Pollution added credit trading (PACT): New dimensions in emissions trading

• , 1 : 7 . • ? ' ,* . , . .

E L S E V I E R Ecological Economics 19 (1996) 35-53

ECOLOGICAL ECONOMICS

Methodological and Ideological Options

Pollution added credit trading (PACT)" New dimensions in emissions trading

Stefan Schaltegger a,*, Tom Thomas b a lnstitutfiir Volkswirtschafi, Wirtsehaftswissenschaftliches Zentrum (WWZ) (Center of Economics and Business Administration), Unil,ersitv

of Basel, Basel, Switzerland School of Business Administration, Department of Management and Organization, Unit,ersio, of Washington, Seattle, WA, USA

Received 23 August 1995; accepted 15 May 1996

Abstract

To date, sources of hazardous, toxic, or otherwise harmful emissions have been regulated on a pollutant by pollutant basis. Environmental policies, even the more advanced 'incentive-based' programs, have focused on individual substances rather than on the overall environmental problem to which the substances contribute. This has produced results that are less economically efficient and ecologically effective than is desirable. A more comprehensive approach combines the principles of emission reduction credit trading with advances made recently in the field of environmental impact assessment, to yield an advanced form of inter-pollutant trading, which we refer to as pollution added credit trading (PACT). PACT incorporates a method for estimating the total environmental harm generated (pollution added) by a facility emitting a variety of pollutants. Weightings that reflect relative harm are used to calculate total pollution added. Each facility covered by PACT would receive annual allowances for total pollution added that they could discharge to the environment. As with existing emissions trading programs, surplus allowances could be sold and shortfalls would be covered by purchasing other facilities' surplus allowances. PACT is more efficient than single-pollutant emissions trading in that it captures differences in marginal reduction costs that exist between pollutants as well as between facilities. It is more ecologically effective because it focuses on the overall environmental problem, rather than on the individual pollutants that contribute to the problem.

1. Introduction

If the purpose of environmental regulation is to solve environmental problems, then all pollutants that contribute to a problem should, ideally, be regulated in the least costly manner available according to their relative harm or impact. Pollution added credit trading (PACT) can help achieve this ideal by

* Corresponding author. Tel.: (41-61) 267-3360; Fax: (41-61) 267-3340.

providing a pol icy framework for improving the efficiency of emissions trading. It combines the principles of emission reduction credit (ERC) trading (Hahn, 1989, 1990; Hahn and Stavins, 1991; Mc- Gartland and Oates, 1985; Perkelney, 1993; Tieten- berg, 1985, 1992) with advances made recently in the field of environmental impact assessment (for an overview of methods see, e.g., Schaltegger et al., 1996) to establish a methodology for more cost-effective inter-pollutant (or cross-pollutant) trading.

The pollution added credit trading concept evolved from a conviction that adverse environmental im-

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36 S. Schaltegger, T. Thomas~Ecological Economics 19 (1996) 35-53

pacts cannot be addressed effectively and efficiently on a pollutant-by-pollutant basis. Such an approach seems inevitably less effective and more expensive than a problem-centered approach that focuses regulatory efforts at the level of environmental impacts caused by the pollutants. When reducing the cumulative adverse environmental impacts of pollutants, reductions in emissions of individual pollutants should reflect their relative contributions to specific environmental problems. One means to achieve this, and move from pollutant-centered regulation toward problem-centered regulation, is through the practice of inter-pollutant emissions trading.

This article introduces the concept of pollution added credit trading by first briefly discussing the rationale for inter-pollutant trading, and reviewing existing examples of inter-pollutant emissions trading programs (Section 2), describing pollution added credit trading (PACT) in detail (Section 3), discussing the problems inherent in existing pollutant trading opportunities and examining the relative advantages and disadvantages of the PACT alternative (Section 4), and offering tentative conclusions and an agenda for further research (Section 5).

2. Environmental goals and inter-pollutant trading

This section begins by discussing the rationale for focusing regulatory efforts at the level of environmental problems or impacts, rather than on individ-

ual pollutants, and for using inter-pollutant emissions trading as an effective tool for achieving this end. We address two programs currently under development that either implicitly or explicitly sanction a limited form of inter-pollutant emissions (inter-pollutant) trading. We proceed to extend the logic of inter-pollutant trading to illustrate how it might be used to address a far broader range of environmental problems.

2.1. Hierarchy of environmental goals

The overarching social objective of environmental regulation is to reduce potential harm to life on our planet (Fig. 1). This objective can be disaggregated into general goals such as reducing risk to humans, maintaining atmospheric balance, preserving species habitats, etc. The former, in turn, can be further decomposed into objectives such as reducing cancer risk, minimizing poisoning, limiting the probability of a greenhouse effect, and the like. Those objectives can in turn be attained by reducing human-made impacts on the environment (e.g., reduction of CO 2, SO 2, lead emissions, etc.).

A regulatory approach which focuses on individual substances, and thus seeks to reduce emissions on a pollutant-by-pollutant basis, risks suboptimiz- ing. This is because it does not exploit differences in the relative impacts and marginal costs of emissions reductions for different substances that contribute to a given environmental problem. Thus, while a given regulation might be extremely effective in reducing

O ~ e ~ goal of environmental Reduction of poten~! harm tO !ife ~ ~ e planet

Fig. 1. Hierarchy of goals of environmental protection.

S. Schaltegger, T. Thomas/Ecological Economics 19 (I996) 35-53 37

emissions of a particular substance, it might also do very little to solve the actual environmental problem, if other substances continue to contribute to the problem. On the other hand, the problem might be mitigated, but at far greater cost than is necessary, since substances contributing to a given environmental problem often exhibit vastly different marginal reduction costs (Howe, 1991; Stritt and Jeanrenaud, 1992; EPA, 1991a).

Thus, the key to achieving more efficient and effective reductions in environmental harm is to pursue regulatory goals that focus on environmental problems, rather than on single pollutants. In the next section, we discuss inter-pollutant emissions trading as one means of doing so.

2.2. Emissions trading and inter-pollutant trading

Emissions trading is generally considered the most cost-effective method of reducing pollution emissions and solving environmental problems. The advantages to be derived from these emissions trading programs have been discussed extensively elsewhere (see, e.g., Bonus, 1984; Hahn, 1984, 1989; Kemper, 1989; Liroff, 1986; OECD, 1989, 1991; Perkelney, 1993; Schaltegger, 1987; Shireman, 1993; Siebert, 1976; Staehelin-Witt and Spillmann, 1992a,b; Stavins, 1989, 1992; Tietenberg, 1980a,b,1986, 1989, 1992). In essence, they are theoretically able to reduce emissions more efficiently than can traditional regulatory methods, since they recognize and exploit the different marginal costs of compliance that each emitter faces. Allowing trading encourages those who can reduce emissions cheaply to do so, and to sell their excess emissions credits to those who cannot. As a result, total emissions are reduced at the same rate that would otherwise have been the case, but total compliance expenditures are reduced. Individual emitters are free to choose the most appropriate means of complying, and have an economic incentive to reduce emissions below their permitted levels. This latter factor spurs technological innovation, as new means are sought to reduce pollution cost effectively.

