Instrument Choice: Regulation and Tradable Permits

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Command and control regulations and a system of tradable permits are similar in that they both fix an emissions target. Otherwise, there are key differences between the two, and cost-benefit analyses are typically employed in deciding between them, or in estimating the utility of using both instruments at once. Such analyses, in turn, are likely to consider the context – including the industry, the pollutant, the market, and the political environment – into which the instrument(s) would be implemented. For example, if the industry emitting the gas in question is geographically concentrated, the risk of an emissions “hot spot” could persist under permit trading, in which event more stringent regulation might be favored.  The structure of the industry or market is another important consideration: For permit trading to take hold, there must be an emissions gradient such that there will actually exist a demand for permits among those firms with higher emissions, and a supply of permits from those whose emissions are lower. When considering an emissions trading system, there must also be enough market participants to achieve market liquidity, and to avoid supply shocks and other forms market volatility.

Crucial to both regulation and permit trading are stakeholder preferences. Empirical evidence suggests that both instruments are more effective in curbing emissions when stakeholders view the system as equitable, and participate in its design and implementation.

The literature in this section compares (contrasts) command and control regulation and emissions trading, and is also concerned with their interaction when both instruments are present in the same market system.