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CHAPTER 29

POLLUTION: HOW MIGHT ECONOMICS HELP SAVE THE PLANET?

Cap-and-Trade Programs as a Market Solution to Problems Large and Small

Scarcity is the central problem of economics. In our pursuit of happiness, we have too few of virtually everything beneficial—hours in a day, gallons of oil, corner dorm rooms, printing privileges on campus computers—to satisfy our desires. We also have too few of the natural repositories for pollution known as . As with a kitchen sink, society can send only a certain amount of “gunk” into an environmental sink before trouble arises. Pollution in limited quantities can be diluted in water, dispersed into air, or absorbed into body fat or soil before problems occur. And by a process called , oceans and vegetation absorb carbon dioxide (CO₂), release the oxygen (O), and store the carbon (C). To deal with scarcity issues, governments could divvy up goods more or less equally and place standard caps on things such as printing and polluting, but the solutions would be inefficient. English majors may value printing privileges more than economics majors do, and power utilities whose plants cannot easily be retrofitted with emissions-reducing scrubbers value the right to pollute more than newer, cleaner plants do. Markets provide alternative mechanisms for allocating scarce goods and services to those who value them the most. This chapter explains how unconventional markets can provide solutions to many of society’s most serious scarcity problems.

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Along with the delights of indoor climate control, electricity, motorized transportation, and manufactured goods come the evils of pollution. Industries in the United States release about 4.4 billion pounds of toxic chemicals into the air and water each year,¹ and the Environmental Protection Agency (EPA) recently found 474 counties in 31 states, home to 159 million Americans, out of compliance with its health-based 8-hour ozone pollution standards.² The value and proper implementation of policies to limit pollution depend on the type and severity of the problems. This section provides perspectives on some of the pressing environmental issues of the twenty-first century.

¹ See the EPA’s Toxic Release Inventory at www.epa.gov/tri/tridata/tri03/brochure.htm.

² See http://epa.gov/region6/6ra/air_pc_041504.htm.

Global climate change has become the hot topic among environmentalists who argue that it should be on everyone’s plate of concerns that deserve attention. The so-called greenhouse gases, including carbon dioxide, methane, and nitrogen oxide, hold heat within the earth’s atmosphere and keep it about 33°C (59°F) warmer than it would otherwise be. Since the Industrial Revolution, atmospheric concentrations of carbon dioxide have risen by about 28 percent, methane concentrations have more than doubled, and nitrogen oxide concentrations have risen by about 15 percent. These trends, with a debated mix of human and natural causes, may be to blame for the reported 0.5°C to 1.0°C increase in global temperatures during the past century. The 10 warmest years in that period have all occurred since 1985. Global warming has already thinned the snow cover in the Northern Hemisphere and the floating ice in the Arctic Ocean, increased the volume and intensity of rainfall in the United States, and raised the sea level by 4 to 8 inches during the past century.³

³ See http://yosemite.epa.gov/oar/globalwarming.nsf/content/Climate.html.

Continuing changes in the global climate and ensuing alterations in soil moisture, sea level, and weather patterns threaten the health and welfare of life on earth. Ecosystems and agriculture are sensitive to climate change, and densely populated coastal regions could be submerged by rising sea levels. For access to the ships that brought delicacies from afar and picked up goods to sell elsewhere, many of the world’s largest cities were built near the sea. Venice and New Orleans are famous examples of cities that already must battle to remain above water. With such high stakes, regardless of whether humans are causing global climate change, it is likely that the benefit exceeds the cost for some finite level of pollution limits that work against it.

Acid rain and its wind-borne cousin, dry acid deposition, result primarily from sulfur dioxide and nitrous oxides released from coal-fired power plants, motor vehicles, and various types of industry. In these forms, acid is deadly to plants, animals, and humans, and damaging to buildings and automobiles. Soil acidity affects the ability of plants to absorb nutrients, and increases in acidity can mortally starve forests. Beyond its direct toxicity, acid causes the release of copper, aluminum, and mercury from rocks and pipes that would otherwise retain those metals. Acid rain presents an externality problem (as discussed in Chapter 11) because much of the damage occurs far from the causal sources. Dead trees and lifeless lakes in Canada and Norway are attributed to sulfur dioxide emissions from the United States and central Europe, respectively. Although the United States emits 6 times as much sulfur dioxide as Canada, the Environment Canada agency reports 95,000 lakes that will remain damaged even after planned acid rain control programs are fully implemented.⁴ And the EPA reports that decreases in fatalities, hospital admissions, and emergency room visits in the United States will bring annual health benefits from the ongoing Acid Rain Program to $50 billion by 2010.⁵

⁴ See www.ec.gc.ca/acidrain/acidfact.html.

⁵ See www.epa.gov/airmarkets/acidrain/effects/health.html.

