Bad Day for Environmental Economics, And the Environment

Almost unnoticed, this week marks a terrible week for advocates of market solutions to environmental problems, including various cap-and-trade systems. The Wall Street Journal reports that new federal air pollution rules have resulted in the tanking of the sulfur dioxide market, rendering extant permits worthless.

Often referred to as “the grand policy experiment,” (also here), the SO2 market was considered a success, and thought of as a model for potential global system to reduce greenhouse gases.  As with so many cases in economics, a credible commitment matters.  The Journal sums it up nicely:

The market’s collapse shows how vulnerable market-based approaches to reducing air pollution are to government actions. That could scare off investors, who won’t commit to a market where the rules can change at any minute.


One of the great benefits of using market instruments to address environmental problems is that they can substantial lower the costs.  The law of demand says that as price goes up, people buy less.  As a result of the collapses of this market, we will likely pay more to get less in terms of environmental quality.  This may well undermine efforts to implement market solutions elsewhere.  If investors are convinced the regulatory environment is unstable or uncertain, they are unlikely to make large capital investments, and are more likely to take stopgap measures.