Are green markets an alternative to pollution laws?
by Michael Rothchild
ith the threat of nuclear annihilation behind us, we
might have hoped that humanity would get a decent breather before facing
its next crisis. No such luck. Just as the ICBMs were being taken off launch
status, the prospect of global environmental catastrophe took center stage.
The threat of nuclear winter was superseded by global warming, the East/West
confrontation turned into the North/South conflict, and the global summit
relocated from Geneva to Rio de Janiero.
Far be it for me to question the thinking of the world's
leaders and media big shots, but is it possible that the central issue of
the environmental crisis, like the root cause of the Cold War, has been
overlooked? In case you've forgotten, despite the incessant media focus
on Pershing IIs, SS-20s and their deadly ilk, the East/West struggle never
was about nuclear weapons. The threat of instant incineration was a symptom,
not the cause. The conflict grew out of two radically different visions
of "the good society."
The socialists held that complex social problems are
best solved by central planning and strict command-and-control regulation.
The capitalists argued that solutions to such problems cannot be planned,
but must emerge spontaneously from the decentralized interactions of free
market forces. We all know which view proved more accurate, but when it
comes to solving our environmental problems, that lesson already seems to
have been lost.
From Rio to Washington to every state capital and village
council, environmental debates center on the specific details of proposed
regulations. Are they tough enough? Are they broad enough? Do they demand
compliance fast enough? Hardly anyone, including the business people involved,
dares ask whether regulations are the best tools for solving our environmental
Why? In part because we've been taught that pollution
is a prime example of "market failure." This is false. Except
for a handful of recent experiments, pollution markets have not been tried.
Something that doesn't exist cannot logically be said to have failed. Market
absence is not market failure. Like stock markets and future markets, "green
markets" will work, but certain systems must be put in place before
trading can begin.
For example, Congress could set up a new environmental
trust fund called the "EcoTrust." The EcoTrust would be authorized
to auction off EcoTrust pollution permits. Ownership of a permit would grant
its holder the legal right to emit a specific quantity of a certain pollutant.
For instance, a one-ton sulfur-dioxide (SO2) permit would allow a company
to discharge one ton of that chemical each year. If the Environmental Protection
Agency caught the firm releasing an amount in excess of its permit quantity,
it would be slapped with stiff penalties.
EcoTrust permits would be issued just once. Like deeds
to real estate, the permits could be resold and subdivided an indefinite
number of times, but no additional EcoTrust permits could be authorized
after the initial offering. To determine the permitted pollution levels,
Congress would select a "base year" - say, 1988 - when 15 million
tons of SO2 were dumped into America's air. The Treasury Department would
then auction off 15 million tons of SO2 permits. Thousands of firms, each
in need of certificates, would bid against each other to secure these property
The market easily could be extended to other pollutants.
Chemical makers would bid for various hydrocarbon permits. Auto manufacturers
would bid for "auto emission" permits, since each vehicle sold
would be required to carry a permit to cover its lifetime emissions. Private
and public, large and small, every organization and individual polluting
the air or water, would have to own enough EcoTrust permits to cover their
use of formerly free resources. And the final prices of products would reflect
their permit costs.
At first glance, one might think a polluter loses the
incentive to reduce emissions once it has purchased a permit, but this ignores
the fact that no one wants to tie up money in paper issued by the EcoTrust.
If an electric utility is forced to buy $30 million worth of SO2 permits,
that's $30 million unavailable for investment, or several million dollars
a year in foregone earnings. Under the permit systems, pollution's costs
will show up where they belong - on the polluter's annual profit and loss
Under the present regulation-based system, it makes
powerful economic sense for polluters to drag their feet by lobbying and
litigating with state and federal agencies. The longer a company can put
off installing mandated anti-pollution equipment, the more it saves. Stiff
resistance to environmental regulations makes economic sense. Delay, in
and of itself, is profitable.
But a green market in pollution permits instantly reverses
this logic. For the first time, it would cost polluters money not to reduce
emissions as soon as possible. Any change in a firm's operating methods
or technology that cuts emissions for less than the cost of a permit would
become economically sensible. In effect, establishing a market price for
a pollutant puts a price on its head. If the market priced SO2 for $1,000
per ton, then any new technology that could scrub a ton for significantly
less would get a trial in the marketplace.
By contrast, under today's command-and-control system,
innovation by pollution-cleanup firms has been sluggish. Before developing
a new product, environmental technology firms must know what technical standards
the EPA will mandate next. Besides, firms selling anti-pollution gear have
no way to cost-justify their equipment to potential customers. No matter
how cheap an anti-pollution technology gets, it can't beat the alternative
free dumping. In short, with today's laws fixing the cost of pollution at
zero, the normal capitalist process of technical innovation, cost reduction
and performance improvement cannot get rolling.
But if green markets existed, society would employ the
signals that entrepreneurs and corporations understand: revenues and profits.
By placing a fluctuating dollar value on air and water, the market will
instantaneously stimulate desired changes in our collective economic behavior.
Creating green markets in pollution rights would establish a set of information-feedback
loops linking the economy to the ecosystem. As in every other aspect of
economic life, free markets would generate intelligent solutions to problems
far too complex to solve through command-and-control rules.
Markets, not taxes
Green markets also avoid the pitfalls of pollution taxes,
a method often proposed as an alternative to command-and-control regulations.
Remember, tax rates on each type of pollutant would have to be written into
law. But no one knows what those tax rates should be. Which should be assigned
a higher tax, a pound of ozone or a pound of nitrogen oxide?
As with all tax legislation, special interests would
exert every ounce of leverage they command to extract favored treatment
from their pet politicians. By their very nature, pollution taxes create
the fetid conditions that lead to corruption. No such problems pertain to
green markets. There is no one to bribe. A decentralized market, not politicians,
would set the relative costs of various pollutants.
Green markets also would be flexible. For example, if
society later decides that the amount of SO2 authorized by the initial sale
of EcoTrust permits exceeds the desired level, tax revenues could be used
to buy up and retire a portion of the permits, just as tax money is used
to purchase parkland from private owners. As the supply of permits shrinks
and prices ratchet up, the incentives for further emissions cutbacks and
investment in more sophisticated antipollution technologies would become
stronger. Conservation groups, like the Sierra Club and the Nature Conservancy,
could accelerate this process by buying up permits and destroying them.
A positive self-reinforcing market process would replace today's morass
of bureaucracy litigation.
Green markets could be set up anywhere in the world.
Any country could sell points for its existing pollution levels. Carbon
monoxide and ozone permits could be traded on world markets just like tin
and cocoa futures. A worldwide problem demands a pragmatic solution that
can be scaled up quickly to global proportions.
But at Rio, no one even mentioned market solutions.
As usual, all the talk was about the form and severity of future regulations.
Nonetheless, in the 20 years since green markets were first proposed, they
have been tried a few times. In one case - the rapid phase-out of leaded
gasoline - a special EPA program allowed refineries to trade lead permits
among themselves as they worked through the transition period. It worked
Most recently, a provision of the 1990 Clean Air Act allowed electric utilities
to trade SO2 permits that were granted to them. Trading has just started,
but with the economic incentives properly aligned, the market for smokestack
scrubbers already has taken off.
Advanced technology can make an enormous contribution
to the quality of our environment, but as the Cold War should have taught
us, only decentralized markets can stimulate innovation and entrepreneurship.
Now is the time to harness high-tech capitalism in the service of the environment.
Green markets will make it happen.