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Water pollution provides the last example of an environmental problem that may deserve careful attention from economists and policymakers. Industrial waste and sewage find their way directly into bodies of water,⁶ and pesticides, fertilizers, and gaseous emissions from vehicles and factories are washed into waterways by precipitation. A watershed is a land area that catches rain and snow and “sheds,” or drains, that water into surface waterways or groundwater. Fifteen percent of U.S. watersheds have “relatively good” water quality; 36 percent have “moderate problems”; 22 percent have “more serious water quality problems”; and 27 percent cannot be characterized because of insufficient information. Another 7 percent of watersheds are considered “highly vulnerable” to degradation below their current levels.⁷

⁶ For example, in 2006, 48 million gallons of raw sewage flowed into waterways near Waikiki Beach in Honolulu, Hawaii. See http://starbulletin.com/2006/03/31/news/story01.html.

⁷ See www.epa.gov/305b/.

All these pollution threats challenge the creativity of policymakers. The next section describes innovative approaches to a variety of problems, big and small, environmental and otherwise.

Chapter 6 explained that markets can serve efficiency goals by bringing goods and services to those who value them the most. For example, markets deliver the 1,504 tickets for each night’s Broadway production of Spamalot⁸ to the 1,504 people who value them the most and thus are willing to pay the most for them—an outcome that could not be expected from a ticket lottery among all those who placed any value on seeing Spamalot or from a government allotment based on chance or politics.

⁸ Spamalot, winner of the 2005 Tony Award for the best musical, is based on the movie Monty Python and the Holy Grail.

The efficiency of markets can be tapped by putting more kinds of goods and services up for sale. Dorm rooms, for example, are typically allocated by a lottery that does not necessarily deliver particular rooms to the students who cherish them the most. A more efficient solution would be to auction off dorm rooms. If the corner dorm room on the second floor was worth $100 more to you than to anyone else, you would be able to bid a penny more than the next-highest bidder and capture those benefits for yourself. The $100 worth of additional benefits you received from that room wouldn’t be created under a lottery system that gave the room to someone else. Similar efficiency gains can be captured by selling the best parking spaces, faculty offices, and other goods to the highest bidder. Concerns about advantages for wealthy bidders can be allayed by allowing people to “purchase” the items with community service hours, high grades, or weeks of perfect attendance. (Of course, wealthy individuals have the same advantage in traditional markets; approaches to income inequality are discussed in Chapter 28.)

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Traditional command-and-control pollution regulations require uniform reductions or specific technology applications across all sources of pollution. This approach pre-sents problems because there is disparity in the ability of polluters to comply with the regulations, and once they do, they have no further incentive to reduce pollution levels. For example, EPA regulation 40 CFR 63 limits mercury emissions from existing industrial boilers to 10 micrograms per dry standard cubic meter.⁹ This rule might be easy for some plants to obey and impossible for others, depending on their age and the adaptability of their equipment. For this common type of dilemma, economic reasoning points to another breed of market solutions: cap-and-trade programs.

⁹ See www.epa.gov/docs/epacfr40/chapt-I.info/.

Cap-and-trade programs were adopted in the United States in 1995 to address the acid rain problem. The Acid Rain Program sets a limit, or “cap,” on the quantity of sulfur dioxide (SO₂) that can be released from regulated sources, such as power utilities. Existing polluters then receive a certain number of “allowances,” each granting the right to emit 1 ton of SO₂. Total emissions are gradually reduced by granting fewer allowances each year. From a starting point of 17.5 million tons of SO₂ emissions from U.S. electric power utilities in 1980, annual caps are set to decline to 8.95 million tons by the year 2010.¹⁰ The trading of pollution allowances is similar to that of stocks, and sulfur dioxide allowances can be purchased from allowance brokers or at an annual EPA auction conducted by the Chicago Board of Trade.¹¹

¹⁰ See www.epa.gov/airmarkets/trading/basics/.

¹¹ See www.epa.gov/airmarkets/trading/buying.html.

Allowing firms to buy and sell a decreasing number of pollution allowances results in a more efficient division of pollution rights and a lower overall volume of pollution. With this special market in place, each ton of SO₂ emissions either requires the purchase of another allowance or represents the lost opportunity to sell an allowance to another firm. Regardless of a firm’s allowance holdings and emissions level, if further reductions can be made for less than the cost of allowances, the incentive exists to reduce emissions and sell more, or buy fewer, allowances. The market-clearing price in the 2005 auction was $690, and 125,000 allowances were sold. Ameren Energy Generating Co. topped the list of big buyers with a purchase of 40,000 allowances. Among the other successful bidders were the Acid Rain Retirement Fund and environmental groups at Bates, Colby, Hobart, and William Smith Colleges and Cornell University.

