Controlling Pollution Using Economic Instruments in Competitive Electricity Markets: The Challenges of Multilevel Governance

In Australia, as in many other developed countries, reforms are taking place which aim at liberalising electricity markets and opening them up to more competition. The hope has been that this will achieve a market for electricity which is more efficient, provide more cost reflective prices and achieve better environmental outcomes. The relationship between market-based structures for electricity industries and improved environmental outcomes is problematic, however. The environmental sensitivity of Australian utilities has not been helped by their public ownership and frequent use by state governments as agents of economic development, so that while putting them on a more commercial footing might remedy past problems, it is by no mans clear that the full range of externalities associated with electricity generation will necessarily be addressed without putting in place policy mechanisms which will create incentives for improved environmental performance. Federal systems such as Australia permit a degree of diversity in how states address such questions, but the existence of distinct subnational political units can also create problems relating to competitiveness between utilities operating in different jurisdictions but trading in a single market. Similar issues are likely to arise in the European Union, where, under the subsidiarity principle, there are analogies with federal states,¹ and more widely in competitive markets across national boundaries. This paper demonstrates these problems by exploring issues which have arisen as the result of different policy settings being adopted by states for pollution control by electric utilities, and notes that the national government in Australia has been reluctant to exercise jurisdiction to address these problems. The commission of the European Union has been less reluctant to use issues such as climate change to enhance its competence. The paper suggests that this reluctance in Australia stems from the potential for national approaches to provoke conflict between the states in the Australian federation, and argues that while this reluctance is appropriate for pollutants with predominantly local impacts, climate change issues are likely to require a greater role for the Commonwealth than it has thus far been willing to assume.