Designing a Market for Tradable Emissions Permits

The economics literature shows that tradable emissions permits have important theoretical advantages over source-specific technical standards as a means for controlling pollution. But efficient, competitive markets in emissions may also be difficult to implement: transactions may be few with high negotiation costs; the market may be highly concentrated. Simple workable versions of the market concept may fail to take account of important complexities in the relationship between the pattern of emissions and the geographical distribution of pollution. This paper examines the feasibility of tradable permits, given these potential problems. Although the empirical part of the paper deals with a specific case—particulate sulfates in the Los Angeles airshed—the methods developed for investigating these issues have general applicability. Moreover, the particular market design that is proposed—an auction process that involves no net revenue collection by the state—has attractive features as a general model.