Tradable emission rights: history, use and legal nature
Dales (1968) is usually seen as the founding father of the tradable emission rights concept, Montgomery (1972) as the one who provided formal proof of its efficiency, and Tietenberg (1980) as the one who firmly advocated and established it in environmental economics.
Emissions trading can be traced back to the property rights school in economics, according to which externalities should be internalized (for example, Demsetz, 1967). This means that negative external costs such as environmental pollution, which are not reflected in the market price, should be included in this price by allocating property rights.1In 1975 the US Environment Protection Agency (EPA) began experimenting with emissions trading to control air pollution. Since then the concept and variants thereof have been used in various other US programmes, for instance to reduce ozone-depleting substances under the Montreal Protocol (since 1988) and to reduce SO2 emissions under the 1990 Clean Air Act Amendments (CAAA) (where such emissions have been traded since 1993). Outside the US, some experience was gained mainly with tradable quota systems, such as the tradable ammonia quota in the Netherlands (since 1994), but the definitive breakthrough of emissions trading outside the US is expected to occur in the context of climate policy in the course of the new millennium’s first decade.
Several countries are in the process of planning or starting to implement trading schemes to reduce greenhouse gas (GHG) emissions. The Kyoto Protocol (Article 17) allows international emissions trading between 2008 and 2012. The annex on emissions trading in the Marrakech Accords allows governments to authorize legal entities to transfer and/or acquire emissions under Article 17. The Kyoto Protocol of 1997 entered into force on 16 February, 2005, after the Russian Federation had ratified it, bringing the number of ratifications over the legally required threshold.
In 2003, when entry into force of the Kyoto Protocol was still uncertain, the governments of the European Community (EC), for instance, had already approved a directive that enables CO2 emissions trading for power generators, steelmakers as well as cement, paper and glass manufacturers to start in 2005. More or less similar emissions trading schemes are already up and running in Denmark (since 2001) and the United Kingdom (UK) (since 2002). Also outside the EU, various countries such as Switzerland, Norway, Japan and Canada, intend to build national tradable emission rights systems, which could eventually be linked to the EC scheme provided that they mutually recognize their transferable units. Moreover, the fact that the US withdrew from the Kyoto Protocol in 2001 did not prevent some North American companies from designing voluntary pilot emissions trading schemes of their own, such as the so-called Chicago Climate Exchange.Most economists see tradable emission rights as property rights, because of their exclusive use, market value and incentive effects. In the trading scheme for SO2 emissions in the US, however, a legal provision was adopted that an emission right, called an ‘allowance’, does not constitute a property right (in section 403(f) of the CAAA). The legislator chose this formulation so that the government would not have to compensate polluters for ‘taking’ allowances when the authorities lower the annual emission caps. Both in this scheme and in the European CO2 emissions trading system, an emission right is basically defined, in legal terms, as an allowance that authorizes a legal entity to emit a certain amount of pollution during a specified period. This is not so much a permanent, private property right, but rather an authorization that can be terminated or limited by the government.
Although some then conclude that emission rights are, and should be, temporary ‘rights of use’ (for example, Convery et al., 2003), the law and economics literature prefers to characterize allowances as mixed, hybrid or regulatory property rights (for example, Rose, 1999; Yandle, 1999). Emission rights contain elements of both public and private property rights: instead of common law private rights and liability rules that form over time when conflicts over resource use arise, allowances are non-permanent, government- mandated rights that combine state control over the emission quotas with private freedom for polluters to choose how to comply (which could be referred to as ‘command without control’). Moreover, although allowances in the American SO2 emissions trading scheme are not property rights themselves, property rights in allowances are in fact recognized as emitters can receive, hold and transfer them, while excluding all others, besides the government, from interfering with their possession, use and disposition (Cole, 1999: 113-14).