To date, however, most emissions trading programs have sought to reduce emissions of individual pollutants (e.g., SO 2, lead, etc.). While these pollutants are strongly linked to the environmental prob-

lems they create (i.e., acid rain, lead poisoning), these programs are pollutant-specific, rather than problem-specific. Most environmental problems, however, are generated by a wider array of toxic or hazardous substances. As previously noted, it makes sense (from an ecological point of view) to include all pollutants that contribute to a given environmental problem under a common regulatory regime (see also Kemper, 1989). From an economic point of view, it is preferable to minimize the cost of reducing environmental harm. One way to achieve this, for a given environmental problem, would be to set overall goals for reducing total adverse impact, as- sign impact-based weights to all pollutants that contribute to the problem, and allow emitters to trade weighted emissions reductions in order to reduce overall impact at least cost. This is the essence of how inter-pollutant trading might operate in the abstract.

The basic idea of an inter-pollutant trading regime of air pollution control has been addressed in earlier studies by Mackintosh (1973; pp. 64, 66f) and Tie- tenberg (1980b; pp. 409f). Although most authors seem to dismiss the approach of inter-pollutant trading because of the lack of a generally accepted basis of aggregation, this approach has been used in a rudimentary way in a World Bank study of air pollution in Mexico (World Bank, 1992; pp. 74f).

There are two regulatory developments currently evolving that will make inter-pollutant trading possible in the near future: the Regional Clean Air Incen- tives Market (RECLAIM) in Southern California, and Section l12(g) of the 1990 Clean Air Act Amendments.

The South Coast Air Quality Management District is the first local air quality authority in the USA to adopt an extensive emissions trading program cover- ing several pollutants (SCAQMD, 1992). RECLAIM currently being developed in southern California will, when fully implemented, create localized cotermi- nous ERC markets for several pollutants including nitrogen oxides (NOt) and SO 2. This will create opportunities for de facto inter-pollutant trading, since sources that emit these compounds and that

i We are very thankful to Tom Tietenberg for this comment .

38 S. Schaltegger, 7". Thomas / Ecological Economics 19 (1996)35-53

wish to increase their allowable emissions of NO x, for instance, will be able to pay for the necessary NO x credits by creating and selling SO 2 credits (after reducing SO 2 emissions). The major difference between this procedure and company-internal inter- pollutant trading is the substantial transaction costs involved.

The concept of inter-pollutant trading has already been incorporated into US federal legislation. Sec- tion 112(g) of the 1990 Clean Air Act Amendments requires the EPA to design and administer a rudimentary form of inter-pollutant trading. Once implemented, it will allow facilities to avoid new source review for certain pollutants by trading emissions reductions internally. Depending upon how the section is interpreted, it will allow facilities to increase emissions of hazardous substances if they are either (CAA, 1990; pp. 2545f; Caldwell-Kenkel, 1993): • offset by greater reductions in other, more haz-

ardous pollutants, or • offset by a decrease of 'a more hazardous quan-

tity of another pollutant' (Caldwell-Kenkel, 1993). The latter interpretation would essentially allow

facilities to trade greater reductions of less hazardous pollutants for smaller increases of more hazardous substances, as long as the net result was to reduce overall hazard. This would require far more rigorous estimates of the relative hazards posed by various

pollutants than would the former interpretation. This interpretation also comes closest to approximating the PACT concept.

In planning for the implementation of Section 112(g)'s inter-pollutant trading program, the EPA currently intends to accommodate uncertainties regarding relative hazards of substances by requiring a ten-to-one reduction in estimated risk for a trade to be approved (Caldwell-Kenkel, 1993). This offset ratio provides for a significant margin of error in risk estimates, and increases the likelihood that trading will indeed result in a net reduction of risk. How- ever, the relatively high and somewhat arbitrary ratio seems likely to discourage active inter-pollutant trading. It would be more efficient, and ultimately more effective, to achieve risk reduction goals by mandat- ing periodic reductions in the total amount of pollution added, while permitting and encouraging internal and external trades of reductions in substances of roughly equally hazardous impact.

These two regulatory reforms represent the cut- ting edge of a new dimension in emissions trading (i.e., inter-pollutant trading), one that allows us to address environmental issues at the problem level, rather than at the pollutant level. The underlying logic of this new dimension is discussed in the next section, followed by a detailed description and analysis of pollution added credit trading (PACT), a

Problem / Substance

I genC Cancer 4; carcmo-

| g e n B carcino-

k gen A

f ... NOx

Smog VOC

SO2

Environmental Media

Soft

Region

Ier

Region X Region Y

Fig. 2. Dimensions of emissions trading.

S. Schaltegger, T. Thomas/Ecological Economics 19 (1996) 35-53 39

methodology that enables a comprehensive, problem-centered approach to inter-pollutant trading.

2.3. New dimensions in emissions trading

Let us return for a moment to the basic single- substance emissions trading concept, as exemplified by the US EPA's SO 2 or lead trading programs. If such programs are judged to be successful, i.e., they allow more rapid reduction in emissions of undesir- able substances at reduced cost (see, e.g., Hahn, 1988; Hahn and Hester, 1989; Hahn and Stavins, 1991; Pearce and Markandya, 1989; Pearce and Turner, 1990; Shireman, 1993; Tietenberg, 1992), then it would make sense to extend their application to a broader range of substances. However, further extension of the current ERC-trading approach is inhibited by the fact that it is basically one-dimensional, or two-dimensional at best. That is, trading typically occurs for one substance, released to one medium, within a given geographically defined bubble.

Fig. 2 indicates the three dimensions across which emission reduction credit trading operates: environmental media, geographical location, and released substance. The box in the lower left corner, for example, represents a SO2-air emission-bubble cov- eting Region X. An extended application of ERC- trading would require the creation of numerous such bubbles.

If such a trading scheme were applied to the hundreds of toxic, hazardous, or environmentally damaging pollutants currently being regulated (disre- garding the many thousands that have yet to be regulated, or even tested), it would not yield nearly the economic efficiencies or the ecological benefits that are theoretically achievable. This is because these programs promote trading of credits for reduced emissions of individual substances released to individual media.

If emissions trading were extended to cover the three hundred or so toxic or hazardous substances businesses are required to report via the Toxic Re- lease Inventory (TRI), then individual markets would have to be established for hundreds of different substances. With thousands of new chemicals introduced into the natural environment each year, the

proliferation of hazardous, toxic and environmentally damaging substances could lead to an equally rapid proliferation of markets for individual types of ERCs. As we note in Section 4, this could lead to subopti- mal outcomes, both economic and ecological.

An alternative approach would be to enhance the efficiency and ecological efficacy of emissions trading by creating trading bubbles that correspond to the underlying ecological problem being addressed.

