The Fox River Fiasco
The Fox River flows from central Wisconsin to the Green Bay. Along its course it has been heavily polluted with toxic waste like PCBs from various manufacturing processes like paper milling. A Tradable Pollution Permits (TPPs) market was implemented to address this point source water pollution. It failed because of several factors. First of all, the market was too small and interconnected to be effective. The regualatory system was also overly complex, with counterproductive rules such as the five-year limit on banking of permits. Rather than removing disincintives for pollution abatement, other features served to dissuade market participation from the covered firms. For instance, one backwards rule said units couldn't trade solely to save money, which is the whole reason to use a TPPs program: provide economic incentives to firms not to pollute above a certain level. Another feature that conflicts with the ideal of a free market was that point-sources were required regardless of market participation to install pollution control technology anyway (Hanley, 270). This across the board measure is atypical of TPPs markets. Usually, the regulatory agency gives the emitters the flexibility to make their own choices concerning how to meet their caps. This shows that the incompetent policy-makers were just trying to put a cap and trade veneer over a traditional command and control regulatory scheme.
The Acid Rain Program: The archetype of TPPs markets
Sulphur dioxide, along with nitrates, are the precursors of smog and acid rain. The primary source of these pollutants are coal fired power plants. Acid rain is a phenomenon that damages ecosystems, historical sculptures and building facades, and is proven to be extremely harmful to human health, especially among the young, aged, and asthmatic populations. So when Congress passed the Clean Air Act of 1990, they charged the EPA with implementing the Acid Rain program. It has proved to be the seminal cap and trade market. Its first phase, limited to the heaviest polluters, began in 1994 and the stricter, more widely applicable second phase started in 2000. Compliance among all industries has been about 100% and sulphur dioxide emissions have decreased by 34% (EPA Progress, 1)
The credit for the phenomenal success of the program goes to its open, unfettered market that allowed firms discretion in decision-making. The market also conveyed vital information in order for firms to make choices to comply with their cap. For instance, the market responded to external factors like the influx of cheap low and lower-sulphur coal by decreasing the price of the permits, following the cost of abatement down. None of this required any government intervention, but happened automatically. Six of the seven requirements for a good market were realized in this program, making it very effective. Even though sulphur dioxide is a non-uniformly mixing pollutant, studies have shown that hotspots haven't occurred and are unlikely to happen for two main reasons.The considerable reduction of emissions have negated any possibility of localized hotspots. And hotspots are more connected to the physical size, type of fuel, and location of the power plant relative to other plants and population centers than any permit trading. Even in an example of lopsided pemit trading where one unit tries to obtain many allowances, maximum emission rate standards that are meant to protect the local citizenry's health are still in effect (Allowance Trading..., 954) .
"Allowance Trading and SO2 Hotspots: Good News from the Acid Rain Program." Environmental Reporter Vol. 31, No. 19:
pp.954-959. May 12, 2000. Weblink here