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Economic Instruments and Clean Water: Why Institutions and Policy Design Matter



During the 1980s, regulatory reform was on the agenda of most governments in industrialized countries. Emanating from the United States, a new philosophy concerning public regulation and the interplay between market and state spread to Europe and beyond. Economic think-tanks, such as the Brookings Institute in Washington, D.C., pointed out how regulation can distort competition and ef- ficiency in the provision of public services, They examined how traditional command-and-control regu- lations can be exchanged for more flexible and efficient regulatory and non-regulatory measures -- measures that have come to be called "economic instruments." By using economic instruments, whether in health services, housing policy or pollution control, governments can employ market forces to secure a more efficient balance between the supply of public services on the one hand, and the demand for and benefits of such services on the other.

Yet the sphere of regulatory reform dealing with economic instruments has inherited some se- rious fallacies from neo-classical economic analysis. The most serious of these is that economic in- struments are often treated in a partial equilibrium analysis; that is, they are considered as complete alter- natives to so-called command-and-control regulations, while institutional issues are more or less ignored. That is, economic instruments are treated in a vacuum that offers little opportunity to understand how the market and its institutions actually function. When institutions are considered at all, they are regarded mainly as barriers to the functioning of market forces. While such presumptions from neo-classical eco- nomics are perhaps ideal for the science of economics, they offer only limited advice to government officials and other practitioners in the field of public policy, who wish to add economic instruments as merely one, albeit perhaps powerful, stimulus in a more complex world of regulations and institutions.

The importance of institutions is becoming better understood. Douglas North (1990) and other neo-institutional economists have pointed out how formal and informal institutions affect the functioning of the market. While some of the first contributions to economic neo-institutionalism implicitly treated institutions merely as obstacles to the market mechanism, North and other more recent writers offer a more sophisticated and differentiated account of institutions. Such economists are coming closer to sociological neo-institutionalism, which treats institutions -- historical, political or social -- as indispensable elements of reality (March and Olsen, 1989).

When governments consider using economic instruments, it is crucial to understand the institutional context in which the market-like mechanism will function. This context is determined partly by other regulations that are in place, but is primarily determined by the "standard operating procedures" through which public regulations are developed and implemented. Fundamental patterns of national policy-making are quite different among countries, but are seldom subject to much consideration because they reflect deep-seated constitutional and historical approaches to governing. Such patterns are repeated time and again as governments define and solve problems, and can be seen as national styles of policy- making (Richardson, 1982). Governments, in the words of North, need to understand such historical paths of institutional change in order to grasp the complexity of their own public policies, and to understand why policies succeed and fail.

This study, by examining the use of economic instruments for water pollution control, shows how national styles of policy-making are important for the choice and design of policy instruments.


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