Such bubbles can be characterized in Fig. 2 as clusters extending among the three relevant dimensions. For example, the shaded area at the top of the figure would represent an emissions trading bubble created for all carcinogenic substances released into the air, water and soil within Region X. Emitters covered by the bubble would, in essence, trade carcinogenic risk reduction credits, rather than ERCs for individual substances. Such a bubble would require a weighting scheme that reflects our best scientific estimate of the carcinogenic risk posed by each substance included in the bubble. It would also require a method for weighting the relative risks of carcinogenic substances released to different media. The pollution added credit trading (PACT) concept, described in the following section, proposes a methodology for doing this.

3. Pollution added credit trading (PACT)

Pollution added credit trading (PACT) is essentially a method for trading trans-media/inter-pollutant emissions reduction credits. The PACT concept operates from the perspective that planners should focus on desirable social objectives when designing trading programs, rather than on individual substances that impede those objectives. It holds that existing emissions trading efforts, which allow trading of emission reduction credits only for individual substances, severely constrain the efficiency gains that are theoretically achievable. A more comprehensive approach, which allows trading among various substances that pose similar threats to the environment, would permit us to pursue and achieve our social objectives more rapidly and efficiently than would otherwise be the case. For example, if one of our goals is to reduce the risk of an adverse green-

40 S. Schaltegger, T. Thomas/Ecological Economics 19 (1996) 35-53

I~' ~"~'" ProcesstoEstablishPACT II iiiii~ ! '~' '~'''~' S teps . . . . . . . . . [ [

i definition of goal and bubble ! ~ 1 defmed bubble I I iii!iiiiiiiiiiiiii: (e g carcinogen oubble) [ l . . . . . . . •.i•iii}i•iiiiiiii•i•iiiiii•iiiii•ii••i••i•:i••i••i}i•ii•iiiiii••iii••iiii•:i•:ii•• . . . . . . . . . . . . . . . . . . . . .... !i:iii:; I ' I

I registration of all respective emissions in a bubble I t poilut~onrelease,nventory I I ~,~,}~;~;~;~;:t le.g. inventory ol air releasea I

.... ;:::::;~;:~' ; carcinogens in kg)

l " weighting the released pollutants according to their [: ] - t o t a l pollution added [ [ relative environmental harm by multiplying the quantity [ I of the bubble in pollution units [ I of released pollutants with the specific weighting factors ~i~!~iiiiii.~.(e.g. total carcinogen risk added) I

......... i~::':" [. pollution added credits [ I - defining the pollution value of one credit [ (e.g. I carcinogen risk unit = 1 carcino-[ I [ gen emission reduction credit (CERC) [

I ":"" I

determination of total allowable environmental impact :::[:::::::: :~: .I respectively total number of credits "ceiling" of the bubble

]-introauction oft~ade (initial assignment of credits) I ] trade and I I - control of trade and achievement of goals ..... :~:: I achievement of goals [ - adjustment of trading plan i::ii:i~:::ii~:~: [ I

Fig. 3. Process of establishing a PACT-bubble.

house effect caused by the cumulative release of greenhouse gases, then we could achieve this goal quicker and at lower cost by allowing trading of greenhouse gas emission reduction credits (GERCs), than we could by fostering separate markets for each individual substance that contributes to the problem.

The key to the PACT concept is the calculation of a source's total pollution added within each of the categories associated with desired social objectives. The expression 'pollution added' is somewhat similar to the concept of value added, the difference being that the focus is on the environmental impacts of pollution attributable to economic activities (Schaltegger and Sturm, 1994; p. 30). A source's total pollution added is calculated as the sum of the weighted amounts of every substance emitted, where the weights are based on estimates of the relative risk each poses to the environment. This figure (total pollution added) then can serve as the baseline from which sources are required to reduce total emissions

on an annual basis. 2 Any reductions beyond what is required can be sold as emissions reduction credits to other sources operating within an appropriately defined bubble. For example, greenhouse gas emissions reduction credits (GERCs) could be traded within national or (ideally) international bubbles, due to the global nature of the threat that they represent to ecological health. 3 Carcinogenic emissions bubbles could be created to cover emissions to all media (air, water, and groundwater) within more circumscribed geographical areas, due to the more localized threat

2 For other approaches for initial allocation of credits, such as auctioning, see, e.g., Bonus (1984); Hahn (1989); Hausker (1992); Tietenberg (1992).

3 The establishment of an international greenhouse bubble and a greenhouse gas credit trading system already have been proposed and analyzed. See Victor (1991) or Stavins (1989). Major problems of such an international system seem to be the accuracy of monitoring and control of non-point sources emissions.

S. Schaltegger, T. Thomas / Ecological Economics 19 (1996) 35-53 41

they represent, and the resulting carcinogen emissions reduction credits (CERCs) would be traded within corresponding localized markets.

The first step in establishing a PACT program is to determine the social objective it will be intended to achieve (Fig. 3). The objective will determine the appropriate geographical area, range of media, and array of substances to be included in the bubble.

Second, weights must be assigned to each substance tbr releases to each medium, which reflect their estimated relative environmental harmfulness. Third, regulatory authorities must construct a detailed inventory of all sources of pollution and the total amount of all released substances, to serve as the baseline for the initial allocation of credits. As a practical matter, releases of many substances are already recorded under existing regulations. Emis- sions inventories, such as the toxic release inventory (TRI), or inventories of the criteria pollutants (CO, SO 2, Pb, PM-10, 03, NO~) already exist on a national, regional and often a firm level. TRI data consisting of total pounds of released toxic substances, are recorded and reported by the discharging companies as required under Superfund Amendment and Reauthorization Act (SARA Title II1) and are compiled and disseminated by the US Environmental Protection Agency (EPA, 199 lb).

The fourth step in the process is to calculate total pollution added for each source, by multiplying the weighting factor for each substance by the total amount released. Regulatory authorities must then determine, for trading purposes, how many pollution-added units will constitute a single PACT credit. The size of a PACT credit must be small enough to ensure sufficient liquidity, but large enough to reduce transaction costs and account for inaccuracies in measurement.

A ceiling for total PACT credits within the bubble must then be established, which would be lowered periodically to systematically reduce total pollution- added within the bubble. PACT credits would then be either allocated or auctioned off to point sources operating within the bubble, and trading could begin. Except for the process of establishing and applying weighting factors to obtain total pollution added, all of these steps are fundamentally the same as those that would be required for any single-substance emissions trading program.

The arduous and controversial task of assigning relative weights is an essential step in solving environmental problems attributable to pollution. The assessment and comparison of relative environmental impacts has been the focus of methods of life-cycle analysis, eco-balancing, ecological accounting, etc., that have been developed over the past decade (for an overview see Schaltegger et al., 1996). These methods are intended to permit comparison of products, businesses, companies, etc., by estimating their total environmental impact in one (e.g., total pollution units), or several dimensions (e.g., pollution units discharged to air, water, landfill). A survey evaluates more than twenty types of assessment methods that have been published to date (Schal- tegger and Sturm, 1994). Its comparison and criti- cism of these methods indicates that most can be applied to only a very few substances.

