April 13, 2010
Are cap-and-trade schemes working? This column presents a summary of eight existing schemes arguing that half meet the independence property whereby the initial allocation of property rights does not affect the environmental or social outcome and the scheme is cost-effective. This success is a contrast with other policy proposals where political bargaining reduces the effectiveness and drives up cost.
Environmental economists have seen their ideas translated into the rough-and-tumble policy world for over two decades. They have witnessed the application of economic instruments to several environmental issues, including preserving wetlands, lowering lead levels and curbing acid rain. This paper examines the impact of the rise of economics in the policy world on the making of environmental policy. The author focuses on two related, but distinct phenomena -- the increasing interest in the use of incentive-based mechanisms, such as tradable permits, to achieve environmental goals; and the increasing interest in the use of analytical tools in regulatory decision making, such as benefit-cost analysis.
The authors investigate a central issue in the climate change debate associated with the Kyoto Protocol: the likely performance of international greenhouse gas trading mechanisms. Virtually all design studies and many projections of the costs of meeting the Kyoto targets have assumed that an international trading program can be established that minimizes the costs of meeting overall goals. This conclusion rests on several simplifying assumptions. The authors focus on one important issue that has received little, if any, attention: the interation between an international trading regime and a heterogeneous set of domestic greenhouse policy instruments. This is an important issue because the Protocol explicitly provides for domestic sovereignty reagrding instrument choice, and because it is unlikely that most countries will choose tradeable permits as their primary domestic vehicle.