Published on December 29th, 2014


Using markets to protect the environment


Operating an industrial boiler requires skill and experience in addition to the significant capital outlay required to obtain them. It also requires something else – adherence to a lengthy set of operating rules laid out and frequently updated by the US Environmental Protection Agency.

Hardly anyone with the requisite skills to manage an industrial boiler is also gifted with the specialized knowledge required to fully understand nearly a hundred pages of detailed operating rules from the EPA, or to properly interpret their intentions and implications. Thanks to the approach to environmental regulation we have adopted, no one can safely operate an industrial boiler without seasoned technicians with the proper experience and protective gear. And a clever attorney.

Virtually no corner of industrial operations in the United States is free to operate without consulting a dense thicket of operating rules issued by regulators at the state, federal, and even local level. Those rules are designed to protect workers from injury, reduce pollution, prevent fraud, or accomplish any number of other laudable goals.

It is very difficult for a highly educated and trained scientist with a keen understanding of the impact of sulfur dioxide on the atmosphere to draft detailed operating instructions for a power plant without wreaking havoc on that plant’s operations. The challenge comes less from understanding how a smokestack works than from a different source.

A regulatory code, like a package of computer code, is stupid. It does not think or adapt or evolve on its own. It is a machine. The process of developing a code of regulations for something as complex as an industrial boiler is extremely time consuming. In an economy as dynamic as ours, those rules are often dated by the time they come into effect.

As the complexity of our economy and our lives accelerates, the cost of regulation is skyrocketing while it’s effectiveness declines. Fortunately, there is an alternative. We have already used it successfully in a few limited settings and it is perfectly suited to tackle our most challenging, complex, and dangerous pollution challenge – climate change.

Markets are much smarter than regulatory codes because they are, essentially, alive. If the rules of a market can be set to include the price of pollution, then markets could be made to do much of the work that otherwise falls to regulators. In many cases, this approach is already working.

Trading in pollution credits has been the key to a massive reduction in acid rain caused by sulfur and nitrogen oxides released from coal burning power plants. The program worked like this. Instead of issuing a new set of detailed regulations forcing power plants to adopt this or that technique for reducing emissions, the EPA set a new cap on sulfur dioxide emissions.

Companies that lowered their emissions below the cap could sell their additional polluting capacity to other companies that had failed to meet the targets. This created a market in pollution reduction with a very impressive side-benefit – new capital investment in innovation aimed at pollution reduction.

Regulators were freed from the tedious and increasingly futile challenge of writing rules that subject companies were constantly working to evade. Companies were released to find the best possible solution to their emissions problem and a new business model emerged around emissions reduction.

Since the plan was placed into effect, sulfur dioxide emissions from the plants covered by the program have decreased by more than half. It is difficult to determine precisely how much of the reduction was due to the trading scheme as opposed to continuing regulation and changes in the energy market, but it has clearly had a significant, sustained, positive impact. Along the way, the cost and misery associated with regulatory compliance also declined, adding to productivity and enabling faster innovation.

Challenges still exist in implementing such a scheme. A cap and trade approach does not immediately ban pollution. Pricing can be complex. It is possible to set the cap too high, which allows polluters to “bank” credits, slowing pollution reduction over time. Set the cap too low and the costs could become ruinous.

Non-profit organizations have participated in these markets by purchasing pollution credits, raising the price of the credits and taking additional sulfur pollution out of the system. This gives environmental groups an additional avenue of participation, having a direct impact on levels of pollution.

How much has cap and trade added to the cost of energy in the US? Slashing sulfur pollution by more than half has cost a few cents per kilowatt hour. The cost has been virtually invisible to consumers, a fraction of the cost of an ongoing dance between regulators and polluters. And it has been radically effective.

Instead of saddling power plants with the burden of additional operating rules that could not possible have adapted fast enough to keep pace with innovation, plant owners were able to capitalize on the most suitable remediation for their needs. This approach would not entirely replace traditional regulation, but offers an opportunity to meet public needs in an increasingly complex economy not just around pollution, but in banking, employment safety and other efforts.


About the Author: Chris Ladd is a longtime Republican political volunteer from Texas now living in Chicago. He has served as GOP Precinct Committeeman in DuPage County and worked with numerous Republican campaigns and PACs. He is concerned about the party’s drift toward the extremes. Chris also writes a blog on the website of his old hometown newspaper, The Houston Chronicle

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