However, a variety of assessment methods can be used for a problem-focused bubble program, due to the relatively constrained set of substances that contribute to particular environmental problems. For instance, a greenhouse gas PACT bubble has to take into account only about half a dozen major pollutants, and covers emissions to a single environmental medium. Thus, a broader range of assessment tech- niques can be applied to pollution added credit trading than would be necessary for a complete life-cycle assessment of products. Though any number of such weighting schemes could be used in a PACT program, it generally would be best to employ one that enjoys the considerable scientific, social and political legitimacy.

One example of such a methodology has been proposed by the Center of Environmental Science of the University of Leiden, Netherlands. It establishes assessment factors for the relative contribution to environmental problems posed by chemical substances (Heijungs et al., 1992). This approach, though certainly not without its drawbacks, has attracted considerable attention in Europe and has been applied by various firms, environmental protection or- ganizations and the Dutch government (e.g., Consoli et al., 1993; WWF International, 1992). Primary advantages of this approach are that it has been developed by a well-known scientific university institute and its focus on specific environmental problems such as the greenhouse effect, the depletion of

42 S. Scholtegger, T. Thomas~Ecological Economics 19 (1996) 35-53

Table 1 Assessment factors for substances contributing to the depletion of the ozone layer (source: Heijungs et al., 1992; pp. 670

Formula Substance ODP Range

CFC13 CF2CI 2 C2F3C13 C2F4C12 C2F5C1 CHF2CI CHCI2CF 3 CHFC1CF 3 CH3CFC12 CH3CF2C1

CCI CH3CCI 3 CF3Br CF2 BrC1

C2F4Br 2

1.0 1.0-1.0 1.0 0.88-1.06 1.07 0.92-1.07 0.8 0.57-0.82 0.5 0.29-0.5 0.055 0.032-0.08 0.02 0.013-0.020 0.022 0.016-0.034 0.11 0.10-0.12 0.065 0.035-0.07 0.025 0.016-0.025 0.033 0.023-0.033 1.08 1.03-1.15 0.12 0.11-0.13

16 10.0-17.2 4 1.8-5.0 1.25 1.25-1.7 7 5.9-10.2 1.4 1.4-1.4 0.25 0.25-0.4 0.14 0.14-0.3

trichlorofluoromethane (CFC- 11) dichlorodifluoromethane (CFC- 12) 1,1,2-tricbloro- 1,2,2-trifluoroethane (CFC- 113) 1,2-dichlorotetrafluoroethane (CFC- 114) chloropentafluoroethane (CFC-115) chlorodifluoromethane (HCFC-22) 1,1 .dichloro- 1,2,2-trifluoroethane (HCFC- 123) 1-chloro- 1,2,2,2-tetrafluoroethane (HCFC- 124) 1, l-dichloro- 1 -fluoroethane (HCFC- 14 lb) 1-chloro- 1,1-diflurorethane (HCFC- 142b) HCFC-225ca HCFC-225cb tetrachloromethane (HC- 10) 1,1,1-trichloroethane (HC- 140a) bromotrifluorormethane (Halon- 1301) bromochlorodifluorometbane (Halon- 1211) Halon- 1202 dibromotetrafluoroethane (Halon-2402) Halon- 1201 Halon-2401 Halon-2311

CH3Br - - 0.6 0.44-0.7

Table 2 Assessment factors for substances contributing to the greenhouse effect (source: Heijungs et al., 1992; pp. 66f)

Formula Substance GWP20 GWPI oo GWPsoo

CO2 CH4 N20 CFC13 CF2C12 CF3CI CF, CHF2Cl C2F3C13 C2F4C13 C2F5C1 C2F6 CHC12CF 3 CI4_FCICF 3 CHF2CF3 CH 2 FCF3 C H 3 C FCI 2 CH3CF2CI CH3CF 3 CH3CHF 2 CCL 4 CH3CC13 CF3Br CHCI 3 CH2C12

carbon dioxide 1 1 1 methane 35 11 4 dinitrogen oxide 260 270 170 trichlorofluoromethane (CFC- 11) 4,500 3,44 1,400 dichlorodifluoromethane (CFC- 12) 7,100 7,11 4,100 chlorotrifluoromethane (CFC- 13) 11,000 13,000 15,000 tetrafluoromethane (CFC-14) > 3,500 > 4,500 > 5,300 chlorodifluoromethane (HCFC-22) 4,200 1,600 540 1,1,2-trichloro- 1,2,2-trifluoroethane (CFC- 113) 4,600 4,500 2,500 1,2-dichlorotetrafluoroethane (CFC-114) 6,100 7,000 5,800 chloropentafluoroethane (CFC- 115) 5,500 7,000 8,500 hexafluorethane (CFC-116) > 4,800 > 6,200 > 7,200 1,1 -dichloro-2,2,2-trifluoroethane (HCFC- 123) 330 90 30 1-chloro- 1,2,2,2-tetrafluoroethane (HCFC- 124) 1,500 440 150 pentafluoroethane (HFC- 125) 5,200 3,400 1,200 1,1,1,2-tetrafluoroethane (HFC 134a) 3,100 1,200 400 1,1-dichloro- 1 -fluoroethane (HCFC- 141 b) 1,800 580 200 l-chloro- 1,1 -difluoroethane (HCFC- 142b) 4,000 1,800 620 1,1,1-trifluoroethane (HFC- 143a) 4,700 3,800 1,600 1,1 -difluoroethane (HFC- 152a) 530 150 49 tetrachloromethane (HC- 10) 1,800 1,300 480 1,1,1-trichloroethane (HC- 140a) 360 100 34 bromotrifluoromethane (Halon- 1301) 5,600 4,900 2,300 trichloromethane (chloroform) 92 25 9 dichloromethane 54 15 5


the ozone layer, photochemical smog, etc. (see Ta- bles 1 and 2). The assessment scheme is generally applicable to a broad range of substances contributing to a defined environmental problem and released to all environmental media (air, water, land).

Nevertheless, it is important to recognize its limitations. There is general agreement, for example, that some pollutants are very toxic (e.g., dioxin) while others cause environmental problems only because they are discharged in enormous quantities (e.g,. CO2). A more precise assessment of the relative harmfulness of pollutants is ideally a matter for objective scientific determination, but the adsorption capacity of the eco-system (dependent on the background level of pollution) 4, geographical conditions le.g., interaction with other pollutants, soil character- istics) and opinions among scientists may vary, so that a generally applicable assessment scheme is not without problems 5. For the weighting factors to be stable, the relationship of all emissions to the objective (the environmental problem, e.g. the greenhouse effect) must be linear. With non-linearity, which is usually the case, the weights should change depending on local circumstances.

The degree of insecurity is, for example, expressed partially in the range of assessment factors given for substances contributing to the depletion of the ozone layer (right column in Table 1). The weighting factors may also vary depending on the time frame of the assessment chosen (see also Swart, 1992). This is shown in the three columns to the right in Table 2 for the example of the greenhouse effect. For product LCAs usually a time frame of one hundred years is chosen.

Nevertheless, these weighting factors provide guidance to emitters. However, under existing regu-

4 Ideally, the relationship between a marginal unit of emission and the resulting marginal increase in ambient concentration should be considered. Heijungs et al. (1992) claim to consider these effects to a certain extent. So far, we have not found an assessment method which considers this effect comprehensively.

