Emissions trading

Emissions trading, an environmental policy that seeks to reduce air pollution efficiently by putting a limit on emissions, giving polluters a certain number of allowances consistent with those limits, and then permitting the polluters to buy and sell the allowances. The trading of a finite number of allowances results in a market price being put on emissions, which enables polluters to work out the most cost-effective means of reaching the required reduction. Emissions trading has been used with notable success to reduce emissions that cause acid rain, and it is currently being used in various attempts around the world to control emissions of greenhouse gases.

An idealized trading scheme might work in the following manner: A regulating authority might assign polluters a certain number of allowances defining the amount of pollutants they are permitted to emit that year. The total number of allowances would represent a certain reduction over the year before, and they would probably be scheduled to go down each subsequent year in order to reach the long-term reduction targets. One group of polluters might be able to take action during the year at relatively little cost that would actually reduce their emissions well below their allowances. In that case, they would face the prospect of finishing the year with unused allowances. A second group of polluters, meanwhile, might find it very expensive to reach their own reduction goals. In order to avoid this cost but also to avoid being fined by the regulating authority for exceeding their allowances, the second group of polluters might be willing to buy unused allowances from the first group—in effect, paying the first group to undertake the extra reductions that are too expensive for the second group. The two would then negotiate a price for the allowances, and the agreed-upon reductions would be undertaken.

The regulating authority would not be concerned with who owned the unused allowances, so long as the total emissions were reduced. Over time, as emissions limits were progressively lowered, the allowances would become fewer in number and fetch a higher price on the market. At some point even the most severe polluter might find it cheaper to invest in pollution reduction than to purchase expensive allowances, though this would not necessarily be the case; some polluters might continue to emit above their allowed levels indefinitely, so long as other polluters were still able to sell them unused allowances at an affordable price. Polluters would continue to invest in emissions-reduction schemes or in emissions trading, depending on which was less expensive at any given time, until the overall reduction target was met.

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