Emission licenses - a model for reducing pollution

Kyoto Convention

As part of the 1997 Kyoto Convention, the countries of the world pledged to reduce the emissions of gases that cause global warming to a level 5% lower than their level in 1990. As part of the first phase, only the developed countries (countries Annex A). In order to carry out the reduction operation in the most economically efficient manner, the treaty allows for managing the reduction of trade using the method of tradable pollution licenses (Tradable Emission Permit) . Despite severe political disputes, culminating in the withdrawal of the United States from the treaty, the treaty is expected to enter into force during the year, when it will be ratified by the countries that emit 551 TP3T of the world's greenhouse gases.

The economic theory

The current problem is that there is no economic value to air pollution and global warming. Therefore, firms decide on production technologies and production quantities in a way that does not take into account the social damage caused by the pollution. Since, as part of a standard production process, pollution has a negative marginal cost, it follows that reducing pollution will increase the firm's expenses.

This situation is not optimal in terms of economic well-being, since the entire cost of the pollution is borne by external parties to the firm (citizens, other firms, the government), while all the economic benefits go to the polluting firm, and this encourages inefficient allocation of resources.

Since the goal is to reach an environmental goal (as defined in the Kyoto Convention) while minimizing the economic damage caused, the chosen economic tool is the creation of a free market mechanism. In order to create such a market there are several requirements, the main one being the creation of legal ownership of the pollution. Once there is a property right (and trade), the firms will be able to buy and sell that property right, and this will put the value of the pollution at the most efficient value. Assuming that the companies know how much it costs them to reduce pollution, and assuming that they have no incentive to provide real information to the government, it follows that they should be allowed to trade with each other in order to reach a market equilibrium, which will reflect maximum efficiency.

In the discussed method (tradable pollution licenses), also known asCap & Trade”, according to which the government limits the amount of permitted emissions, dividing this amount into a very large number (to allow liquidity) of pollution licenses. The government provides the licenses, free of charge or for a fee, to the polluting firms and allows them to trade them among themselves.

existing models

There are currently four working models for tradable pollution licenses, and all of them are in the US:

The first, largest and most developed among them is the pollution trade market SO2 among electricity producers in all 48 states, which was announced in 1990 and entered into force in 1995. Started after him, but entered into force before him, a project RECLAIM where companies in the Los Angeles metropolitan area trade in nitrate pollution NOX. In 23 countries in the eastern USA, a market for trade began in 98NOX and in pollution-creating-ozone. Last but not least, a market in volatile carbon compounds started in the Chicago area in 2000 (VOC).

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