MINI-CASE
Fossil fuel-burning electric power plants in the United States and Canada produce air pollution as a by-product of their operation. The pollutants produced by these plants are linked to high levels of acid rain in the northeastern United States, and the Canadian provinces of Ontario and Quebec, as well as a growing number of "smog" days in Ontario. The primarv pollutants associated with acid rain are nitrogen oxide and sulphur dioxide (XOx, SOi). Acid rain is linked to increased fish morbidity rates, destruction of forests, and building decay. Overall increases in smog levels have led to a host of respirator' illnesses such as asthma and lung cancer in the northeastern United States and Ontario. Air quality is a public good. Though there are markets for fossil fuels and electricity, they fail to take into account the public costs of smog, acid rain, and climate change. Government regulation in the form of an emissions trading system has been used as a mechanism to produce more socially desirable outcomes. Emissions trading refers to a market-based approach to controlling pollution in which companies can buy and sell allowances for emitting specified pollutants.

Alternatively, companies can get credits for reducing emissions. In such trading systems, a central agency-typically a government-sets goals or limits on the allowable volume of pollutants that can be emitted. Companies must hold sufficient allowances for that volume. Those that reduce their emissions can sell their allowances and those that have emissions above their allowable limit must purchase credits from those that pollute less. Since 1995, the L"S Environmental Protection Agency (EPA) has used an emissions trading system to permit plants to adopt the most cost-efficient approach to reduce their sulphur dioxide emissions. The EPA sets caps, or limits, on allowable total emissions levels, and then issues a limited number of permits that are auctioned off annually. These permits can be traded or saved.

In 2003, a permit for the atmospheric release of one tonne of sulphur dioxide cost approximately US S170. By 2004, the cost was S225 per tonne, and by 2006, it was more than S1500 per tonne. In 2001, Ontario introduced a "Cap, Credit, and Trade" emission trading system for controlling sulphur dioxide. Emissions trading systems apply to controlling other pollutants. The recent rise in temperature of the earth's atmosphere, global warming, is understood to be the result of higher concentrations of certain "greenhouse gases" in our atmosphere. The Kyoto Protocol is a 1997 international agreement that went into effect in 2005. It commits developed countries to reduce their emissions of certain greenhouse gases to below 1990 levels by 2012. The Kyoto Protocol uses an emissions trading scheme to coordinate reductions in emissions. In conjunction with the Kyoto accord, the European Lmion (ELT ) has introduced a mandator}- carbon trading program to control emissions of carbon dioxide.

In the United States, which is the only major country that has not ratified the Kyoto accord, a number of trading schemes for carbon dioxide and other pollutants are underway or planned. These systems are other examples of a growing trend for countries around the world to implement emissions trading systems so that the overall levels of greenhouse gases can be reduced in coming years. These trading systems are not without their implementation challenges, however, as the discussion questions to follow indicate.

Sources: "EPA's Clean Air Markets-Acid Rain Program," Environmental Protection Agency site, www.epa.gov/airmarkets/progregs/arp/index.html;

"Ontario Emissions Trading Registry Introduction," Ontario Ministry of the Environment site, www.ene.gov.on.ca/envision/air/etr/ index.htm; United Nations Framework Convention on Climate Change, wuw.unfccc.int/2860.php;

"European Union Emission Trading Scheme," European Commission site, ec.europa.eu/ emdronment/climat/emission.htm; "Emissions Trading Analysis," Australian Greenhouse Office site, www.greenhouse.gov.au/emissionstrading/index.html. All accessed November 10, 2007.

Discussion
Despite the early successes of these systems, some issues remain. First, these regulations may be successful in reducing overall emission levels, but they may not address local "hot spots." Second, the global targets themselves may not be sufficient to truly reflect the social costs of acid rain or greenhouse gases.

Finally, there may be more efficient ways of distributing the allowances so that the overall cost of operating the system is lowered. Government regulatory programs such as the emissions trading systems are established to remediate the impact of market failure. These programs are intended to act as an incentive to allow plants to adopt the most cost-efficient means of emissions reductions. But despite the best intentions of the government, individuals or companies can exploit poorly designed programs for their own gain. At the best of times, such as with SCh or carbon emission controls, the inherent process of establishing the system incurs inefficiencies. On the other hand, the benefits to society of correcting situations of market failure can nevertheless be enormous.

Questions
1. What are the implications of having too high a level of carbon allowances in an emissions trading system?

2. What problem could arise if an emissions trading system allowed companies to sell carbon credits to other companies at a mutually acceptable price? Why would an open-market auction be preferable?

3. Emissions trading schemes require some form of enforcement. One kind of enforcement uses regulators that can fine companies that do not have sufficient allowances for their emissions. What are potential shortcomings of this form of enforcement?

4. An alternative to an emissions trading system is an emissions tax. Some economists argue that a tax would be simpler to implement, would have more predictable costs, and would be less prone to corruption. Can you see any disadvantages to an emissions tax?