5 Furthermore, if human health is considered, exposure must be taken into account. Then, the assessment scheme and the emissions data must be complemented with information about exposure. It is not the intention here to discuss direct impacts on human health. Exposure based emissions trading has been analyzed, e.g., by Roumasset and Smith (1990).

latory arrangements, this guidance is often not matched by corresponding incentives (whether pun- ishment or reward). If incentives faced by emitters are aligned with the relative scientific assessments established by representative research institutions, it is more likely that the environmental objectives fos- tered by those institutions will ultimately be achieved. Although advance in the development of assessment schemes for, e.g., the greenhouse effect, the depletion of the ozone layer, nutrification of waters and soil, photochemical smog, etc. have been made, more research is still needed for most environmental problems (i.e., loss of biodiversity).

Tables 1 and 2 illustrate this weighting scheme in practice. Various pollutants (chemical formula and name of substance) contributing to the depletion of the ozone layer, and contributing to the greenhouse effect, respectively, are listed in the left-hand column of Tables I and 2. The two columns to the right of Table 1 list (a) the ozone depletion potential (the assessment factor), and (b) the range of the ozone depletion potential (range of the assessment factor) for the respective substances. The three columns to the right of Table 2 show the relative weighting factors for pollutants contributing to the greenhouse effect when considering the time frame of 20, 100 and 500 years.

The weighting factors are expressed in terms of ozone depletion potential (ODP) and global warming potential (GWP) per kilogram of the respective substances.

Pollution added by a released specific substance is calculated by multiplying the discharged quantity of the substance (kg) by its corresponding weighting factor. Next, a source's total pollution added, expressed in pollution units (PU), can be aggregated and documented in order to establish a baseline for a credit trading system in which all pollutants contributing to the same environmental problem may be traded. Recall from Fig. 2 that problem oriented bubbles might cover several pollutants that are released into the air, water and soil, e.g., carcinogens in Seattle, heavy metals in Basel, or smog gases in Los Angeles, greenhouse gases in Europe, etc. In many cases, however, problem oriented bubbles would also be em, ironmental media and geographically oriented bubbles dealing with all water emissions contributing to the over-nutrification of the


River Rhine, all air emissions contributing to the photochemical smog in the Puget Sound Air Quality District of Seattle, etc.

By establishing a worldwide greenhouse gases reduction trading system, the rich industrialized countries could help developing countries finance their pollution prevention by buying greenhouse gases reduction certificates (GERCs) from these countries. This would provide them with capital to invest in, e.g., pollution prevention technologies, reforestation, etc. Which criteria best suits the purpose of a PACT-bubble depends on the specific social goal, and on the environmental media, respectively, of the biosphere which is to be protected.

traditional (command and control) methods of pollution control, have been covered extensively elsewhere (see, e.g., Bonus, 1984; Hahn, 1988, 1989, 1990; Hahn and Stavins, 1991; Liroff, 1986; Mc- Gartland and Oates, 1985; Passell, 1993; Perkelney, 1993; Shireman, 1993; Stavins, 1992). In this section, the relative merits of single-pollutant trading are weighted against those of pollution added credit trading (PACT). The two trading methods are com- pared by considering their respective economic, scientific, technological, ecological and political impli- cations.

4.1. Economic analysis

4. Comparison, opportunities and limitations

The advantages and disadvantages of single-pollutant emission trading programs, relative to more

Perhaps the most significant factors to consider when evaluating the economic merits of the two forms of emissions trading include their relative impacts on marginal costs of pollution control, on the liquidity of markets for emissions reduction cred-

Marginal Reductio Costs ( Reduction of Environmental Harm) of two Pollutants in $

A MRC 1

MRCAo

MRC B

MRcB0 MRC

Pollutant B

PA~ PAR PAo

v

Pollution Added in Pollution Units

Fig. 4. Marginal emissions reduction costs for different pollutants.


its, and on the transaction costs associated with trading. All three factors can have a significant impact on the efficiency gains that are theoretically achievable through emissions trading.

4.1.1. Marginal reduction costs

Over the last two decades, spending on conventional pollution reduction methods has moved businesses in industrial countries up the marginal cost- of-control curve (CBO, 1986; Hahn and Stavins, 1991). That is, the marginal benefit to be derived from each dollar invested in pollution control has begun to diminish, even though technological advances have shifted the curve itself (EPA, 1991c). "As a result, many are beginning to seriously consider the possibility that altemative means of achieving overall risk (and pollution) reduction goals may be more cost-effective than the conventional tools" (Hahn and Stavins, 1991; p. 29). Emissions trading offers companies the choice between alternative modes of reducing emissions of a particular substance or buying needed credits to cover the gap between permitted and actual emissions. Efficiency gains accrue from the market's ability to take advantage of differences in marginal reduction costs that exist between sources of pollutants (CBO, 1986; ICF, 1986; Raufer and Feldman, 1987). Pollution added credit trading also offers this advantage, but allows markets to capitalize on marginal reduction cost (MRC) differences that exist between sub-

stances as well. Inter-pollutant trading in general, and the PACT approach in particular, thus allows individual polluters emitting multiple substances the ability to, in essence, make company or facility internal trades that produce the most cost-effective reductions in overall risk.

Fig. 4 illustrates the potential savings in reduction costs that can be achieved by switching from a single- to an inter-pollutant trading. The two curves represent the theoretical costs of reducing pollution added for two hypothetical substances over the full range of potential emissions which contribute to the same specific environmental problem.

The existence of substantial differences in MRCs of various pollutants has been noted previously (Howe, 1991; Stritt and Jeanrenaud, 1992). As described earlier, pollution added by emission of a given pollutant is estimated by multiplying the quan-

tity discharged by its estimated relative environmental harmfulness. Note that achieving a given reduction in pollution added would cost substantially more in the case of pollutant A than for B, over the indicated range (pollution added reduction: PAR). The differences in the total costs of reduction of harm (shaded area PA0-MRCA-MRCA-pAI minus dark shaded area PA 0-MRC0~-MRC ~-PA 1) are due to differences in the marginal reduction costs of pollutants and their differences in respective harmfulness.

If equal emission reductions were mandated for each of the two pollutants, the lightly shaded area indicates potential efficiency losses. Conversely, it indicates the magnitude of potential gains available from inter-pollutant trading. Under an inter-pollutant trading program, sources required to reduce their pollution added by a given amount may find, for instance, that it pays to focus pollution reduction efforts on a few substances with relatively low marginal reduction costs. This would help reduce costs of achieving overall reductions in actual environmental risks.

4.1.2. Liquidi~

As noted above, existing trading schemes operate on the assumption that different facilities emitting a given substance face different marginal costs of reducing the releases of the same pollutant. If true, this helps ensure that facilities have an incentive to trade, since those with low marginal reduction costs can profit from selling credits to those with high abatement costs. And for existing programs, this assumption is certainly valid, since there is a great variety of industrial activities that produce SO x and NO~ as waste byproducts. But if less ubiquitous substances were brought under trading regimes, it would be quite possible that for some subset of them the vast majority of emissions would be discharged by plants facing fairly similar marginal abatement costs. If this happened, we would periodically find everyone in the market trying to sell (or buy) at virtually the same time.

