Academic journal article Agricultural and Resource Economics Review

Cap-and-Trade: The Evolution of an Economic Idea

Academic journal article Agricultural and Resource Economics Review

Cap-and-Trade: The Evolution of an Economic Idea

Article excerpt

Over the past three decades or so, emissions trading has evolved from an idea that was little more than an academic curiosity to its current role as the centerpiece of the U.S. program to control acid rain and international programs to control greenhouse gases. This essay identifies some of the key milestones of this evolution, describes how that evolution was shaped by economic analysis, elicits some of the lessons about the design and effectiveness of emissions trading that have emerged from analysis of that evolution, and points out a few of the barriers that lie in the path of achieving a truly global carbon market.

Key Words: emissions trading, cap-and-trade, climate policy

From its inauspicious beginning as an idea that was little more than an academic curiosity, emissions trading has matured into its current role as the centerpiece of the U.S. program to control acid rain and international programs to control greenhouse gases. What explains this rather remarkable transition? This essay identifies some of the key milestones of this evolution, describes how that evolution was shaped by economic analysis, elicits some of the lessons about the design and effectiveness of emissions trading that have emerged from that evolution, and points out a few of the barriers that lie in the path of achieving a truly global carbon market.

Early History

By the late 1950s both economists and policymakers had formed quite well developed and deeply entrenched visions of how pollution-control policy should be conducted. Unfortunately these two visions were worlds apart.

Economists viewed the world through the eyes of Pigou (1920). Professor A.C. Pigou had argued that in the face of an externality, such as pollution, the appropriate remedy involved imposing a per-unit tax on the emissions from a polluting activity. The tax rate would be set equal to the marginal external social damage caused by the last unit of pollution at the efficient allocation. Faced with this tax rate on emissions, firms would internalize the externality. By minimizing their own costs, firms would simultaneously minimize the costs to society as a whole. According to this view, rational pollution control policy involved putting a price on pollution.

Policymakers, on the other hand, preferred controlling pollution through a series of legal regulations, ranging from controlling the location of polluting activities to the specification of emission ceilings.

The result was a standoff in which policymakers focused on quantity-based policies (Kelman 1981), while economists promoted price-based remedies (Kneese and Schultze 1975). During the standoff, the legal regimes prevailed. Taxes made little headway.

In 1960 Ronald Coase published a remarkable article in which he sowed the seeds for a rather different mindset (Coase 1960). Arguing that Pigou's analysis had an excessively narrow focus, Coase argued that by making property rights explicit and transferable, the market could play a substantial role not only in valuing these rights, but also in ensuring that they gravitated to their best use. To his fellow economists, Coase pointed out that a property-rights approach allowed the market to value the property rights (as opposed to the government in the Pigouvian approach). To policymakers Coase pointed out that the then existing legal regimes provided no incentives for the rights to flow to their highest-valued use.

It remained for this key insight to become embedded in a practical program for controlling pollution. John Dales (1968) pointed out its applicability for water and Tom Crocker (1966) for air.

Theoretical Foundations

The appeal of emissions trading comes from its ability to create incentives that are compatible with achieving a prespecified environmental target at minimum cost even in the absence of any regulator information on control costs. Under this system, permits (authorizations to emit a specific amount, usually one ton, of a specific pollutant) are either auctioned off or distributed among emitters on the basis of some criterion such as historical use. …

Search by... Author
Show... All Results Primary Sources Peer-reviewed

Oops!

An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.