Market Mechanisms

updated December 2016

If nature is being destroyed on account of its exclusion from contemporary economics, then nature’s best hope is to become part of the market itself. In the context of raising finance, that is the philosophy of “market mechanisms” for sustainable development. If people and businesses value nature, let them do so by the tried and tested means by which they value familiar goods and services.

In its simplest form, this approach is known as “payment for ecosystem services.” A business or government service dependent on a local ecosystem – such as a forest that provides water security – has a commercial interest in paying the community that lives in the forest region for protecting the environmental service.

Extrapolating this example to the global scale, the international community has an interest in protecting the world’s tropical forests, in order to reduce emissions from deforestation and to protect biodiversity.

Unfortunately. the opportunity cost to local owners and communities of not cutting the timber and not clearing the land for agriculture exceeds the amount that public or private sector aid budgets of the richer countries are willing to pay.

However, many private sector sources of finance are willing to pay the full price of protecting forests if in return they receive something of tangible value to their business, over and above the greater human need of a stable climate.

The concept of “carbon credits” was devised to fulfil this need. Companies can “offset” their credits against excessive emissions for which the business is responsible or sell them in the market. Demand for carbon credits can be created through targets for businesses imposed by governments to deliver their pledges to cut emissions.

This type of full-blown market mechanism is controversial. Many environmentalists describe carbon credits as a “licence to pollute” because they relieve pressure on the buyer to cut emissions. Some object in principle to putting a price on functions in nature which are critical to human life. They observe that it is impossible to calculate the cost of restoring an extinct species or an ecosystem which has totally collapsed.

Campaigners fear that market mechanisms for carbon will spread to biodiversity, water and soil, subsuming nature into the ether of speculative investment. The chronic failure of markets in the 2008 banking collapse and in subsequent rocketing food prices provides strong supporting evidence for these opponents to the “commoditisation of nature.”

Further evidence lies in the poor performance of  pioneering market mechanisms for sustainable development – the Clean Development Mechanism of the Kyoto Protocol and the European Emissions Trading Scheme. Unambitious national and global targets for emission reductions, beaten down by corporate lobbyists, have reduced the price of carbon credits to the point that they fail in their purpose.

Market mechanisms have therefore struggled to gain wholehearted acceptance by parties to multilateral environmental agreements such as the UN Framework Convention on Climate Change or the Convention on Biological Diversity. Whilst the 2015 Paris Agreement on climate change endorses the potential of market mechanisms, the talismanic scheme for Reducing Emissions from Deforestation and Forest Degradation (REDD) is running years behind schedule.

The weakness of opponents to market mechanisms is their failure to articulate alternative methods of financing the actions necessary to achieve sustainable development. The theoretical basis of the carbon market is robust, if politicians can muster the resolve to regulate it effectively.

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IFC Launches Innovative Forests Bond
The private sector lending arm of the World Bank raises capital by offering a yield of carbon credits which place a value on the protection of forests

from International Finance Corporation


Developing Water Markets – Jennifer Morris, Executive VP of Conservation International looks at some projects which pioneer market mechanisms in water

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