Another assumption of current emissions trading concepts is that large numbers of buyers and sellers exist for each individual substance to be traded. If true, this helps ensure smooth functioning of the market, as buyers and sellers can be readily matched

46 S. Schaltegger, T. Thomas~Ecological Economics 19 (1996)35-53

at any given point in time. However, as trading bubbles are created for less populous or economically thriving jurisdictions, this assumption is less likely to hold true, and markets could become non- competitive (Hahn and Stavins, 199l). The problem could become particularly acute in cases where de- mand fluctuates rapidly or seasonally for products or services that produce regulated substances that are thinly traded. Liquidity problems, for example, already seriously limit the emissions trading program in Basel, Switzerland (Knechtli, 1992; Staehelin-Witt and Spillmann, 1992a,b). Taken together, these concerns suggest that liquidity might become a serious problem if emissions trading is adopted on a broader scale. Resulting surpluses, shortages, and dramatic price swings might produce such uncertainty that potential traders will choose to withdraw from the market. That is, high price volatility due to an illiq- uid market may induce emitters to either forego investment in new sources, bank their surplus credits for future use, or perhaps even cheat by under-reporting their emissions. At the very least it would increase political pressure to relax emission standards.

In the case of the national SO 2 trading program, liquidity is created artificially by reasserting a measure of command-and-control. Each year, as mandated by the Congress of the United States, the US EPA 'witholds' a small percentage of all outstanding credits from the utilities that hold them, and auctions off to the highest bidders (Hausker, 1992; Feder, 1993; Goffman, 1993; Passell, 1993; Taylor and Kansas, 1993). Proceeds are rebated to the utilities, so that the auction is 'revenue neutral' from the EPA's standpoint. Two separate auctions exist, one for 'spot ' credits to be used in the year they are purchased, and one for 'long-term' credits to be used seven years later. This auction design is criticized for its inefficiency as well as its contribution to total administrative costs of the program (Hausker, 1992; p. 569). The fact that the US Congress considered it necessary to guarantee a measure of liquidity through artificial means, even in a national market where there are many buyers and sellers with vastly differ- ing marginal costs of SO 2 reduction, suggests that policy makers recognize the potential significance of illiquidity (Feder, 1993; Passell, 1993). And if it is a problem even in well-developed markets, it may prove to be a major barrier to extending existing

emissions trading methods to less ubiquitous substances and smaller geographical regions.

4.1.3. Transaction costs

Emitters wishing to sell or buy ERCs in single- pollutant markets incur certain transaction costs, including the costs of documentation, certification, search, and legal fees (Staehelin-Witt and Spillmann, 1992a; p. 89). These costs should decline over time as emitters gain experience, brokerage services develop, and transactions become routinized and more numerous (Hahn and Stavins, 1991; p. 14). However, transactions will continue to be accompanied by costs, reflected in the spread between bid and ask prices, that reduce the returns available from trading. As emissions trading is extended to cover a wider variety of substances, a firm may incur substantial transaction costs as it buys and sells an ever-broader range of ERCs.

The potential wastefulness of transaction costs under a single-substance ERC-trading regime can be illustrated by considering the case of a company that trades credits for more than one substance. If more than one regulated substance is tradable (as is true under the RECLAIM program, for instance), then an individual source can, in effect, trade internally among substances. To illustrate this, let us say that two criteria pollutants, SO 2 and NO X, are tradable within an air quality district, and that every source in the district must reduce emissions of the two substances by ten percent per year. Plant A, located in the district, emits 100 ton each of SO 2 and NO x. Let us further assume that, over the relevant range of emissions, reducing NO x emissions would cost Plant A half as much as would similar reductions in SO e. It would make sense, other things being equal, for the firm to reduce its NO X emissions by 20 percent (20 ton), while keeping its SO 2 emissions constant. It could do just that by selling credits for the surplus 10 ton of NO x on the market, and using the proceeds to purchase credits for 10 ton of SO z. Whether or not this would actually be a wise thing to do would, of course, depend on the relationship between the facility's internal MRCs and the market prices of ERCs for the two substances. Regardless, this form of 'improvised' inter-pollutant trading would incur the transaction costs associated with buying and selling both types of credits in the marketplace. And

S. Schaltegger, T. Thomas/Ecological Economics 19 (1996)35-53 47

these costs would multiply as more substances be- came tradeable. This would, in turn, reduce the efficiency gains that could be achieved through a more straightforward method of internal inter-pollutant trading, as would be possible under PACT.

PACT could also substantially reduce transaction costs associated with external trading in emissions credit markets, particularly search and 'currency exchange' costs. Regarding the former, search costs are incurred in the process of locating or identifying buyers or sellers willing to transact at a price agree- able to both parties. The search itself may be con- ducted by the parties involved, or (more likely) by some type of broker. In general, the more participants there are in a given market for emissions credits, the lower is the cost of locating potential trading partners. Given that PACT would, in essence, consolidate markets for a broad array of individual substances into a smaller number of more active PACT-credit markets, it promises to increase the number of market participants within any given market. This could, in turn, dramatically reduce search costs.

An important advantage of PACT is that it re- duces the costs of 'currency exchange'. The fact that several 'currencies' are not directly tradeable means that a facility would incur higher expenses than it would if they were directly convertible. PACT elimi- nates the need to use cash as an intermediate medium of exchange that allows trading of dissimilar commodities (ERCs), since PACT-credits would themselves be standardized and readily exchangeable commodities.

4.1.4. Administrative costs

The expense of establishing, maintaining, and monitoring the market for emissions credits is an important component of the overall cost of administering a trading program. If multiple markets exist in parallel for a variety of substances, much of the cost of administering these separate markets will be un- necessarily redundant. By consolidating and reducing the number of trading programs, PACT could eliminate a significant portion of these administrative costs. On the other hand, PACT would increase the analytical burden borne by facilities required to calculate pollution-added surpluses or shortages by ag-

gregating the weighted emissions of individual substances. As for costs borne by regulatory agencies charged with administering or overseeing the program, it is unclear whether they would rise or fall under PACT. While trades themselves would proba- bly be less complicated to monitor, agencies would be likely to devote more resources to auditing and verifying the authenticity of emissions reductions, due to the greater latitude afforded facilities in achieving emissions reduction goals.

4.2. Scientific and technological considerations

Perhaps the most significant barriers to the eventual implementation of a PACT program are the scientific and technological advances that will be required for it to be operationally feasible. The most daunting challenge will be to develop scientifically defensible methods for conducting accurate and comprehensive environmental assessments of hazardous and toxic substances, so that a legitimate weighting scheme can be created and applied to pollutants regulated via PACT. A somewhat less formidable, but equally important, task will be the development of technology required to accurately monitor and record emissions of a wide variety of chemical substances.

