Environmental controls: Market incentives v. direct regulation

Cap-and-trade environmental markets, where the commodities are tradable pollution rights, are being introduced in several closely watched applications as a potentially more cost-effective way of cleaning up the environment than direct or command-and-control (CAC) regulation. In this study, we examine the evidence on control cost savings provided by price and transactions data from the first few years of activity in two markets designed to reduce atmospheric pollution. Some observers of both markets have argued that prices for tradable permits lower than expected, and transactions fewer than expected, are evidence that the markets are not achieving the hoped for savings. It was found, on the contrary, that observed prices point toward more flexible and improved pollution control choices and that the number of transactions has been steadily increasing as market incentives are incorporated into enterprise decisions. These new markets during their first few years are generating, according to our estimates, control cost savings in the neighborhood of one to two billion dollars annually. However, there is evidence that the markets have not yet reached their full potential. In the course of this study, several obstacles to market performance were found that are worthy of attention by policy makers. 13 refs., 4more » figs., 1 tab.« less