Journal of Environmental Management (1995) 43, 185-188

International Pollution Control: a Review of Marketable Permits--a Comment

Alan Collins

Department of Economics, University of Portsmouth, Locksway Road, Milton, Southsea, Hants, P04 8JE U.K.

Received 16 July 1994

Tomkins and Twomey (1994) offer an outline and discussion of the use of a marketable permit system (MPS) approach to address international pollution problems. Whilst the economic principles underpinning the use of MPSs is not disputed, it is argued that the nature of their associated discussion is misleading. It is suggested that they significantly underplay a variety of problems impacting on the negotiation, costs and practical application of the approach. In addition, the various incidental comparisons with the use of "command and control", and fiscal instruments therein, seem to imply general superiority of the MPS approach over these approaches to address intemational pollution problems. It is argued that this is not likely to be the case.

Keywords: pollution control, economics, marketable permits.

1. Introduction

The economic case for using marketable permit systems (MPSs) has emerged from the work of Coase (1960). The theorem set out therein states that externalities may be eliminated via market transactions, so long as all relevant property rights can be assigned, and regardless of the distribution of those rights. This theorem assumes no significant transactions costs (i.e. costs associated with reaching an agreed settlement) or income effects. Dales (1968), followed by numerous economists, has advocated using this type of framework in the context of environmental pollution, by addressing the problems of incomplete property rights for the services of various environmental waste sinks (atmosphere, rivers, etc.), and attempting to minimize transactions costs. An MPS for addressing pollution problems institutionalizes full property rights in a synthesized market for the services of an environmental waste sink.

This general approach has been outlined and discussed in a number of introductory texts accessible to environmental management professionals (e.g. Pearce and Turner, 1991; Tietenberg, 1987). Tomkins and Twomey (1994) sought to review the MPS approach particularly as a means of addressing international pollution problems. Given that, so far, the approach has only been applied in the context of regional and national

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environmental policy, a "review" of MPSs in this context could be viewed as somewhat jumping the gun. However, there has been much discussion of their potential application in a global and sub-global international policy context. Furthermore, many of the pollutants that may be addressed by using MPSs are trans-boundary, and, hence, may be viewed as international pollution problems by framing the issue in that way.

The basic economic principles underpinning the MPS approach are well presented in Tomkins and Twomey (1994). However, though the scope of their paper may have been to provide an accessible exposition of the use of MPSs to address international pollution problems, it is argued that the nature of their associated discussion presents a too naive and uncritical assessment of the likely efficacy and prospects for the approach in an international context. That work may thus present a misleading knowledge base to decision makers in forming environmental policy.

This comment on the work of Tomkins and Twomey (1994) addresses various points of contention associated with the use of MPSs, which are considered to be either wholly neglected or significantly underplayed in that paper.

2. Global negotiation

The contribution of economic thought to resolving contemporary global problems has, in order to be effective, to take account of the relevant operating context. It is simply no use for such thinking to be divorced from international political obstacles which present major real and persistent high transactions costs. Tomkins and Twomey (1994) acknowledge " . . . the political problems of international co-operation.." (p. 40), but there is no statement of the simple fact that there is no prospect of instituting a full global permit system to address the problem of greenhouse gases (GHG) in the foreseeable future. Rather, there may be developments towards sub-global markets linked possibly to customs unions in, say, Europe or North America. Tomkins and Twomey (1994) note that the market does not determine the initial allocation of permits but do not indicate the inevitable impasse precluding a consensus amongst countries of widely differing levels of economic development, wealth and of diverse dominant political ideologies. Such differences seem likely to induce issue linkage of environmental policy matters with trade, development or other policy matters within an international political strategic bargaining situation. The multilateral institution of an MPS is very complex and is not likely to be a favoured instrument in such bargaining situations or games. Thus, their upbeat conclusions relating to the great potential for tradeable permits in the context of global pollution problems seem not wholly justified from an international political economy perspective. What may support the case for MPSs to deal with GHG in a global policy context emerges from the work of Rose and Stevens (1993). They examined, via a computer simulation exercise, the economic welfare implications of alternative equity criteria (fairness rules) for initial permit distribution, and found them not too dissimilar. Should such a view be accepted by all bargaining parties, then this may help reduce bargaining table tensions when discussing alternative distributions, but may not be seen as conclusive evidence.

3. Permit market adjustment and competition

Tomkins and Twomey (1994) rightly note that there are significant monitoring and enforcement costs associated with any pollution instrument. Indeed, it may be argued that the enforcement burden is more effective and widely spread amongst regulators

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and firms in an MPS. This is because marketable permits become valuable company assets, and firms have an incentive to report known non-permit backed emissions to maintain the value of those assets. By the same logic, there may arise economy-wide and industry-wide objections to a regulatory body having the unattenuated power to increase or reduce permit supply (a fraction of industry assets) without warning, to induce a particular environmental standard. This may be particularly significant for energy-intensive firms. Consideration should be given to attenuating regulatory actions such that they display some level of cognizance of the financial year, and of the timescales over which firms' financial, investment and strategic plans typically follow. Otherwise, economic costs may be generated that may offset or exceed the environmental benefits from a particular regulatory action.

