World’s First Particulate Pollution Market Reduced Pollution and Increased Industry Profits

Particulate air pollution is causing a public health crisis in many lower-income countries, with the average person in India losing more than 3 years of life expectancy as one important example. These countries tend to rely on difficult to enforce command-and-control approaches to regulating pollution, even though pollution markets, or cap-and-trade programs, have a strong track record of reducing pollution at low costs in the United States and Europe.

A new study, in the May issue of The Quarterly Journal of Economics, experimentally evaluates the world’s first cap-and-trade market for particulate pollution that has been operating for more than five years. Its success demonstrates that pollution markets can work in low- and middle-income countries where pollution is frequently very high and state capacity is often low.

“The market delivered a rare win-win-win by reducing pollution, decreasing abatement costs, and raising government’s success at enforcing the law. And, it did all this in a setting where there was great skepticism that pollution markets could work,” says study co-author Michael Greenstone, the Milton Friedman Distinguished Service Professor in Economics at the University of Chicago. “This success of pollution markets is generating a great deal of interest from other governments that are trying to balance the goals of economic growth and environmental quality. In addition to our continuing collaboration with the Gujarat Pollution Control Board, we’re now working with other states in India and governments in other countries to scale-up the use of pollution markets.”

Greenstone and his co-authors Rohini Pande and Nicholas Ryan, both of Yale University, and Anant Sudarshan of the University of Warwick, worked with the Indian state of Gujarat to launch and evaluate the market in the city of Surat. The government mandated 317 large, coal-burning plants to install pollution monitors. From there, half the plants were randomly assigned to the market while the rest were kept under traditional regulations. The plants in the market were given a cap on the total amount of pollution they could emit. Those that easily met the cap traded permits with those who could not meet the cap, with both buyers and sellers benefiting.

The plants that participated in the market reduced particulate emissions by 20 to 30 percent overall, relative to plants that were experimentally assigned to continue with the status quo form of regulation. Further, plants that participated in the market benefited from 11 percent lower pollution abatement costs that increased their profits.

From a legal or regulatory perspective, the market also functioned almost perfectly—with plants holding enough permits to cover their remaining emissions 99 percent of the time. By contrast, those plants outside of the market were in violation of their pollution limits at least a third of the time.

When the researchers put it all together, the benefits of the market exceeded the costs by at least 25 times. It is usually a cause for celebration when a program has a benefit-to-cost ratio of 1.2, so this finding suggests there is a tremendous opportunity to be had in using pollution markets. The high benefits come from the large mortality costs of air pollution and the low costs of abatement in the market.

Because of the success of the market, the Gujarat government expanded it to include those plants originally left out of the pilot experiment. It also launched a second market in the city of Ahmedabad—Gujarat’s largest city and a major industrial hub—and is exploring expanding the market regime to additional industry clusters and pollutants, as well as additional cities. Meanwhile, the research team is working with another Indian state to develop a statewide market for sulfur dioxide emissions. The research team is providing strategic advice to several other Indian state governments and beginning conversations with other countries on how to use markets to meet their environmental and climate goals.

The research team behind this work is affiliated with the Energy Policy Institute at the University of Chicago’s India program (EPIC-India), J-PAL South Asia, and the Economic Growth Center at Yale University.

The research team was awarded funding to scale the market by J-PAL’s King Climate Action Initiative (K-CAI), and J-PAL South Asia’s Solutions and Advancements through Research for Water, and Air (SARWA) and Alliance for Scaling Policy Impact through Research and Evidence (ASPIRE).

This article originally appeared at the Energy Policy Institute at the University of Chicago.