Are markets good or bad for the environment? This is at best an ill-posed question. Markets are often perceived as an entity with a personality, goals and methods, as if they had a life of their own. However, markets are simply the environment where buyers and sellers exchange goods and services with or without money involved.
Under certain circumstances, markets work very well to improve our individual and collective well-being and profits. If we voluntarily trade – as buyers or sellers – we do so because we are better off trading than not. That doesn’t mean we will necessarily be happy after we trade, but we would be worse off if we didn’t.
Unfortunately, however, markets sometimes fail to provide what is best for society. This is the case with pollution and environmental degradation in general. Take the case of air pollution, for example. When a factory produces a good for sale in the market and pollutes the air in its production process, it generates some costs that fall onto the victims of air pollution. These victims may not even be part of the market transaction that motivated the production decision in the first place. We say that the market failed to promote what is best for society in this case, because the polluter ignored some of the costs of production (pollution nuisance that the victims have to deal with). When buyers and sellers look only at their private gains after they trade, they ignore the pollution damages that are generated and nevertheless end up on society’s balance sheet.
What is the solution then? How do we make sure that we carefully account for pollution costs so that markets promote what is best for society? Instead of restricting or getting rid of markets associated with environmental degradation, the solution might be to create a new market for the unaccounted for pollution damage. That is, ironically, markets sometimes fail because some other markets are missing.
In our air pollution example, one policy prescription is to have the polluting firm buy the right to pollute. This will cause the price of the polluting good to reflect the full costs of production, including that pollution damage that used to be shifted onto others. With higher prices of polluting goods, pollution will fall either because consumption decreases or because the polluter develops cleaner technologies to avoid pollution costs.
This is the idea behind the famous carbon markets, where carbon permits, also known as carbon credits, are bought and sold. Some European countries use these carbon markets as a means to curb emissions of greenhouse gases stemming from other markets. Perhaps surprisingly, in some cases, it is possible to use markets to help us solve market failure problems such as pollution. In other cases, though, the pollution markets themselves might fail and we might need to consider other environmental policies. Markets do not exist to either hurt or protect the environment. They exist to enable exchange. Like in the case of so many other social issues, when it comes to the environment, markets are neither good nor bad. Markets are simply markets.