The efficiency of indirect instruments for waste externalities: Integrated approaches to environmental policy

Transcription

1 The efficiency of indirect instruments for waste externalities: Integrated approaches to environmental policy Paper prepared for the 14 th EAERE 2005 Conference June, 23-26, Bremen (Germany) ABSTRACT: Although traditional policy prescriptions suggest the use of direct instruments on pollution, the literature has extensively proposed indirect instruments for the optimal correction of waste externalities. Based on a literature review exercise, this paper shows that the confluence of both the risk of illegal disposal, which prevents the use of direct instruments, and the existence of different options for waste control (output, substitution and disposal effects) demands a comprehensive approach. Production, consumption and disposal decisions need to be influenced by indirect instruments to execute the optimal mix of waste control options. The efficiency of indirect instruments rests on the material and technological interdependencies between the different material flows along the product s life-cycle. These interdependencies affect the number, types and optimal level of instruments and, then, constitute the essence of an integrated approach to waste management. Keywords: Waste management, direct and indirect policy instruments, life-cycle approach.

2 1. Introduction Traditional policy prescriptions for pollution control suggest the use of direct economic instruments (mainly taxes/subsidies and tradable permits) on (point) pollution for its optimal or cost-effective correction. However, post-consumption wastes generation and disposal can be considered as a non-point pollution problem to which, therefore, the classical Pigovian model cannot be applied (Bowers, 1997). 1 I. e., there are difficulties in applying direct instruments 2. So, indirect instruments 3 for the optimal control of post-consumption waste externalities have been proposed in the literature as alternative to the traditional instruments. The downstream versus upstream instruments debate has emerged from this literature. This debate is equivalent to the direct versus indirect instruments debate on the relative advantages and disadvantages of direct and indirect instruments on non-waste pollution (see e.g., Sandmo (1976), Balcer (1980), Wijkander (1985), Stevens (1988), Common (1977, 1989), Eskeland and Jiménez (1992), Eskeland and Devarajan (1996), Schmutzler and Goulder (1997), Vatn (1998), Fullerton, Hong and Metcalf (1999), Fullerton and Wolverton (2000)), but referred specifically to waste pollution. In contrast to other discussions on the relative advantages of the different types of instruments (e.g., CAC regulations versus economic incentives; price versus quantity instruments), both debates account for the important point that the relative advantages of the different instruments (mainly in terms of efficiency and monitoring and enforcement costs) depend heavily on which variables/factors they target. This paper pays attention to the downstream versus upstream debate to show that the efficiency of indirect instruments is based on the adoption of more integrated/comprehensive frameworks that allows an integral view of the waste management problem. Comprehensive frameworks has been adopted through the development of general and partial equilibrium models that account for the interdependencies between material flows (inputs, outputs and pollution), and the corresponding interdependent monetary flows, involved in (post-consumption) waste generation and disposal. The approach used for the determination of optimal indirect instruments for the waste management problem is, in general, more integrating than that used in other pollution problems for the same purpose. 4 Generally, material and technological interdependencies 5 considered fall both within and beyond the processes (consumption) from which wastes are generated. 1 This author notes also that this form of non-point pollution has the peculiarity that it is managed by bodies which represent sources of point pollution. See Chapter 8. 2 Those that tackle (price or regulate) pollution flows directly. 3 Those that tackle pollution flows indirectly by pricing or regulating flows/factors material and/or technologically associated with pollution flows. 4 For a review on the use of indirect instruments on non-waste pollution see Granero-Gómez (2005). 5 Material interdependencies refer to the interdependencies between the different material flows (inputs, outputs and pollution) derived from the material-balance principle. Technological interdependencies refer to the interdependencies derived from technologies in used. 1

