Polluters, permits and profits

The Financial Times recently reported that “loopholes” in climate change regulations are allowing Chinese factories to profit from installing scrubbers on local chemical plants (see “Chinese plants and carbon traders exploit loophole,” 1/18/07).

Personally, I thought this was actually the point of the regulations, and represented a welcome evolution from command-and-control regulations. In fact, this is essentially what I wrote my undergraduate thesis on, though I discussed the SO2 market rather than the CO2 market.

The idea of tradable pollution permits is that imposing uniform standards on all producers is disproportionately expensive for some of them. So they'll fight the policy, rightfully arguing that it would put them out of business - and policymakers respond by watering down the regulations, leading to less total abatement.

An alternative that economists tend to favor is to set the total amount of pollution that you "want" (i.e., can stand) - generally at less than its current level. Then you allocate "rights" to it, and those companies that can reduce their pollution with the lowest cost do so in order to trade their rights for money. Companies that find abatement more expensive buy these rights. The net result is that you get the amount of abatement you originally wanted, and the polluters work out among themselves who can physically accomplish it at the lowest cost - which is the economically efficient thing to do.

So, the article says that Chinese companies are installing scrubbers, and making a huge profit from cheaply reducing their pollution that way. So what? If the total amount of CO2 reduction doesn't seem like enough, it should have been set differently at the beginning. But this is exactly the sort of behavior that the system is designed to encourage.