4.2.1. Environmental assessment

Technically, a PACT program would require only that some politically legitimate (i.e., widely accepted among relevant parties) weighting scheme be developed that could be applied to substances included in PACT bubbles. However, since legitimacy in this policy making arena is highly dependent upon scientific validity, assessment methods ought to be capable of accurately assessing the full range of substances contributing to a specific environmental risk, over a broad range of concentrations, geographical conditions (e.g., weather and soil condition), adsorption capacities, etc. Of course, the current state of the art comes nowhere close to this ideal (Brinkley, 1993: Taylor et al., 1993). For example, animal studies used to estimate the relative toxicity or car- cinogenicity of chemicals are notoriously blunt instruments for assessing risk to humans (Brinkley, 1993; Ottoboni. 1991). They are also quite time-con-

48 S. Schaltegger, T. Thomas~Ecological Economics 19 (1996) 35-53

suming and expensive, which suggests that the vast majority of chemicals introduced every year will remain untested if current methods continue to serve as the primary means of environmental assessment. Breakthroughs will clearly be required before PACT can be implemented as a means of efficiently reducing emissions of hazardous or toxic substances. Note, however, that this would be less of a problem for PACT bubbles for ozone smog or greenhouse gases where the relative contributions of individual substances to these particular social problems are fairly well established.

There are some promising indications that this hurdle is not insurmountable in the foreseeable future. For example, substantial progress has been made in recent years in the use of in vitro methods of testing for toxicity and mutagenicity (Ellis, 1987; Gad, 1990; Wachsmuth, 1991; Zbinden, 1990). Biotechnology holds the potential for improving accuracy while reducing both cycle time and expense of testing procedures (particularly in the case of testing for effects of chronic exposure), as easily replicated cell tissues (or even genetic material) come to displace rats and other laboratory animals currently used in the process. Nevertheless, this remains a challenge that must be met to the satisfaction of the scientific and regulatory communities before PACT will become a feasible alternative.

Of course, even if consensus can be achieved regarding appropriate assessment methods for establishing pollution-added weights for individual substances, this will not eliminate political battles over the scientific validity of these assessments. This is because once weights are established, they will begin to resemble quasi-property rights in the minds of emitters. For instance, companies can be expected to plan capital outlays partially on the basis of these standards. Any proposed changes based upon addi- tional knowledge derived from subsequent testing would be opposed by any firm that stood to lose on its prior investments were readjustments made. In such cases, pleas of financial hardship can be expected to be accompanied by challenges to the scientific validity of the testing procedures. While such challenges must be given adequate consideration and due process, care must be taken to insulate the assessment process from political pressures (see, e.g., Hausker, 1992; p. 567).

4.2.2. Monitoring and recording The creation and accurate valuation of pollution-

added credits will require technology capable of accurately and cost-effectively monitoring emissions of a wide variety of substances. This requirement is complicated by the need to measure not only point sources of emissions, but non-point and fugitive emissions as well. Point-source emissions are relatively easy to monitor. Continuous sensing devices are already in use in Southern California that use the chemiluminescence of chemical reactions to detect the presence of pollutants. While there are concerns that existing monitoring technology will not be able to accurately detect low levels of pollution as permitted emissions decline, more precise methods using infrared light are already showing promise (Steven- son, 1993).

Measurement of non-point sources, on the other hand, can be technically daunting and financially prohibitive. Consider, for example, the difficulties inherent in estimating greenhouse gas emissions from such agricultural activities as rice cultivation (methane), slash-and-bum forestry (CO2), beef and dairy production (methane), etc. (see, e.g., Victor, 1991). Note that the use of bar code technology to monitor non-point use of materials (paints, solvents, etc.) containing VOCs, as in the case of the RE- CLAIM program, will necessarily yield inaccurate estimates of actual emissions, even if 100% compliance is achieved among emitters (Stevenson, 1993). This is because the method does not take into account efforts by facilities to minimize or reduce the emission of VOCs through the use of more efficient application equipment, enclosed application booths that permit recovery, etc. Not only would this method prove inaccurate, it would also eliminate any incentive to reclaim or recycle VOCs, since they would be charged against allowable credits regardless of such efforts.

Estimates of fugitive emissions, while operationally feasible, can be "a costly complex logistical nightmare" (Berglund, 1991; p. 161). Accurately determining process leakage requires each process component to be individually wrapped and sampled. The EPA currently allows the use of less rigorous estimating procedures using standardized correlation curve estimates (Berglund, 1991). These methods, while less expensive, are also less accurate, and are

s. Schaltegger, T. Thomas/Ecological Economics 19 (1996) 35-53 49

less sensitive to performance variations that exist between different types of equipment used in similar processes. Nevertheless, significant progress has been made to increase the efficiency of recording pollution discharges of companies by applying recently developed ecological accounting methods (Schal- tegger and Sturm, 1992, 1994). As with single-pollutant emissions trading the accurate monitoring and recording of discharges has to be controlled by inde- pendent auditors or the EPA. The main difference in monitoring requirements between ERC trading and PACT is that the latter operates on a much larger scale. The essential consideration is that the transaction costs of monitoring and documenting all forms of emissions should not exceed the theoretical cost savings that could be achieved through a PACT program.

4.3. Ecological impacts

potential for eventual leaching into soil and groundwater (Buchholz, 1993). Some older plants employ 'wet ' scrubbers in which exhaust gases are forced through curtains of water, which absorb the sulfur compounds and present similar disposal problems.

PACT offers the means to create a multi-media bubble for every specific environmental problem, in which emissions to various media could be brought under a single regulatory framework. Emission standards established for the different media can be normalized using the procedure described in Section 3, and a single emissions 'budget' can be imposed for either a given substance (such as SO~) or (ideally, from an efficiency standpoint) for total pollution added of a given type (e.g., carcinogens). Thus, total emissions to all media could be subjected to a single limit, which would reduce incentives and ability to shop around for the most leniently regulated medium.

The PACT alternative must also be considered on its ecological merits, that is, its potential effectiveness in achieving the aims of improving environmental quality and diminishing risk. Three factors that can diminish a regulatory regime's effectiveness in achieving these aims are (1) media shifting, (2) the creation of dangerous concentrations of hazardous or toxic substances ( 'hot spots'), and (3) misalignment between policy, assessment scheme and actual harm or risk, which can reduce both ecological efficacy and economic efficiency. In general, PACT fares well when evaluated against the first and third criteria, while the second is likely to somewhat more problematic.

4.3.1. Media shifting Given the compartmentalized manner in which

emissions to various media (air, water, soil) are regulated, it should not be surprising that emitters often face incentives to shift discharges of toxic or hazardous substances from a more strictly regulated medium to a less stringently regulated one. In the process, regulatory efforts might help solve one problem only to create yet another. The electrical utilities industry offers a prime example of media shifting. Smokestack scrubbers that remove SO 2 from the exhaust gases of spent coal combustion transfer it to sludge that is then typically landfilled, creating the

4.3.2. 'Hot spots' Increasing the range of substances covered under

a single bubble, and providing facilities the flexibility to choose their preferred mix of emitted substances, increases the likelihood that facilities will choose to increase emissions of a few substances that are more costly to reduce, while decreasing emissions of a greater number of substances with relatively low marginal reduction costs. With an emissions mix that is based largely on relative marginal reduction costs, rather than individualized emission standards, it becomes more likely that potentially harmful concentrations ( 'hot spots') of a particular hazardous substance will occur at some location within the bubble. To a certain extent, this problem is mitigated by the fact that PACT bubbles would ideally allow trading among only a limited range of substances with similar, respectively, the same environmental effects. For example, the effect of 10 pollution added units of one greenhouse gas should not have a materially different impact than, say, 5 units of two different greenhouse gases.