3 Specifically, the relevant phases in the life-cycle of the consumption good the so-called waste chain are included in a comprehensive characterisation of this type of polluting processes. It is argued in this paper that this change in approach towards a more integrated one has been motivated by the recognition that the implementation of direct taxes on waste disposal in the Pigovian fashion, the so-called user charges, might incur in a problem of cross(intra)-media pollution 6. Consumers facing an user charge for legal waste disposal might have incentives to dispose of their post-consumption waste illegally (dumping, burning, etc.), and so avoid the charge. Furthermore, the existence of several options for the control of the generation and disposal of solid wastes also requires the adoption of comprehensive frameworks when optimal (indirect) policies are to be designed. The aim of this review paper is to contribute to the debate about comprehensive versus piecemeal approaches to environmental policy by establishing the need for a life-cycle approach for the optimal (indirect) control of waste externalities. The purpose of the paper is twofold: First, to review the literature about indirect instruments on waste externalities that focuses on their efficiency properties. And second, to draw its main results together to produce a (stylised) framework within which direct and indirect instruments for waste management can be compared, and from which indirect policies can be optimally designed. An integral view of the waste generation and disposal problem is provided in sections 2 and 3. The former identifies the different options for the control of waste generation and disposal, and, therefore, the effects through which instruments can operate. The latter examines, first, the reason for which an indirect policy approach is required for waste externalities, the potential for cross-intra media pollution, and second how this potential risk and the existence of different control options affect the design of optimal policies. Section 4 analyses the wastes reduction options that the most common instruments for waste management can exercised and, based on this, provides a novel categorisation of direct and indirect instruments. Next, indirect (optimal) policies proposed in the literature that can replicate the effects generated by optimal direct instruments are reviewed, first, when waste minimisation and disposal reduction measures can be taken (section 5.1), and second, when in addition source reduction measure are also available (section 5.2). Finally, section 6 offers some concluding remarks. 2. Options for waste disposal reduction The waste management problem comprises two (sequential) aspects, first the generation of waste and, second, its disposal. Strictly speaking, it is waste disposal what provokes environmental costs. Therefore, from the efficiency point of view, the optimal level of waste refers actually to the optimal waste level to be disposed of. Nonetheless, the prevention of waste 6 This term refers to the transfer and/or transformation of pollutants from one receptor media/area to 2

4 from reaching final disposal can be exercised through the decrease of the level of disposal itself as well as the reduction of the level of waste generated. Options for waste disposal control might, then, involve either a reduction of waste disposal or a decrease in waste generation. In other words, instruments for waste management can affect waste generation and/or waste disposal. Particularly, they can operate through an output effect (or substitution in consumption), a substitution effect (or substitution in production) and a disposal effect (or substitution in disposal method). 7 The output effect reflects the effect (increase) on output price that the implementation of an instrument might bring about (through the increase of the overall production costs) and the consequent substitution of the waste generating good by a substitutive one. Therefore, it generates a reduction in the consumption of the waste-generating good (i.e. a reduction in the level of the polluting activity), and so decreases the quantity of waste generated (waste minimisation measure) 8. The size of this effect depends on the possibilities to substitute in consumption the waste-generating good. The substitution effect derives from a substitution in production (changes in technologies, types and/or combinations of inputs, etc.) that lowers the amount of waste generated per unit of output. It entails the adoption of measures that make the waste-generating good cleaner by reducing its waste content. These are called source reduction measures. The size of the substitution effect depends on the elasticity of substitution in production. In sum, instruments that operate through an output and/or substitution effect affect waste generation. Additionally, depending on the type of waste, a reduction in the waste rate per unit of output can also be achieved at the (post)consumption stage when consumers can undertake actions to reduce the amount of waste. For example, consumers can reduce the amount of waste to be disposed of by reusing it. Therefore, options for waste disposal control might also be available at the consumption stage. Instruments that target this stage and aim at inducing waste reduction efforts by consumers will affect waste disposal since the level of waste to be disposed of will diminish. This effect will be called disposal effect or substitution in disposal method at the (post)consumption stage. Consumers will reuse waste instead of finally disposing of it. As the substitution effect, the disposal effect makes the waste-generating good cleaner. Strictly speaking, a disposal effect reduces the amount of waste disposal per unit of output. Finally, another option for waste disposal control is available at the final disposal stage. Once post-consumption waste has been generated according to the consumption level, wastecontent of the good and consumers waste reduction actions, consumers might still decide another. 7 Output and substitution effects are defined in Fullerton, Hong and Metcalf (1999) for the case of instruments on non-waste pollution. 8 Waste minimisation measures or strategies are commonly used to refer to the so-called three R actions: reduce, reuse and recycle (see e.g. Sathiendrakumar, 1996). 3