Another problem associated with an MPS and acknowledged im passim by Tomkins and Twomey (1994) relates to concern over the likely level of competition in permit markets, where arguably for many pollutants the market structure is inclined to be oligopolistic. This can clearly foster the possibility of collusive behaviour to engineer non-competitively determined permit market prices, thus generating another task for the regulatory body. There are also implications that need to be seriously addressed relating to the possible use of permit purchases as a strategic measure to deter new firm entrants to an industry.

4. Least-cost control

Tomkins and Twomey (1994) present the widely-held view that an MPS is likely to deliver least-cost control of pollution (p. 42). However, this need not be the case in practice. Alternative instruments may be more comparable in terms of offering a cost- effective allocation of control responsibility than is commonly thought. This arises because of potential market failure in actual emission trading. Atkinson and Tietenberg (1991) examined actual emission (bubble) credit trades in connection with non-uniformly mixed pollutants in the United States. Their study revealed significant deviation from cost-minimizing trading because most trading was identified as sequential and bilateral in nature, and that much of the trading process takes place with traders having significantly less information about market opportunities than is generally believed. Their simulation studies incorporating these more realistic trading characteristics in- dicated market outcomes that diverged markedly from a cost-effective allocation of the control responsibility. Further refinements of the MPS approach, or more comparative analyses with alternative instruments (e.g. Howe, 1994), may be necessary to identify the appropriate instrument to tackle a particular pollutant.

5. Synergistic pollutants and marketable permits

Synergistic pollutants are those where the joint effect of two or more pollutants differs from the sum of their individual effects if manifest singularly. Formally, the impact function of the pollutants in combination is non-linear. There are several examples of such pollutants in the environment, including hydrocarbon/nitrogen oxide combinations (lower atmospheric ozone), sulphur dioxide/suspended particulate combinations, and water discharges of cyanide/metals combinations. Most consideration of MPSs relates to the particular case of single pollutants affecting (linearly) ambient concentrations. In addition, it may also be likely that the abatement cost functions are not convex and may be subject to large threshold effects (discontinuities). From this basis, Zylicz (1993)

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argues that synergistic pollutants significantly raise the information requirement of the permit market. Marketable permits for synergistic pollutants are different in that the emissions they represent at the time of purchase is uncertain. He shows that, in the non-linear impact case, it may be necessary also to apply supplementary taxes to achieve an efficient solution, depending on the market price and the distribution of emissions. In this situation, because of the complexity of the trading arrangements and of the potentially unrealistic convexity assumptions, command and control strategies may well be a more efficient practical instrument.

6. The attainment of optimal pollution

Tomkins and Twomey (1994) explain how an MPS approach to international pollution control can be extended from a mechanism which simply delivers a preset pollution target at least cost, to one which can discover and attain optimal pollution levels. This extension can occur as environmental pressure groups purchase permits, effectively reducing the actual quantity of permits available to polluters. While this approach may have some attraction within industrialized countries, it would surely add to existing tensions in developing countries should foreign pressure groups, as well as foreign producers/polluters, be seen to be dominating the market for pollution permits. It may well be viewed from a developing country perspective as the setting of local environmental standards from outside, and, hence, encouraging domestic resistance.

7. Summary and conclusions

Within this comment, it is argued that the prospects and case for MPSs to resolve international pollution problems are overstated in Tomkins and Twomey (1994), because they neglect or underplay the extent of practical problems associated with global negotiation, likely permit market structure, conduct and performance, and the effect of synergistic pollutants. Particular international pollution problems may be more efficiently addressed by alternative instruments, and this point is not made clear or given sufficient emphasis in their review.

I am grateful for the comments of Guy Judge on an earlier draft of this comment.

References

Atkinson, S. and Tietenberg, T. (1991). Market failure in incentive-based regulation: the case of emissions trading. Journal o f Environmental Economics and Management 21, 17-31.

Coase, R. (1960). The problem of social cost. Journal of Law and Economics 3, 1-44. Dales, J. H. (1968). Pollution, Property, and Prices. Toronto: University of Toronto Press. Howe, C. W. (1994). Taxes versus tradeable discharge permits: a review in the light of the U.S. and European

experience. Environmental and Resource Economics 4, 151-169. Pearce, D. W. and Turner, R. K. (1991). Econom&s of Natural Resources and the Environment. Hemel

Hempstead: Harvester-Wheatsheaf. Rose, A. and Stevens, B. (1993). The efficiency and equity of marketable permits for CO2 emissions. Resource

and Energy Economics 15, 117-146. Tietenberg, T. (1987). Environmental and Natural Resource Economies. Harper-Collins: New York. Tomkins, J. M. and Twomey, J. (1994). International Pollution Control: a Review of Marketable Permits.

Journal o f Environmental Management 41, 39-47. Zylicz, T. (1993). Improving the Environment through Permit Trading." The Limits to the Market Approach.

Beijer Discussion Paper No. 23. Stockholm, Sweden: Beijer International Institute of Ecological Economics, The Royal Swedish Academy of Sciences.