When Green Markets Backfire
Herweg, Köszegi & Schmidt "Some Simple Economics of Green Markets" CRC Discussion Paper No. 572
Green markets are often viewed as a natural complement to environmental policy. If some consumers are willing to pay more for low-externality goods, then certifying such goods, separating green from brown markets, and integrating green markets across regions should help reduce harmful production.
In “Some Simple Economics of Green Markets”, Fabian Herweg (University of Bayreuth), Botond Köszegi (University of Bonn) and Klaus M. Schmidt (LMU Munich, Project B01) show that this intuition is incomplete. The environmental effect of green markets depends crucially on the relation between conscious demand and green supply. Market separation or integration reduces externalities only if demand from environmentally motivated consumers is sufficiently large relative to the available supply of green goods.
If this condition is not met, a demand displacement effect can arise. Once green goods become more easily identifiable or more widely tradable, conscious consumers shift toward them. But if some green output was previously consumed by standard consumers, these consumers may be displaced into brown consumption. In that case, brown production (and hence externalities) can increase, even though green consumption by conscious consumers rises.
The paper therefore qualifies the standard “one market for one good” principle in the context of environmental externalities. Green markets can be useful, but they do not automatically reduce emissions. Their effectiveness depends on empirical market conditions, especially the relative size of conscious demand and green supply.
This has direct implications for policy design. Green certification, green electricity markets, and emerging markets for low-carbon steel, cement or chemicals should not be assessed in isolation. Their effects interact with subsidies, quotas and other supply-side policies that may expand green production beyond conscious demand. In such cases, additional market differentiation can become counterproductive.
The broader lesson is simple but important: Whether green markets reduce environmental harm depends on the equilibrium response of all consumers, not only on the intentions of the environmentally conscious ones.
Link: Some Simple Economics of Green Markets