5 whether to dispose of waste or to dedicate it for recycling purposes. 9 Then, instruments might target this final stage in an attempt to pursue consumers to take recycling instead of final disposal decisions. In this case, instruments will generate a reduction in waste disposal by operating through a disposal effect or substitution in disposal method at the disposal stage. Therefore, in general, an important difference between non-waste and waste externalities is that policy instruments can operate through an output and/or a substitution effect for the control of the former (Granero-Gómez, 2005), while instruments to control the latter can work additionally through a disposal effect. A disposal effect can be induced by enhancing both recycling and other consumers waste reduction actions. In this sense, waste reuse can be considered as a disposal option, and so other waste reduction actions. Whether or not consumers waste reduction efforts are considered to include recycling and other waste reduction actions, like reuse, is not important. Both contribute to waste disposal reduction through a substitution in disposal method, and therefore, both can be termed disposal reduction measures. It is important, however, to recognise that recycling, as an alternative disposal option, has a certain particularity. This particularity derives from the fact that the result of this option for waste disposal reduction, the recycling material, is or can be used in the production of the waste-generating good as, at least, an imperfect substitute for the corresponding virgin material. Thus, the recycling material supplied by households 10 might be demanded by producers. 11 Recycling material may, then, be subject to market forces if a market for it emerges. In the best case, in which the recycling material market develops, this market will likely fail in recognising the (external) environmental benefits derived from recycling. Waste recycling constitutes a substitutive clean disposal option to final (legal) waste disposal. While waste disposal generates environmental costs, waste recycling does generate environmental benefits since external costs are avoided when wastes are not disposed of. 12,13 This failure will yield a sub-optimal level of 9 Choe and Fraser (1998b) do not distinguish between recycling and consumers waste reduction actions. Waste reuse and recycling are examples of efforts that consumers can make so as to reduce waste. By contrast, Morris and Holthausen (1994) distinguish between recycling and waste reduction actions. These actions can be undertaken by consumers prior to their decision on either recycle waste or dispose of it as garbage. 10 Households recycling decisions might be highly conditional on time costs since time is a scarce resource. 11 The process of recycling might be carried out by a separate recycling sector in which case, recycling firms will demand recycling material from households and offer recycled material to good producers. 12 The environmental benefits of recycling as an alternative cleaner disposal option are discussed in Sigman (1995), Ready and Ready (1995), Highfill and McAsey (1997) and Huhtala (1997, 1999). 13 Of course, recycling material, as a substitute of virgin material in the production process, might generate additional environmental benefits when that raw material is an scarce resource and/or its extraction has externalities associated (see, e.g. Hoel (1978), Dinan (1993) and Huhtala (1994)). On the other hand, recycling can also have associated environmental costs when the recycling process generates some type of pollution, and it has attached some external costs since its use contribute to the production of the waste-generating good. 4

6 recycling as disposal method, if any is produced by market forces the private or financially optimal level of recycling. In general, the existence of different disposal options makes the waste management problem different from the remaining pollution problems. Choe and Fraser (1998a) note that the problem of waste disposal is much more complicated than a standard externality problem. The reason is that the problem of waste disposal encompasses two aspects. The first one relates to the optimal amount of waste generated and to be disposed of. The second is related to the optimal way in which that optimal amount should be disposed of or as it is called by the authors the optimal mix of available waste management technologies (p. 276). Post-consumption waste can be either (dirtily) disposed of on, for example, landfill or (cleanly) recycled. However, this is not the case of emissions and effluents. The deposition of pollutants into air and water does not have, a priori, an alternative option for discharge; i.e. if everything in production is fixed, pollutants will be released either into air or into water. Nonetheless, one can argued that when polluting agents can decide on the type of pollution control technology to be installed and these decisions are considered, the possibility to discharge pollutants into alternative receptor media might appear. If this is so, then, substitutive options for the disposal of pollutants are available and non-waste pollution problems become similar to those of waste disposal (or recycling). In sum, if the potential for cross(intra)-media effects exists, the control of non-waste externalities also require the determination of both the optimal pollution level and the optimal mix of disposal methods. (Granero-Gómez, 2002). However, the difference still remains in that the new disposal options available are not clean ones and they are not or cannot be subject to market rules. Theory predicts that the use of taxes/charges in the Pigovian fashion to deal with postconsumption waste (the so-called waste disposal or user charges) will induce the efficient level of waste generation and disposal. The Pigovian tax/charge per unit of waste set on consumers at the disposal stage will give perfect incentives to them to (self)select those measures that in a cost-effective manner reduce waste generation and/or disposal. The optimal mix of output, substitution and disposal effect will so be generated. Consumers might decrease the consumption level of the waste generating good. Source reduction measures may also be adopted when, sending consumers appropriate signals to producers through the market, the latter undertake substitutions in production methods that lower the good s waste content. Finally, consumers might also be induced to adopt disposal reduction measures by increasing recycling and/or other waste reduction actions. The combination of all these measures will generate the optimal amount of waste and the optimal mix of disposal options. In sum, the Pigovian tax/charge would operate through an output, substitution and disposal effect to achieve the efficient outcome. 5

