Satyajit Das explores the complex market of emissions trading
Emissions trading is focused on the trading of credits
designed to control and ultimately reduce pollutants produced
from business activities. The central driver of emissions
trading is the impact on global climate and the degradation of
environmental resources from emissions of various gases.
Principal targeted pollutants include sulphur dioxide
(SO2)/nitrogen oxides (NOx) (causes of acid rain) and carbon
dioxide (CO2) (cause of global warming)2. The principal causes
of emissions include economic/industrial development,
demographic pressure and use of polluting technologies.
The concept of emissions trading is driven by market failure
on a significant scale. Emissions trading is directed at
intervening in the operation of market economies. It primarily
operates economically to specifically internalise the costs
borne by parties external to the production process.The system
is designed to deal with the problem of 'externalities'. An
externality refers to the position where one party
(such as a power plant) generates a product (as a by-product of
its production process, for example emissions of toxic gases)
that harms others, but the producer is not held responsible for
the damage caused or the cost. The problem of externalities can
also be considered as the result of undefined property rights.
In this example, the ownership rights to clean air are not
adequately defined. This means that
the right to clean air cannot be monitored or enforced. In
economic theory, there are various ways in which the
problem of externalities is dealt with. Emissions rights
and trading in those rights is one way of seeking to control
those externalities. Exhibit 1 sets out the types of emissions
programmes and tradeable commodities that are generally
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