Pollution and Profit

A new strategy for climate change
Tim Harford
24 - 5 - 2005

A market-based approach to pollution control pioneered in the United States suggests a way to overcome inadequacies in the European approach to climate change, and a model the whole world can join to the benefit of its poorest people.



In 1993 the Environmental Protection Agency (EPA) in the United States faced a familiar dilemma: sulphur emissions from coal-fired power stations were causing acid rain but the cost of cleaning up the emissions seemed to be impossibly expensive. The EPA estimated that to remove a single ton of sulphur dioxide from emissions would cost up to $1500.

The lobbying efforts of polluters were formidable. To overcome their objections the EPA used a clever piece of strategy. It gave polluters a choice: either install scrubbing technology to remove the sulphur from their emissions, or go to an auction and buy one of a limited number of “permits” to keep on polluting as before.

The surprising result was that not many companies wanted the permits at $1,500. A collective of protesting students bought one, but power companies demonstrated that they would rather install the scrubbers or burn cleaner coal than buy permits. Permit prices had to fall to $70 per ton before many polluters would consider actually polluting rather than cleaning up their act. Emissions fell dramatically, the government made money, and any power plant facing genuine difficulty meeting the emissions target had an escape, for a price.

The usual argument in favour of emissions permits is that they allow pollution reductions to be allocated efficiently. Nobody knows whether the most efficient way to reduce sulphur emissions is by consuming less electricity, using cleaner coal, installing scrubbers, or something else. Given the right price signal, though, the market will work it out.

The EPA had figured out that emissions permits also had a strategic, political advantage: permit auctions made transparent the fact that reducing pollution was much cheaper than most people had believed.

Now tradable permits are being used to reduce carbon dioxide emissions through “cap and trade” schemes such as the European Union’s Emissions Trading System (ETS). The ETS, though, does not use an auction but simply hands out quotas for free and allows countries to trade them.

The ETS could work, but the trouble with such systems is deciding what the quota should be for each country. As Michael Grubb explains on openDemocracy, many governments are assigning themselves – or, more specifically, particular companies – generous quotas. If countries can decide what these quotas are then cap-and-trade is a charade. If they have to agree more serious quotas through a treaty, the likely outcome is stalemate, which is where Kyoto has finished up.

Most Europeans would like to blame George Bush for the absence of the United States, but the problem is deeper. Bill Clinton, US president from 1993 to 2000, signed the Kyoto Protocol even though he knew that the US Senate would not ratify it. The Senate’s refusal was ostensibly because developing countries refused to restrict their emissions but also because the obligations on the US were especially challenging. Developing countries had an infinite quota and America’s quota was too small to be politically acceptable. The conflicting interests were too great.

Is there any hope that the United States and developing countries can come together to sign an agreement that could stretch far beyond the horizon of Kyoto? There is still time, but we need a more compelling focal point for the negotiations.

Some economists (including Peter Cramton and Suzi Kerr: How and why to auction, not grandfather) have suggested adopting the same political strategy as the EPA did. That is, emulate the sulphur dioxide auctions by doing away with national quotas altogether and simply fixing a global supply of emissions permits which would be sold to the highest bidders. The overall emissions would be the same as with a quota system, but instead of giving the emissions permits away as quotas, every ton of carbon dioxide would have to be paid for.

A global auction of emissions permits would raise a lot of money. How would it be spent? It’s tempting to argue that it should fund the United Nations and global poverty relief. But a simpler option with some appealing moral intuition is that the money should simply be shared equally between every person on the planet. (It might have to flow through governments, but it would be much better if the grants, which might be around $100 per person per year at current prices, went straight to the people.)

Such a system would immediately meet the concerns of the United States Senate that developing countries like China have some incentive to reduce emissions. At the same time, the Chinese would want to be included, because the money they received from the permit auction would be substantially more than the money they would have to spend on permits. Even a country like Ethiopia would gain from joining the agreement, and Ethiopians would have an incentive to adopt more energy-efficient technologies.

Richer countries, of course, would tend to pay more, and countries growing quickly would tend to face an increasing bill in the auction – yet those are precisely the countries which would be most able to afford to pay. These effects would be automatic, not the result of Byzantine negotiations. Most importantly, by raising the price of any activity which required carbon-intensive energy, the system would give every citizen of every country an incentive to reduce his or her carbon footprint.

Remembering the lesson of the EPA’s sulphur dioxide auction, we might also discover that a low-carbon energy system isn’t quite as expensive as we feared. Environmentalists have been asserting this for a long time. It’s time we all proved it together.

Correction: The Environmental Protection Agency contacted me to point out two errors in my piece: only a small share of the sulphur dioxide permits were auctioned; and the government did not retain the auction revenue but returned it to the industry. The EPA auction nevertheless demonstrated the power of an auction to reveal that the true cost of reducing pollution was very low. Apologies to the EPA and to Open Democracy readers -- Tim Harford

This article appears as part of openDemocracy‘s online debate on the politics of climate change. The debate was developed in partnership with the British Council as part of their ZeroCarbonCity initiative – a two year global campaign to raise awareness and stimulate debate around the challenges of climate change.