Nevertheless, this problem must be recognized and alleviated if PACT is to become a viable alternative. One means of addressing this concern would be to maintain strict ambient standards that prevent hazardous concentrations from developing within PACT bubbles. Such an approach would be similar

50 S. Schaltegger, T. Thomas / Ecological Economics 19 (1996) 35-53

to the strategy used to prevent hot spots from developing under RECLAIM's trading programs. Of course, to the extent that ambient standards based on environmental concerns restrict free trading of allowances, this will reduce the potential efficiency gains that are theoretically achievable under PACT. This, however, might be a necessary and beneficial restriction.

On the plus side, PACT enables regulatory authorities to design geographically smaller bubbles, due to the increased liquidity in credits that it confers (see Section 4.1.2). This, in turn, can reduce the scope of the geographical area that must be moni- tored or audited in order to guard against dangerous concentrations, and also can reduce opportunities for one region to 'dump' a substantial portion of its pollution-added credits on another. Concerns over the latter possibility were heightened recently when environmentalists and local residents protested an east-coast utility's sale of surplus SO 2 credits to a midwestern facility. Ironically, they were concerned that these emissions, which currently blow mostly out to sea, will instead return to fall upon the Adirondacks in upstate New York (Dao, 1993). Though these concerns proved largely unfounded (Goffman, 1993), we should anticipate ongoing pressures to restrict the geographic scope of emissions trading bubbles of all kinds. Again, the greater market liquidity afforded under PACT makes smaller bubbles more feasible, and should help reduce both public anxiety and operational difficulties attributable to the potential for hot spots.

4.3.3. Efficacy Greater economic efficiency is not of itself ade-

quate justification for adopting a new program. In the realm of environmental protection, ecological efficacy must be the primary value of interest. Thus, preferred regulatory methods will achieve desired environmental objectives in the most economically efficient manner possible, rather than pursue economic efficiency subject to given environmental constraints. Thus, regulatory alternatives must be evaluated primarily on the basis of their effectiveness in reducing harm or risk to humans and the natural environment.

On this score, PACT's primary ecological benefit is its potential for inducing more focused and rapid

reductions in overall emissions. The flexibility it affords, allowing sources to determine their own least-cost methods of reducing overall pollution-added, has the potential for dramatically reducing the cost of achieving environmental objectives. This, in turn, should increase the likelihood that the business community, as well as the public at large, is recep- tive to accelerated annual reductions in allowable overall pollution added. This softening of political resistance could at least marginally liberate policy from the pressure of the marketplace. It could also lead to a more efficient allocation of scarce public resources.

Another important consideration is that PACT is fully compatible with risk-based approaches to regulation. The US EPA has recently signaled its intention to move toward risk-based regulation of substances and practices that threaten the environment. The EPA's Science Advisory Board has recom- mended that "EPA must weight the relative risks posed by different environmental problems, determine if there are cost-effective opportunities for reducing those risks, and then identify the most cost-effective risk reduction options" (EPA, 1990). PACT offers a methodology that matches these objectives across the board.

4.4. Political considerations

The very flexibility that would serve to make PACT more economically efficient and ecologically effective than single-pollutant trading programs could also make it more controversial. One can imagine, for example, the impression created by characteriz- ing PACT as a scheme for offering polluters the ability to trade liver cancer for kidney cancer. An- other consideration, as noted above, would be the increased potential for creating potentially hazardous ambient concentrations of substances ( 'hot spots'). Both factors are likely to generate concerns that a PACT program would grant far too much latitude for compliance to individual sources. As a result, political pressure could be intense to restrict the scope of each PACT bubble to the narrowest possible band of similar pollutants, emitted within the most constrained geographical areas, and discharged to one medium only. This might be offset, to a certain extent, by public desires to reduce overall environ-

s. Schaltegger, T. Thomas / Ecological Economics 19 ¢ 1996) 35-53 51

mental risk as rapidly as possible. All things being equal, and barring widespread fraud, the greater latitude afforded by PACT should lead in general to greater efficiency. This would in turn enable society to reduce total pollution added more rapidly. This creates an opportunity for political bargaining that would balance fears of localized risks against broader environmental concerns.

5. Conclusions and agenda for further research

In conclusion, inter-pollutant emissions trading appears destined to become a reality in the near future, via either the U.S. EPA's implementation of Section 112(g) of the 1990 Clean Air Act Amend- ments, or through the trading of different substances within the same geographical boundaries (as with the RECLAIM program), or both. Pollution-added credit trading is one policy alternative with the potential to make such trading more economically efficient and ecologically effective. However, further research and debate on the optimal design of bubbles will be required before we can assess with any confidence whether PACT can live up to that potential.

First, it will be necessary to refine environmental impact assessment that allows us to calculate relative PACT units for each substance. Preliminary weighting methods have been developed (see, e.g., Hei- jungs et al., 1992; for an overview of assessment methods, see Schaltegger and Sturm, 1994). How- ever, the assessment factors themselves, and the risk assessment methods they are based upon, need to be refined substantially if the scientific community is ever to form a consensus on their suitability for risk-based regulation (EPA, 1990).

Another essential step will be to conduct further research into the identification of pollution abatement cost curves for specific substances, industries, and applications. This data would allow estimation of marginal reduction costs across a range of emissions levels. This, in turn, would allow simulation of hypothetical applications of the PACT concept to specific environmental problems, individual firms (internal trading) and broader geographical regions (external trading). Note that in the case of individual facilities, simulation might determine the optimal mix of emitted substances, based upon these esti-

mates. Such simulations could help determine the potential significance of problems such as hot spots and media shifting. They could also yield estimates of potential cost savings under PACT.

Given the profusion of synthetic chemicals in modern industrial societies (approximately 3000 new substances are introduced in the USA each year), simple yet comprehensive methods must be developed to reduce the overall risk to the environment in a manner that is both cost effective and politically feasible. The PACT concept represents a step in this direction, one that can stimulate debate as to the merits and drawbacks of inter-pollutant trading as a policy alternative.

Acknowledgements

S.S. is exceedingly thankful for the generous sup- port from the Swiss National Science Foundation. We are very grateful to Herman E. Daly, Ren~ L. Frey, Ana Roque de Oliveira, Rob Smith and Tom Tietenberg who helped us to improve the text with their excellent and helpful comments. The authors would also like to acknowledge the diligent research assistance of James Atkinson and Melissa Schilling. The usual disclaimer applies of course.

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Pollution added credit trading (PACT): New dimensions in emissions trading