An efficient mechanism to control correlated externalities: redistributive transfers and the coexistence of regional and global pollution permit markets

Abstract

We examine joint tradable permit markets as a self-enforcing mechanism to control correlated externality problems. By ''correlated'' we mean multiple pollutants that are jointly produced by a single source but which simultaneously cause differentiated regional and global externalities (e.g. smog and global warming). By ''self-enforcing'' we mean a mechanism that accounts for the endogeneity that exists between competing jurisdictions in the setting of environmental policy within a federation of regions. We find that joint domestic and international permit markets are Pareto efficient for a wide class of preferences. r 2004 Elsevier Inc. All rights reserved. JEL Classification: C72; D62; D78; H41; H77; Q28

Prices vs quantities with multiple pollutants

“…Climate change mitigation models also consider multi-gas control strategies (see for instance Nordhaus 2000 andTol 2006) to evaluate emission path scenarios. Montero (2001) and Caplan and Emilson (2005) analyze the design of environmental regulations with several pollutants. Contrary to our paper, they consider only one instrument, namely marketable emission allowances.…”

“…They imply that the second-order conditions of the maximization programs below hold. 5 To simplify notation, we write q * instead of q * (ω, θ) even though ex post efficient abatements depend on ω and θ. 6 Quotas are obviously binding.…”

Double-dipping in environmental markets

“…If the marginal damage curves are steep, then it is less efficient to allow cross pollutant trading. Caplan and Silva (2005) and Caplan (2006) investigate a multipollutant problem in an international setting. A productive sector in each nation creates both a regional and global pollutant in a fixed proportion.…”

Urban Structure and Environmental Externalities

“…Analyses of multiple interacting pollution sources are more scarce. Caplan and Silva (2005) introduced the notion of "correlated externalities" in a context where a single source is responsible for emitting multiple pollutants that may have local or regional impacts.…”

“…They analyzed the properties of different policy instruments to manage efficiently such correlated externalities in the context of a global federation with decentralized leadership in a series of papers (Caplan and Silva (2005); Caplan (2006); Caplan and Silva (2007)). However, there exist different types of correlations between atmospheric pollutants, since they can interact during or after the production process in various manners : complement or substitute abatement technologies, interactions between stocks, interacting damage, etc.…”