Issuing permits for pollution which are then traded between countries (or companies within countries) countries on the same basis as the international commodity market or domestic shares markets.
Economic instruments such as tradeable emissions and carbon taxes, will allow market forces to set prices at the best level for reaching targets at the lowest cost. They will need to be complimented by research and development, education and information, green policies for government procurement and voluntary reductions in energy consumption.
Developing countries would benefit from involvement in climate change policies, through the clean development mechanism and the financial transfers connected with emission trading. Accelerating the implementation of these mechanisms is therefore needed to encourage broader participation in global efforts to limit climate change.
The world must move as fast as possible towards a pattern of world economic development that compliments, rather than compromises the stability of the global environment. This in turn requires mechanisms and financial incentives for participation by developing countries.
Tradable emission permits were first introduced in the USA during the mid-1970s by the Environmental Protection Agency (USEPA) as a means of combatting the high cost and rigidity of tradition legal approaches – so called "command and control measures" including limits set on emissions, court procedures for non-observance and fines for infringement. The EPA's Emissions Trading Program allows polluters to reduce their emissions below a set standard and then apply for a credit. The credit earned at one site can be used to offset excess emissions at other places. USEPA allows these credits to become transferable and hence tradable on a forward basis. Permits in sulphur dioxide (SO2) emissions have been traded since 1992, and amounted to 255,000 tonnes of credits in 1992/93. (As yet an active spot market for SO2 permits has not developed.)
Credits on lead reduction in petrol are "banked" and also transferred by USA refineries. A similar system with a Federal tax pertains for the trade of production and consumer allowances for ozone-depleting chemicals. It is argued that credits are the currency of the system, a currency that can be stored in a bank or spent in a number of ways that reduce costs for individual firms but maintain overall emissions of pollutants at or below set standards.
An instance of the benefit of tradable permits is the deal announced in 1994 by two electric utilities in the USA. They agreed to trade permits to emit one type of pollutant (SO2) for permits to emit another type of pollutant (CO2). The deals come about because one utility, Niagara Mohawk, produces large amounts of hydropower. It therefore has not difficulty in meeting target carbon dioxide (CO2) emission reductions under the US Climate Challenge Accord, a voluntary agreement in which companies agree to do their share in reducing national carbon dioxide (CO2) emissions to below 1990 levels. Arizona Public Service, however, supplies power to an area where power consumption is growing at twice the national average and where consumption is already three years ahead of projections. However, the company has surplus SO2 permits under the USA Cleaner Air Act of 1990s since it has already agreed to finance the cost of equipment that will reduce the haze above the Grand Canyon.
The twist to the story is that Niagara Mohawk has, in fact, no need for the SO2 permits which it earns, and intends to donate them to an environmental group. The permits will thus be "retired"; no other company will be able to use them and this will contribute to the absolute reduction of SO2 emissions. Niagara Mohawk nonetheless also benefits from the trade in that it receives tax concessions worth some US$3.75 million. The utility intends to use some of this money to finance research on ways of reducing CO2 emissions in other countries. It is investigating the possibilities of financing schemes to generate power from the burning of sugar cane waste in India, studying reafforestation in Mexico, helping to modernize electricity production in China and repairing leaks in Russia's natural gas pipelines. These are areas where potential climate improvements can be made more cheaply than they can in many areas of the USA.
Tradable permit systems are more cost-effective since the system is based on actions – buying and selling – in which participants seek to minimize their costs, even without having to evaluate their costs. Therefore they can produce greater environmental improvements at lower cost than systems based on non-transferable quotas. They also facilitate technology transfer because they provide a means of sharing both costs and risks. Monitoring such a system would be easier than with a system of external offsets because the latter cannot be monitored unless values are put on what is saved.
Tradable permits works best for pollutants that are uniformly mixed (and do not require diffusion modelling) such as greenhouse gases.