7 In order to induce appropriate consumption, production and disposal decisions through the use of alternative instruments, the different phases in which these decisions are taken (production, consumption, recycling and final disposal) need to be considered and targeted by the different alternative instruments. As Menell (1990) recognises, the correction of solely one of these distorted decisions can lead to unintended effects. An optimal policy should address systematically all decisions that affect the problem. Consequently, a comprehensive framework should be adopted in order to include all the relevant stages in the life-cycle of the wastegenerating good. Eskeland and Jiménez (1992) argue that, in general, the use of more than one instrument to deal with only one externality is provoked by the impossibility of using direct instruments on the source of the externality due to monitoring problems. When monitoring of pollution sources are not costless, the different decisions that affect pollution should be influenced by indirect instruments. This argument, which is demonstrated for non-waste pollution problems in Granero-Gómez (2005), is confirmed by Choe and Fraser (1998b) for the case of postconsumption wastes. Although monitoring problems might be serious for legal waste disposal, it is the possibility of waste illegally disposed of and the unfeasibility to monitor illegal disposal what prevents, in a greater extent, the use of direct instruments. 3. Cross(intra)-media pollution in the waste management problem: illegal disposal As already mentioned, the potential of cross(intra)-media effects exists in the waste management problem as in other pollution problems. They, basically, take the form of illegal waste disposal. Strictly speaking, the problem can be interpreted as one of intra-media effect in which the correction of a type of pollution (legal disposal) generates other type (illegal disposal). External costs from illegal disposal constitute the policy failure attached to direct economic instruments on legal waste disposal. Waste illegally disposed of is the result of behavioural responses of consumers to traditional (Pigovian) policies that tackle directly the source of the externality. 14 Then, legal and illegal disposal become interdependent material (waste) flows in the presence of user charges (Dobbs, 1991). Specifically, they became substitutive since, other things being equal, the decrease in legal disposal will be at the expense of increasing illegal disposal. The potential of cross-media pollution in the waste management problem does not alter the social optimum since transfers of waste from legal to illegal disposal are not welfare improving. The social optimum entails only waste legally disposed of due to the higher environmental costs associated with illegal disposal. In other words, illegal disposal is 14 The substitution between legal and illegal disposal when the cost of the former raises is empirically examined in Sigman (1994). 6

8 not part of the optimal mix of disposal methods. As a consequence, it should be fully prevented or avoided. Indirect instruments are then needed to avoid potential cross(intra)-media effects, and this requires the adoption of a comprehensive framework in which all material and technological interdependencies are considered. Alternative optimal policies for waste management rest on the (material and technological) interdependencies between the different material flows along the relevant phases in the life-cycle of the consumption good (the waste chain). They are conducted by the two facts mentioned, first, that post-consumption waste disposal can be reduced through substitution in consumption, substitution in production or producers waste reduction efforts, and substitution in disposal method or consumers waste reduction efforts; and, second, that there exists the possibility of wastes to be illegally disposed of. In a comprehensive (informal) analysis, Choe and Fraser (1998b) highlight the interdependence of policy instruments for optimal post-consumption waste management. Their analysis is used here to emphasise how both the risk of cross(intra)-media effects (illegal disposal) and the existence of different options for waste disposal control affect the design of optimal policies. 15 They characterise optimal waste management policies intended to avoid illegal disposal for different types of wastes. Two waste types are considered. First, that for which consumers cannot take waste reduction actions (i.e., no disposal effect can be generated) and, second, that for which they can (i.e. a disposal effect can be induced). In the first case, the quantity of post-consumption waste generated and disposed of depends on the quantity consumed and the waste content of the good the latter being determined by firms waste reduction effort. In the second one, the quantity of waste generated depends on the same factors, while waste disposal depends additionally on consumers waste reduction effort (recycling, reuse and other waste reduction actions). Firstly, when the optimal reduction in waste generation and disposal can be fully generated thought a substitution effect (and output effect), the efficient outcome can be achieved by targeting the production stage in which the waste-content of the good can be reduced according to firms reduction efforts. 16 Firms can be subject to control such that the appropriate waste reduction effort is made and, thereby, the socially optimal amount of post-consumption waste is achieved. Environmental costs from legal waste disposal can be, then, indirectly internalised by a tax on the waste-content instead of a waste collection/disposal charge. Furthermore, the whole 15 It should be noticed that Choe and Fraser (1998b) only mention explicitly waste reduction efforts made by producers (substitution in production) and consumers (substitution in disposal method) as ways to reduce post-consumption waste. However, they refer implicitly to the output effect. In describing the effects of a tax on the good s waste-content on producers, it is stated that the consequent increase in marginal production costs will lead to a higher consumer price and so to a reduce in consumption (p. 25). Similarly instruments intended to affect consumers choice of disposal method affect the level of consumption (p. 29). 16 See section 4 for instruments for wastes disposal control. 7

