One approach to resolving problems of pollution is to assign marketable pollution rights that permit holders to discharge waste products into the environment.
Pollution rights are licenses to discharge given amounts of waste products.
In some cases, the government might simply sell pollution rights, or auction pollution rights to the highest bidders. Another possibility, known as “cap-and-trade”, involves setting a maximum on pollution (a cap), with tradable rights being assigned to established polluters. Lawsuits are another way to rely entirely on market forces to deal with pollution.
Ronald Coase, was awarded the Nobel Prize for, among other things, showing that an equilibrium pollution level is optimal, and this equilibrium is unaffected by whether pollution rights are assigned to the polluter or the harmed party as long as those affected (a) are easily identified, (b) have roughly the same bargaining power, and (c) can bargain without cost. In this view, the environment is just another productive resource.
[figure 6, ch. 19]
This bargaining process is reflected in the figure above. The demand for pollution rights, D0 slopes downward. Pollution is Q0 if the environment can be used freely as a garbage dump. Quotas might be auctioned if the community decided to allow only Qe pollution. Business demands to pollute reflect how the production of pollution contributes to a firm’s revenues and profits. A firm willing to pay only Pa for each right to pollute (point a) undoubtedly can curtail pollution for Pa or less per unit of effluent. Businesses would be willing to pay Pe each for Qe pollution rights. If purity lovers would be hurt more than Pe by each unit of pollution, they could buy and retain the pollution rights. In this way, the initial sale of these rights would generate revenue for the community. If an auction were held and Qe rights were sold, then excessive pollution (Q0 – Qe) would be eliminated.
What if other firms wanted to set up locally after the Qe pollution rights had already been sold? They could buy rights from the owners of existing pollution rights. This might require buying an acutely dirty plant, shutting it down, and transferring its pollution rights to a new plant. Alternatively, a new firm could pay existing firms to install more antipollution equipment. Both techniques shift the demand for the right to contaminate from D0 to D1 in the figure. The value of pollution rights rises, but not the level of waste. Consumers of goods entailing pollution pay full production costs as higher costs of polluting are shifted forward.
This approach has several advantages. First, polluters have incentives to clean up. Little administration other than monitoring is required. And if the government decides later to reduce pollution, it can repurchase existing rights—or if it becomes more accepting of pollution, it may sell even more rights as a revenue source. This approach can confer significant cost advantages to firms that implement relatively clean technologies. It may be a cheap and attractive alternative to direct regulation, and it works reasonably well in a relatively enclosed environment, like a lake under the control of local authorities. But administration is more difficult when spillovers are more extensive. Another flaw is that some voters and politicians equate pollution with sin and are outraged at the idea of allowing economic reasoning to dominate what is for them a moral issue. Even these moralists, however, would probably agree that selling pollution rights is better than giving them away for free.
In order to comply with the Kyoto Protocol's stipulations that Europe decrease its pollution levels by 8% from what it emitted in 1990 by 2012, the European Union has installed a system of gradually decreasing pollution credits. The countries within the EU take their nation's credits and are free to distribute it amongst their industries, or even sell it to other countries within the EU if they see it fit to do so, and are able to do without them. With each carbon allowance (the right to expel the equivalent of 1 ton of carbon dioxide waste) valued at around 10 dollars in 2005, the government of a country like Great Britain, which was given 736 million tons for that year, was suddenly handed a new commodity valued at over 7 billion dollars which it could distribute at will. And as the credits decrease in number, their value is expected to increase sizably.