The Political Economy of Market-based and Information-based Environmental Policies

Contemporary research shows consumers are willing to pay a premium for eco-friendly products, suggesting eco-labels and other information-based policies may be an alternative to market-based policy tools. Emission taxes and tradable permits incentivize pollution reduction through monetary penalties, thereby punishing dirtier firms. Eco-labeling, instead, incentivizes pollution reduction through monetary rewards, allowing producers to leverage environmentally concerned consumers’ willingness-to-pay to increase their profits. A comparison of emission taxes and eco-labels illustrates a “carrot” versus “stick” approach to environmental policy. Both approaches yield environmental benefits; however, the political nature of environmental policy can create scenarios where the socially-optimal environmental policy is not implemented. This paper compares the political and economic impacts from traditional market-based policies to the popularized use of information-based eco-labels. The political nature of environmental policy suggests the “stick” provides an unpopular but effective environmental guidance, whereas the “carrot” shifts cost to consumers and yields only minor environmental benefits.