9 social (private and external) costs from legal disposal can be fully covered by such environmental tax when no price is charged for waste collection. Indeed, the waste-content tax is an optimal policy when both consumers can react to waste collection charges by disposing of waste illegally, and monitoring illegal disposal is either impossible or highly costly. Consumers will dispose of waste illegally whenever costs they will incur in doing that are lower than charges for legal disposal. Therefore, a continuum of optimal policies is available to the regulator in which the disposal charge might range between zero, as the lower bound level, and the private cost of illegal disposal, as the upper bound level. The difference between the charge level and the social cost of legal disposal will have to be covered by the waste-content tax on producers. All these policies will induce legal waste disposal. Secondly, these optimal policies, however, will not attain the social optimum if consumers can undertake actions to reduce wastes. With this type of wastes, a substitution in disposal method might be required to attain the socially optimal level of waste disposal. In this case, a positive charge set at the disposal stage is needed to induce consumers to make waste reduction efforts. The lower bound of the disposal charge is precisely the private cost of illegal disposal, for which monitoring costs will be zero, provided consumers prefer to dispose of waste legally when private costs of legal and illegal disposal are equal. A level below that will decrease consumers incentive to reduce waste, while maintaining monitoring costs. On the other hand, a disposal charge set at the level of the full social cost of legal disposal will provoke too much illegal disposal and, hence, monitoring costs. Therefore, a positive waste-content tax is also needed with this type of wastes to cover the difference between social costs of legal disposal and the disposal charge. Furthermore, since incentives for illegal disposal are given by a disposal charge set at its lower bound, monitoring of and fines for illegal disposal are necessary to induce compliance with legal disposal. In the first case, apart from the consumption decision, there is just one decision (the firms decision on the good s waste-content) affecting the waste management problem, while in the case just described the consumers decision at the disposal stage (the choice of disposal method) also affects the level of the externality. Therefore, since the waste-content tax cannot correct the latter distorted behaviour, the disposal decision should be influenced by an instrument targeting the corresponding stage. If the instrument used for this purpose is a disposal charge, a trade-off emerges between two of the objectives pursued: the increase of the consumers waste reduction effort and the prevention of illegal disposal. When consumers cannot take waste reduction efforts, policies that can optimally correct the post-consumption waste problem might include either one instrument (the waste-content tax) or two (the waste-content tax and the disposal charge). Paradoxically, the whole system can be controlled by an indirect instrument alone, but it cannot be controlled with just one direct tax on the source of the externality. The latter necessitates the support of an indirect instrument 8

10 upstream in the waste chain to fully cover social costs of legal disposal. This is due to the existence of potential cross(intra)-media pollution. On one hand, the waste-content tax can internalise the environmental or social cost of legal disposal but, because of its indirect character, without provoking any behavioural response from consumers. On the other hand, the disposal charge can provoke such responses giving rise to unintended environmental costs or, in other words, to a policy failure. Since this failure cannot be directly controlled because of monitoring problems due to the fully unobservable character of illegal disposal-, it should be prevented by setting an adequate disposal charge (equal to or lower than private costs of illegal disposal) and completing it with a waste-content tax to fully cover social costs of legal disposal. Therefore, in this latter case, two instruments are required to deal with an existing market failure and a potential policy failure: current externalities from legal disposal and potential externalities from illegal disposal, respectively. 17 A third instrument, monitoring and fines, is in addition required to prevent illegal disposal when consumers can undertake waste reduction actions. This is because illegal disposal cannot be avoided by implementing both the waste-content tax and the disposal charge. The consideration of a new determinant of post-consumption waste (consumers waste reduction effort) implies that an indirect policy towards the waste problem needs to target both producers (by the waste-content tax) and consumers (by the disposal charge) decisions such that the corresponding optimal effort levels are induced. As mentioned above, there is a trade-off between incentives to reduce waste and to dispose of waste illegally that the disposal charge should face. If the charge level solving the trade-off induces illegal disposal, then illegal disposal should be prevented through an enforceable regulation against it (monitoring and fines). This arises when the optimal level of consumers waste reduction effort requires a disposal charge greater than the private cost of illegal disposal. The situation is then a secondbest one since illegal disposal is either generated or prevented at the additional costs of monitoring and the establishment of fines. Therefore, the risk of illegal disposal and the possibility of substitution in disposal methods jointly determine that three instruments are required to deal with both a market and policy failure. The analysis developed by Choe and Fraser (1998b) assumes that consumers actions to reduce waste are unobservable and, therefore, impossible to control directly. This fact determines the second-best nature of the solution to the waste management problem when consumers can affect the amount of waste to be disposed of. Should consumers waste reduction effort be observable, it could be directly tackled by other instrument than the disposal charge (as 17 This situation does not arise if the potential of cross-media effects does not exist. This occurs when social costs of legal disposal are lower than private costs of illegal disposal. While this situation is unlikely per se, an enforceable regulation against illegal disposal (with a suitable scale of penalties) might increase its private costs considerably. Then, the problem is in fact corrected with a combination of 9

