Some assets are overused or underprovided - why?

Policy failures

The overuse or underprovision of an environmental asset can sometimes be the result of policy interventions to correct market failures that in turn have consequences for another set of problems-leading to a policy failure in the case of the latter. For example, countries may implement policies-to improve the competitiveness of certain products, industries, regions, or to support particular social groups-that have adverse environmental impacts. When the social costs outweigh the social benefits, this constitutes a policy failure, requiring offsetting corrections or even elimination of the policy intervention.

So-called perverse subsidies are an example. Many subsidies are introduced initially to stimulate the use of a good or service that is underutilized-fertilizer, electricity, water. But in the absence of sunset clauses, and with the creation of a constituency based on perceived acquired rights, these subsidies can persist beyond their economically useful life and be detrimental environmentally. They can be economically costly if they sustain processes that would otherwise not be viable (for example, producing rice in California). They can also be economically harmful if they reduce the costs of environmental inputs to the point that eventual degradation of this complementary asset affects productivity (for instance, power subsidies in India encouraging the overpumping of ground water-box 2.7) or if in attempting to benefit one activity, they harm others, so that their net impact is negative.⁶⁵

Energy subsidies,⁶⁶ the bulk of which are directed to fossil fuels⁶⁷ in both industrial and developing countries, entail economic efficiency losses. But they also have highly deleterious effects on the environment, some reflected in higher economic costs.⁶⁸ Subsidies to fossil fuel and nuclear energy in Organisation for Economic Co-operation and Development (OECD) countries total $71 billion annually.⁶⁹ Studies that simulate the effects of removing coal and other energy subsidies-either for individual countries or the world-all find significant environmental benefits in reducing CO2 emissions. And most studies that look at the economic effects also find real GDP gains.⁷⁰ The problem is not limited to industrial countries. While many developing countries significantly reduced their energy subsidies in the 1990s, they would still gain considerably by removing the subsidies altogether (table 2.3). Although it is often argued that these subsidies are needed to help poor people, the poor rarely benefit.

In general, subsidies encourage the use of the supported inputs, processes, or products-and reduce the incentives to find alternatives that may be more economically efficient. Fuel subsidies to fossil fuels reduce the incentive to develop renewable energy sources.⁷¹

Although dismantling perverse subsidies may be good for society, some groups would lose. For example, studies looking at the effects of removing energy subsidies in industrial countries point to a significant loss of jobs in the coal sector (although there would be real GDP gains associated with their removal).⁷² Social considerations may thus call for incentive-compatible transfers and compensation (see chapter 7, box 7.7), as well as other support (vocational training for other jobs) to enable the transition out of perverse subsidies.