Economic Policy Instruments (EPIs) are incentives designed and implemented with the purpose of adapting individual decisions to collectively agreed goals. EPIs are traditionally classified in: pricing (e.g. water tariffs), environmental taxes and charges, subsidies (on products and practices), trading (e.g. tradable permit for pollution or water abstraction, compensation mechanisms, payments for environmental services) and finally voluntary agreements and risk management schemes (such as insurances or liabilities). EPIs can significantly improve an existing policy framework by incentivising, rather than commanding, behavioural changes that may lead to adaptation.

EPIs can spur behavioural change through incentives or disincentives, change conditions to enable economic transactions or reduce risk. In the last decades, economic instruments have received increasing attention as a way forward in environmental management, due to their capacity to align individual decisions with collectively agreed goals and promote sustainable economic growth. The main advantage of these instruments is their economic efficiency, i.e. the ability to distribute the burden of the distortion and reduction where it is cheaper to do so. The drawbacks are on the equity side, as they affect differently different agents or social groups not necessarily in a progressive way, and strictly linked to this, important drawbacks are on the political feasibility side.

Economic policy instruments have been applied in a diverse range of environmental policies. Emission trading schemes have been for example developed for climate change mitigation policy and EPIs have been also used in the context of air quality, climate change adaptation and energy policies. In the latter case, policy instruments have been applied to improve energy efficiency, including energy taxes, regulations fixing a minimum level of energy efficiency, and Tradable White Certificates (TWC) for energy saving. The project EuroPACE intends to develop an innovative financing mechanism to boost energy efficiency investment in existing residential buildings. The WEATHER “Weather extremes: impacts on transport systems and hazards for European regions” FP7-funded research project provides an overview of possible incentives to transport adaptation and their potential impact.

Application of EPIs to water policies presents specific characteristics and challenges. The most recurrent EPIs in the water sector are tariffs, taxes and charges, but also subsidies and cooperative schemes are broadly applied. In Europe, trading schemes on water quantity, which are popular in Australia and USA, have been limited to few cases located in Spain, England and Wales. A good overview of economic instruments applied to the water sector and references to case studies are provided by the EU-funded project EPI-Water. The project produced a large body of evidence about the different types, design features and outcomes of water-related economic policy instruments in place as well as about the practice guiding their selection and implementation. The assessment exercise is one of a few comprehensive and consistent (e.g. employing the same assessment principles) ex-post reviews of EPIs in water resource domain in Europe, and in many cases the first one to have shed light on the use of instances of economic instruments across the EU Member States.

Adaptation Details

IPCC categories
Institutional: Economic options, Social: Behavioural
Stakeholder participation

Not surprisingly, public participation is a crucial element in increasing the general acceptance of EPIs and in motivating stakeholders to participate. This is not to say that public participation is always required to make the EPI acceptable. For example, the importance of public participation may be reduced in cases where the EPI as such, or the specific solution EPI intends to promote, has already gained public (social) acceptance.

Success and Limiting Factors

When dealing with the application of EPIs, there is substantial variation in the needs, opportunities, and constraints facing each country. Even within countries, there is a substantial variation in the capacity to implement economic instruments across different regions or sectors. Some desired changes are easier to implement through economic instruments while others are easier to implement through command and control regulations. EPIs are by no means substitutes for other modes of governmental action, but instruments that can complement and strengthen governance as part of a broad mix of policy instruments. Broadly, it is possible to discern between: (i) combinations of EPIs, as part of a strategy for “packaging incentives”, and (ii) mixing with other types of policy instruments, including regulatory, awareness raising, information, etc. When screening potential EPIs, one should be aware of the existing policy mix, but the selection should not be dictated by it.

Costs and Benefits

The costs and benefits of EPIs are hardly investigated, and little information can be found on how they compare to classical command and control approaches.

The costs of an EPI can be distinguished between the direct costs (e.g. cost of paying the tax) and transaction costs (e.g. the time and money cost of getting to the market, finding a buyer or seller, negotiating a purchase, consummating the trade, and returning from the market). Transaction costs might also relate to additional monitoring required. For example, the transaction costs from monitoring groundwater or surface water may impede the adoption of a tax (e.g. tax on the disposal of polluted drainage water on a volumetric basis), but it may also be worth paying to make sure the tax is effective. Likewise, a new water allocation mechanism may increase economic efficiency but impose high negotiation and enforcement costs, making simpler allocation mechanisms potentially preferable.

The benefits of EPIs include improved environmental quality and economic efficiency as well as a better social distribution of the burden to achieve the desired objective. At the same time, EPIs raise revenue (in the case of charges) in order to finance pollution monitoring and control or allocation activities, for instance, and can be therefore relevant for financing adaptation measures.

Implementation Time

The design and implementation of EPIs could take from 1 to 5 years.

Life Time

EPIs are normally long lasting measures. However, lifetime is often determined by the policy framework, the specific legislation in place and social acceptance.

Reference information


OECD, (2016) Reforming economic instruments for water management in EECCA countries - Policy Perspectives.

OECD, (2009) Strategic financial planning for water supply and sanitation. A report from the OECD task team on sustainable financing to ensure affordable access to water supply and sanitation.

Rey, D., Pérez-Blanco, C.D., Escriva-Bou, A., Girard C., Veldkamp, T., (2019). Role of economic instruments in water allocation reform: lessons from Europe. International Journal of Water Resources Development, vol. 35, issue 2, pp. 206-239.

(PDF) Application of economic instruments for adaptation to climate change. Final report (

Published in Climate-ADAPT Sep 3, 2016   -   Last Modified in Climate-ADAPT May 17, 2024

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