11 in the case of firms waste reduction effort tackled by the waste-content tax). Then, no trade-off would arise between the objectives of inducing reduction actions by consumers and preventing illegal disposal. Consequently, the first-best optimal control of waste externalities could be achieved through a set of indirect instruments affecting the different decisions that determine waste generation and disposal. However, it cannot not be attained through direct instruments (charges) on waste disposal since illegal disposal is induced. This is so unless direct instruments are coupled with indirect ones (as with the first type of wastes) to cover the social costs of legal disposal above the private costs of illegal disposal, and the efficient mix of substitution and disposal effects is so induced. Strictly speaking, some actions that consumers can be undertaking to reduce waste, e.g. reuse, cannot be observable at all. Hence, the solution to the problem will be a second-best one attained by a policy package containing both direct (disposal charge) and indirect (waste-content tax) economic instruments, and direct regulations (monitoring and fining of illegal disposal). However, if recycling is considered, then observations might not be so difficult to obtain. If so, this alternative (clean) disposal method can be enhanced directly by a recycling subsidy. The first-best is then attainable by a set of indirect instruments that both affect the different decisions determining waste generation and disposal, and prevent illegal disposal. Furthermore, given that recycling is or can be subject to market forces, when the recycling behaviour of consumers i.e., the level of recycling material supplied is difficult to observe, the recycling level can be measured by the quantity of recycling material demanded and used by producers. In other words, the efficient level of recycling can be induced by targeting the production stage through the subsidisation of its use in production. Producers, then, will send appropriate signals through the market to consumers who will be induced to alter their current inefficient decision on disposal methods. In short, a disposal effect will be generated indirectly by targeting the production stage. Summarising, there is not scope for direct (Pigovian) instruments for the optimal correction of post-consumption waste externalities. Some scope, however, exists for indirect instruments on waste disposal. Optimal waste management policies depends on both (a) the risk of a cross(intra)-media pollution process that is not part of a media-integrated social optimum, and (b) the existence of several options for waste disposal control located at different stages in the life-cycle of the waste-generating good. Generally, the risk of illegal disposal prevents the use of disposal charges, unless coupled with indirect instruments affecting the decisions that determine waste generation and disposal. These indirect instruments should cover the social costs of legal disposal above the private cost of illegal disposal. This private cost represent the upper level of the disposal charge that prevents illegal disposal. This problem does not appear disposal charge and direct regulation against illegal disposal. This policy generates a second-best solution since the direct regulation entails additional costs. 10

12 with indirect instruments. By affecting all the decisions determining waste generation and disposal, they can both correct optimally (legal) waste disposal and prevent illegal disposal. The first-best can be attained. Nonetheless, the exception occurs when some of the determinants of waste generation and disposal cannot be directly tackled, but only indirectly through disposal charges, what gives incentives to illegal disposal. In this case, both the (unobservable) character of some of the options for waste disposal control and the risk for illegal disposal prevent indirect instruments to attain the first-best optimum. Thus, the first-best solution can be achieved neither by a direct policy nor by an indirect policy package. A second-best can only be attained through the combination of direct and indirect (economic) instruments on legal disposal and direct regulations on illegal disposal. Indirect instruments for waste disposal control can be said to be superior to direct ones since they do not give rise to additional environmental costs (from illegal disposal). Furthermore, indirect instruments can complement direct ones when, due to the risk of illegal disposal, limits are imposed on the upper value that direct instruments can adopt. Specifically, these restrictions require the use of either indirect instruments or the combination of both direct and indirect ones to attain, according to the observable/unobservable character of the options for waste control, the first or the second-best. In order to allow for the whole range of technological, material and allocative among agents options for waste disposal control, all relevant processes or economic activities conforming the life-cycle of the consumption good should be explicitly considered. Since indirect instruments target directly all these options, the design of optimal alternative (indirect) policies to waste management requires the adoption of comprehensive frameworks in the sense just mentioned. In the next section, the most common instruments for waste management are analysed in terms of the waste reduction options they exercised or, in other words, in terms of the effects they can induce to reduce waste generation and disposal. 4. Instruments for waste disposal control There are several instruments that can be used to alter the non-optimal consumers and producers behaviour. The most common ones are waste-content taxes (virgin material or packaging taxes), product charges, waste collection/disposal charges (user charges), recycling subsidies, recycled content standards, and deposit-refund systems. The definition of direct and indirect instruments in terms of the direct or indirect pricing/regulation of pollution flows, and in terms of target and control flows can be applied to instruments for the correction of waste externalities. From the listed instruments waste collection/disposal charges are direct instruments, while the remaining ones are indirect. In the waste management problem, direct and indirect instruments can also be defined and distinguished in terms of the effects induced to reduce waste generation and disposal. 11