Emissions trading programs have three primary benefits:

There is no end to the possible applications of tradable allowances. Cap-and-trade programs are currently in place or in the works for sulfur dioxide and nitrogen oxide in California,¹³ for sulfur dioxide at the national level, and for carbon dioxide at the national and international levels.¹⁴ Articles 6, 12, and 17 of the 1997 Kyoto Protocol on Climate Change implement emissions trading on a global scale.¹⁵ In the United States, cap-and-trade policies under the Clear Skies Act will reduce greenhouse gas emissions by 18 percent over 10 years. Regarding water pollution, the discharge prohibitions under the Clean Water Act require a permit for the release of designated substances, and the EPA is considering effluent-trading programs for National Pollutant Discharge Elimination System permit holders.

¹³ See www.epa.gov/airmarkets/trading/basics/.

¹⁴ See www.cbo.gov/showdoc.cfm?index52876&sequence50.

¹⁵ See http://unfcc.int/resource/docs/convkp/kpeng.html.

Cap-and-trade programs aren’t only for pollution. In the wake of overfishing problems, the National Fisheries Conservation Center reports that tradable permits in the form of individual transferable quotas (ITQs) have benefited both fish and fishers.¹⁶ Unlike traditional command-and-control fishing regulations that limit the excursion frequency, crew size, or gear used on fishing boats, ITQs provide the flexibility and incentives of tradable emissions allowances while protecting vulnerable fishing areas. Fishers receive quotas for the volume of fish they can catch, and if their actual catch falls below the level of their quotas, they can sell their unused ITQs to others who place a higher value on those fishing rights. As another possible application of tradable allowances, in 2002, the National Research Council’s Committee on the Effectiveness and Impact of Corporate Average Fuel Economy (CAFE) Standards recommended the adoption of tradable fuel-economy credits for automakers.¹⁷

¹⁶ See www.nfcc-fisheries.org/ir_pov_c19.html.

¹⁷ This committee’s report is available at www.nap.edu/books/0309076013/html/. See, for example, Finding 11 on page 113.

Tradable allowances also offer a way to distribute printing privileges efficiently on college campuses. At Centre College, as on other campuses, students can print out 500 pages on school printers without charge. This is great for students who don’t have an overabundance of long papers but inadequate for students who do. Imagine if printing rights were tradable. Then chemistry majors, who can easily conserve paper, would have an incentive to do so, enabling the sale of extra printing rights to classics majors.

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As with all such programs, allowance trading faces challenges. It may be less successful at the international level than within nations because of monitoring difficulties and the barriers of culture, language, and distance. Some people fear that the focus on developing new emissions-trading systems will distract from efforts to address the root causes of pollution, including immoderate consumption and inefficient transportation systems.¹⁸ Even well-functioning policies to enforce emissions targets are only as good as the choice of those targets. The EPA and analogous agencies in other countries face the contentious task of selecting pollution standards. In this type of policymaking, the tools of cost–benefit analysis and ethical decision making are susceptible to influence by politics, emotions, and imperfect information.¹⁹

¹⁸ See, for example, www.oneworld.org/ips2/Dec98/07_14_005.html.

¹⁹ For perspectives on ethical and emotional arguments, see http://ecoethics.net/hsev/newscience/200012b-res.htm.

Solutions to the problems of scarcity are at hand if we allow the efficient characteristics of markets to work in unconventional ways. The splendor of cap-and-trade programs is that they serve the interests of environmentalists and free-market advocates at the same time. President George W. Bush says that a cap-and-trade program “cuts pollution further, faster, cheaper, and with more certainty, . . . replacing a cycle of endless litigation with rapid and certain improvements in air quality.”²⁰ Liberal ecological economist Herman Daly describes cap-and-trade programs as “a beautiful example of the independence and proper relationship among allocation, distribution, and scale.”²¹ It isn’t often that these two fellows are on the same side of an issue; they agree on this, however, with good reason. Cap-and-trade programs allow flexibility and creativity in pollution reduction, allocate pollution rights to those who get the most value from them, and provide incentives for reductions below individual plant limits, while constraining activities to the level deemed appropriate by authorities.

²⁰ See http://www.whitehouse.gov/news/releases/2002/02/20020214.html.

²¹ In Beyond Growth: The Economics of Sustainable Development (Boston: Beacon Press, 1996), p. 52.

Market solutions can be applied to problems that threaten life as we know it—problems that we are otherwise far from resolving. They can also solve problems on campus, at the office, or in the household. If someday you have kids who have an unequal availability of free time, you might assign them equal sets of chores but allow them to buy chore transfers from each other. That way, if one has an alternative activity worth $10 and another would pick up the slack for $5, the busier kid can transfer the chore for a payment of, say, $8, and the budding capitalists would both be happier than before.²² If someday you’re the leader of a country and you need to limit the use of toxic pesticides without nixing their most beneficial applications, you can divide the total acceptable quantity by the number of acres of agricultural land and then grant each farmer pesticide allowances for the resulting quantity per acre. Those who can most easily use organic farming methods will conserve on pesticide and sell their allowances to those who get the most out of them. If you think outside the box when applying these tools, you’ll probably increase efficiency, and you just might save the world.

²² Note that this might not be the most efficient outcome if there are positive externalities from each kid learning to work hard at household chores.

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