Environmental Finance: Innovating to Save the Planet *

This article demonstrates that it is not only possible, but urgently necessary, to apply principles of finance and economics—efficient use of scarce capital, price transparency, and lowered transaction costs—to environmental issues. From limiting acid rain with the sulfur dioxide‐allowance market to the implementation of the Clean Water Act, market‐based solutions have proven consistently more effective in protecting the environment than government regulation alone. Project financing, public‐private partnerships, and tradable permits have come to supplement or replace conventional command‐and‐control regulation and purely tax‐based instruments. Tradable permit systems have been deployed to phase down use of leaded gasoline, end the use of ozone‐depleting chloro‐fluorocarbons, and even reduce air pollution in the smoggy skies above Los Angeles. And the United Nations Environment Program has launched a Finance Initiative as a formal means of mobilizing the financial sector to take a more active role in protecting the environment. Such an approach can minimize the aggregate costs of achieving environmental targets while providing dynamic incentives for the adoption and diffusion of greener technologies.