestic product GEF Global Environment Facility GHG greenhouse gas GJ gigajoule GNP gross national product GTZ German Technical Assistance Agency (Gesellschaftfair Technische Zusammenarbeit) 119 120 VOLUMEI IAST Institute of Agrarian Studies IPCC Intergovernmental Panel on Climate Change LP linear programming LRMC long-run marginal cost LSS Living Standards Survey MADIA Managing Agricultural Development in Africa MEC marginal external cost MIT Polish Ministry of Industry and Trade MOC marginal opportunity cost MPC marginal private cost MUC marginal user cost NAFTA North American Free Trade Agreement NEAP national environmental action plan NEPP National Environmental Policy of Poland NGO nongovernmental organization NPR nominal protection rate NPV net present value NWMT Nyaminyami Wildlife Management Trust (Zimbabwe) OECD Organisation for Economic Co-operation and Development OED Operations Evaluation Department of the World Bank OLS ordinary least squares OS oil steam-electric p.a. per annum PFBC pressurized fluidized bed combustion PM particulate matter PPGC Polish Power Grid Company PPP Purchasing Power Parity SAM social accounting matrix SNA System of National Accounts SOCB state-owned commercial bank SOE state-owned enterprise SRMC short-run marginal cost T&D transmission and distribution TJ terajoule UN United Nations UNSO United Nations Statistical Office VIDCO village development comnuittee VIM vehicle inspection and maintenance (program) WADCO ward development committee WCED World Commission on Environment and Development WHO World Health Organization WPA Wildlife Producers Association ZIC Zimbabwe Investment Centre i i~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ l THE WORLD BANK 1818 H Street, N.W. 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