13 As stated in section 2, a waste collection/disposal charge (direct economic instrument), which is targeted at the disposal stage, will provide incentives to consumers to choose the costeffective mix of options to reduce waste generation and disposal: reduction of the consumption level and change in disposal method. The substitution in consumption towards goods with lower amount of intrinsic waste will give incentives to producers to reduce it through a substitution in production. The cost-effective mix of output, substitution and disposal effect would be generated. In sum, direct economic instruments can operate through these effects to reduce waste generation and disposal by inducing waste minimisation, source reduction and disposal reduction measures. Indirect economic instruments might operate either by an output effect, or an output and substitution effect, or an output and disposal effect or just by a disposal effect. Instruments targeted at the production stage (waste-content taxes) will provide incentives to producers to adopt appropriate methods to reduce the amount of waste per unit of output, i.e., source reduction measures. Since the tax, or the actions induced, would increase marginal production costs, the consumer price of the good would rise thereby reducing consumption and, thus, generating an output effect. The waste-content of a consumption good can be defined as the fraction in weight of the good that would have to be disposed of at the end of its useful life. Then, the tax rate will be set per unit of weight of the good for final disposal. This waste-content tax can take the form of a virgin material tax (i.e., an input tax) when the use of virgin material in production contributes directly to the waste content of the good. When this material can be recycled, then the virgin material tax might instead generate a disposal effect if producers, who might increase the demand for recycling material as substitutive of the virgin one, send appropriate signals to consumers through the market to increase their level of recycling. Again, when this substitution between virgin and recycled material rises overall net production costs, an output effect could be incited if that increase reduces the demand for the consumption good. Alternatively, the waste-content tax can take the form of a packaging tax, which prices the packaging or container of the product, when waste generated by the good consumption comes from its packaging. The tax rate can be set, for example, per unit of container or per unit of weight of the package. 18 In this case, the tax would operate through a substitution and, possibly, output effect. Indirect economic instruments targeted at the consumption stage, product charges (or taxes per unit of output) 19, will alter consumption behaviour by directly affecting the price of the waste-generating good. Hence, product charges work through an output effect or substitution in consumption. A product charge set on producers would equally induce a reduction in the level 18 A packaging tax of these characteristics is designed in Fullerton and Wu (1998). 19 This instrument is also called disposal tax. To distinguish it from the direct tax on waste disposal (the waste disposal tax), the terms product charge or output tax will be hereafter used. 12

14 of the polluting activity, i.e., the consumption of the waste-generating good to the extend that the tax can be shifted to consumers though a price increase. To generate appropriate incentives, the charge would have to be related to the waste disposal impacts. 20 Although recycling subsidies to consumers are targeted at the disposal stage, they tackle other flow than the final disposal of wastes. Specifically, they tackle the flow of wastes to be recycled. The induced change in the relative prices of the different disposal options affects consumers disposal decision. Final waste disposal will be substituted by recycling. To give appropriate incentives, the subsidy would have to be based on waste disposal costs savings. Recycling subsidies operate, then, through a disposal effect. Given that recycling material flows are guided by market rules, the same type of incentive to consumers can be provided by subsidising the use of recycling material in production. Then, producers will send signals to consumers through the market to increase the level of material recycling provided. Recycling content standards on producers impose the quantity of recycled material (generally as a proportion of the total material used) that have to be employed in the production of a waste generating good. Clearly, this type of indirect command-and-control regulation for waste management generates a disposal effect, although they are instruments targeted at the production stage. In the face of a recycled content standard producers would eventually have to substitute virgin by recycling material, increasing the demand for the latter. A higher price for recycling material will give incentives to consumers to change their disposal behaviour (disposal method), providing for recycling wastes that were previously devoted to final disposal. If the fulfilment with a recycling content standard raises overall net production costs, an output effect might in addition be generated if the increase in costs reduces the demand for the consumption good. Deposit-refund systems are essentially the combination of a product charge and a recycling subsidy. 21 Rigorously speaking, they are not pure instruments, but in fact constitute (indirect) policy packages. The waste reduction effects induced are those generated by the single instruments included in the scheme: an output effect generated by the product charge and a disposal effect provoked by the recycling subsidy. 22 Deposit-refund schemes might be constituted by other combinations of instruments (taxes and subsidies). The tax represents the deposit which will be partial or totally returned through the subsidy. The following table summarises the waste reduction effects through which the different instruments for post-consumption waste control operate. Direct economic instruments can exercise all possible options to reduce waste generation and disposal. They induce consumers 20 Turner and Pearce (1994) suggest that a product charge might in principle induce a change in the amount of waste per unit of output (p. 260). In other words, that a product charge can operate through a substitution effect. This is because they identify a product charge with a packaging tax. 21 For a review of experiences in deposit-refund systems see Fullerton and Wolverton (1999). 22 For an analysis of deposit-refund systems see, e.g., Bohm (1981). 13

