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Tapping the Market for a Cleaner Environment

  • Fred Krupp
  • The strategy of the early environmental movement, according to some, could be boiled down to three words: “mandate, regulate, litigate.” Although we still go to court when necessary, Environmental Defense has long advocated a different approach: working with businesses, government, and private landowners to craft lasting solutions. Consistent with the findings of PERC and the experience of Environmental Defense, harnessing the power of the market is often the best way to achieve the greatest environmental benefit at the lowest cost.

    By making environmental protection profitable, people will invent ways to make it happen. Our first success came in the 1970s, tackling the water shortages in the West. By creating a market for water rights, we gave farmers an incentive to conserve water and sell it to urban districts—avoiding new dams on California’s wild rivers. The farmers used their profits to install more efficient irrigation systems and increase productivity, while cities and rivers got the water that was saved on the farms.

    The appeal of this “win-win” outcome spurred dozens of major water trades across the West and spawned the creation of water trusts, such as the Deschutes River Conservancy in Oregon, to buy water for the environment. Over the past decade, Arizona, Colorado, Nevada and other western states have reformed their water laws to facilitate water transfers—taking the pressure off new dam and diversion projects. Such economic common sense will take us a long way toward defusing the West’s water crisis.

    The 1991 publication of Free Market Environmentalism helped make market-based approaches and corporate-environmental partnerships mainstream by providing the intellectual framework and supporting data for these ideas. As a result, the world has certainly changed.

    In 1990, Environmental Defense persuaded the first Bush administration to adopt a cap-and-trade system to halve power-plant emissions of sulfur dioxide, a major cause of acid rain. The plan was hugely controversial. The utility industry insisted the cuts would trigger a “clean-air recession,” while many environmental groups chided us for passing up old-style mandates.

    The market-based program, written into the 1990 Clean Air Act, required that sulfur emissions be reduced overall by 50 percent, but let plant owners decide how to do it, which created competition among pollution-reduction methods. The plan also allowed owners to decide among themselves which companies would make the reductions. Furthermore, companies could be rewarded for reducing emissions by more than the law required, since extra reductions could be banked or traded.

    Called “the greatest green success story of the past decade” by the Economist (July 4, 2002), this approach brought sulfur dioxide emissions down faster than expected, at one-tenth of the predicted cost. Meanwhile, the economy has boomed. The U.S. Office of Management and Budget found that the program has accounted for the largest human health benefits of any federal regulatory program implemented in the 1990s, with annual benefits exceeding costs by more than forty to one. The problem of acid rain has not yet been solved, but the emissions reductions already achieved demonstrate the effectiveness of the cap-and-trade method.

    By setting the cap, the government de facto created quasi-property rights in the form of emission allowances. This is similar to what government (mostly states) did more than 100 years ago by establishing rules by which farmers and others “own” water rights that now underpin water markets.

    Today, market-based approaches such as water marketing, congestion pricing, and cap-and-trade systems have proliferated and gained wider acceptance. Cap-and-trade programs, for example, have been introduced in some states to curb nitrogen oxides and non-point water pollution. Even the Chinese government has embraced this approach to cut sulfur dioxide emissions.

    A partnership between PERC and Environmental Defense, resulting in research documenting the efficacy of a cap-and-trade program applied to fishery management, contributed to Congress’ recent revision of the principal U.S. fisheries law, the Magnuson-Stevens Act. This approach, already in place in the Pacific halibut and Gulf of Mexico red snapper fisheries, typically assigns each fisherman a tradable share of the total allowable catch. As a faltering fishery recovers, the tradable shares rise in value, giving anglers a financial stake in conservation.

    Such methods work when the government does what it alone can do—sets and enforces a strict environmental standard—and then lets businesses, investors, and entrepreneurs discover the most cost-effective ways of meeting the standard. When reductions in pollution are cheaper, stronger environmental goals can be set, and the environment and the economy both gain.

    Looking forward, the market offers tremendous promise to slow global warming, one of the most challenging environmental problems of all time. In the United States, the idea of using markets to cut carbon dioxide has gained traction, spurring new investments in alternative energies, including low-carbon biofuels. People now understand that creating an open field for the broadest bloom of innovation is a better approach than passing the kind of legislation that anoints a few fixed technologies. Already, states from Maine to California are pursuing this market approach.

    As we create a market value for reductions in carbon emissions, we harness the energy of entrepreneurs and engineers to turn dreams into working solutions. America must unleash the full power of innovation by passing a national carbon cap—with a real market for trading. No single act will do more to end our addiction to fossil fuels, promote energy security and get America back in the game of inventing clean technologies the world needs. With proper government oversight, Adam Smith’s invisible hand can indeed have a green thumb.

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