Choice of environmental policy instrument in developing countries: an application to fire regulation in the Brazilian Amazon

Abstract Market-based instruments are increasingly incorporated into developing countries’ environmental regulation, which has historically been dominated by command-and-control (CAC). To discover whether this shift can enhance efficiency, the two policy instruments are compared in the context of agricultural fire regulation. We unveil optimal policy principles, such as incentivizing compliance proportionally to non-compliance’s net benefit. A simulation based on data from Brazilian Amazon municipalities accounts for ambiguous land tenure, indirect deforestation and non-additionality. The results reveal that CAC, when perfectly sanctioned, is more efficient than market-based policy. Such primacy is exacerbated in the realistic case where sanctions are likely to be cancelled on appeal to the judicial power and legally limited in size, because of the opportunities to better address adverse selection and to generate revenue with fines. Therefore, we show that market-based policy is not necessarily superior to CAC and that imperfect sanctioning does not inevitably lead to inefficiency.