15 and producers to adopt all measures available in consumption and production for waste control, or the most appropriate (cost-effective) combination of them. By contrast, indirect (economic and CAC) instruments can exercise only some of the waste control options. They can operate through an output effect (product charges), a substitution and output effect (packaging taxes), a disposal and, possibly, output effect (virgin material taxes and recycled content standards), or a disposal effect (recycling subsidies). Hence, indirect instruments can miss the disposal effect or the substitution effect or both, or the output and substitution effect. In other words, the difference between direct (economic) and indirect instruments for waste control rests on the latter missing some of the effects necessary to reduce waste generation and disposal in a costeffective (optimal) manner. Table 1: Types of waste reduction effects induced by the different waste management instruments Types of policies Types of effects on waste control Direct economic instruments: Collection/disposal charges Indirect economic instruments: Packaging tax Virgin material tax Product charge Recycling subsidy Indirect CAC instruments: Waste generation control Output effect Substitution effect Output effect Substitution effect (Output effect)* Output effect Waste disposal control Disposal effect Disposal effect Disposal effect Recycled content standard (Output effect)* Disposal effect Source: See text * Brackets mean that the effect might not be always generated. It depends on circumstances. Economic instruments for waste management are grouped by Fenton and Hanley (1995) into three categories. These are: purchase-relevant instruments, discard-relevant instruments and jointly-relevant instruments. Purchase-relevant instruments are defined as those that affect the pricing of the waste-generating good. The consumer price can be altered directly or indirectly through, for example, a product charge and a waste-content tax respectively. This category includes then all instruments that affect the consumption decision, and would include all instruments analysed above that generate an output effect. Therefore, purchase-relevant instruments cannot be identified with either direct or indirect instruments. The second category refers to those instruments that affect the disposal behaviour of consumers by altering the relative prices of the different disposal options. Then, discard-relevant instruments refer to those 14

16 direct or indirect instruments that operate through a disposal effect. 23 Finally, the last category refers to those instruments that affect both consumers consumption and disposal decisions. Therefore, direct economic instruments (disposal charges) and deposit-refund schemes are included within jointly-relevant instruments. The literature also distinguishes between upstream and downstream instruments. They are implemented, respectively, up and down in the waste stream. In terms of flows, upstream instruments aim at correcting flows other than waste ones, while downstream instruments target the latter flows. One might initially think that direct instruments correspond with downstream ones, and indirect with upstream instruments. This equivalence, however, is not perfect. While all upstream instruments are precisely indirect instruments, downstream instruments might refer to both direct and indirect ones, e.g., waste disposal charge and recycling subsidy respectively. Basically, this distinction corresponds to that between purchase-relevant and discard-relevant instruments. A debate has emerged about the convenience of using upstream instead of downstream instruments. The debate refers to the possibility of using upstream instruments to replicate the effects of downstream optimal instruments. Strictly speaking, then, the debate is one concerning direct versus indirect instruments. In sum, the downstream versus upstream debate corresponds to the direct versus indirect instruments debate for the postconsumption waste generation and disposal problem. 5. Indirect optimal policies for waste externalities 24 In this section, a review of the literature on waste management is carried out to identify the different alternative (indirect) policy packages proposed for the control of waste externalities. Each policy package is examined in terms of the type of waste of concern, its different determinants, and the number and types of instruments composing the package. For each instrument, the (material) flow at which it is targeted, i.e. the control flow, and the instrument optimal level are identified. How each policy package attains the social optimum, i.e. generates the (optimal) mix of waste reduction effects that replicates a Pigovian disposal charge is investigated. Finally, the review highlights how the design of optimal indirect policies rests on the consideration of the material and technological interdependencies existing between the different flows involved in the post-consumption waste problem. Policy packages reviewed include indirect instruments or combination of direct and indirect instruments. Deposit-refund systems, or the combination of output taxes and recycling 23 Note that, according to Table 1, indirect CAC regulations should also be considered discard-relevant instruments. 24 Choe and Fraser (1998a) carry out a review of the theoretical and empirical literature on waste management. The theoretical literature is reviewed to see how policies proposed address the two aspects of the waste management problem: waste generation and mix of waste disposal methods. The review of the empirical studies focuses on the estimations of the magnitude of the disposal effect. 15