A Case Study in Pollution Markets: Dismal Science vs. Dismal Reality

Economists long have argued that economic incentives can reduce pollution more efficiently than do narrow regulatory prescriptions, but this theory has not enjoyed wide application. Southern California experiences the worst air pollution in the United States and has developed the most complex set of regulatory approaches in the world to address the problem. Rising costs and increasing resistance to further regulation led to the Regional Clean Air Incentives Market (RECLAIM) program, which is expected to reduce pollution control costs by about 50 percent over a decade (relative to direct regulation). This paper describes the theoretical advantages of pollution trading, clearly identifies three criteria that acceptable economic incentive‐based programs must meet, explains the structure of RECLAIM, and raises issues regarding firm behavior in response to a newly created asset with an initial price of zero.