Description

Abstract: Ever since the passage of the 1990 amendments to the US Clean Air act and the creation of a market in sulfur dioxide (SO2), it has become clear that market mechanisms can be effectively used to achieve environmental policies. But markets are neither infallible nor automatic. They have blind spots and they need to be designed effectively if they are to effectively achieve environmental ends. This paper defines markets as regular gatherings of people for the purpose of buying and selling goods or services. Such markets are distinguished from public payments to private landowners for ecosystem services, or private deals between a few buyers and sellers. It then provides a brief Overview of several existing and proposed environmental markets, including: the Acid Rain market in the US, the Emissions Trading Scheme in the UK, the proposed Emissions Trading System for the European Union, the US market in greenhouse gases proposed by Senators McCain and Lieberman, the US market in wetlands mitigation credits, and the renewable energy market in Texas. From these the paper attempts to draw some lessons and conclusions.

The paper argues that although markets can help maintain, provide, and distribute environmental goods and services, they require government will, government power, and established legal institutions to do so effectively. This is for two reasons: First, many environmental markets operate by taking goods and services that were previously public in the economic sense of the term, setting limits on their use, and allowing property or usage rights to be traded. Limiting the use of public good can only really be achieved equitably via a consensus agreement of all current users, or through the enforcement of government regulations and government power. Secondly, markets require secure property rights if they are to function; and strong governments and legal institutions are necessary in order to create, maintain, and protect property rights. The lack of a strong global system of government is proposed as one reason why global environmental markets (such as those envisaged by the Kyoto Protocol) are so difficult to achieve. Instead, the paper argues that global environmental markets will likely develop as a result of the organic aggregation of national or regional environmental markets.

In addition to government intervention and a robust system for allocating and protecting property rights, the paper borrows from McMillan (2002) and lists several other factors that are essential for the proper operation of environmental markets. These include equity and the involvement of relevant stakeholders, trust among market participants, easy access to market information, competition, and some understanding of possible market externalities.