Technology advances, such as computerized exchanges, are helping to lower transaction costs, thereby facilitating the capture of more of the rent.

  • The two elements that most jeopardize the success of a tradable permits program are inadequate enforcement and uninternalized externalities.

Unfulfilled Theoretical Expectations

Two important expectations flowing from the economic theory have proved to be an inaccurate characterization of reality:

  • The first is the theoretical expectation that transferable permit programs do not effect conservation of the resource because that is handled by the cap. In the theory, setting the cap is considered to be outside the system. Hence, it is believed, the main purpose of the system is to protect the economic value of the resource, not the resource itself. That is an oversimplification for several reasons. First, whether it is politically possible to set an aggregate limit may be a function of the policy used to achieve it. The use of grandfathered permits in the acid rain program, for example, made it possible to establish the limit on sulfur emissions. Second, in both fisheries and air pollution control, the evidence suggests that both the magnitude of the implemented limit and its evolution over time may be related to the policy. The flexibility and lower cost of meeting the limit offered by tradable permits systems can, and has, resulted in the acceptance of more stringent limits. Third, the choice of policy regime may affect the level of monitoring and enforcement, and noncompliance can undermine the achievements of the limit. Experience suggests that depending on the context, transferable permits can either improve or degrade the monitoring and enforcement situation. Fourth, the policy may trigger environmental effects that are not covered by the limit. Activity may be diverted from covered to uncovered resources.

  • The second theoretical expectation that falls in the light of implementation experience involves the tradeoff between efficiency and equity in a tradable permits system. Traditional theory suggests that tradable permits offer a costless trade-off between efficiency and equity because, regardless of the initial allocation, the ability to trade assures that permits flow to their highest valued uses. This implies that the initial allocation can be used to pursue equity goals without lowering the value of the resource. In practice, implementation considerations nearly always allocate permits to historic uses, whether or not that is the most equitable allocation. This failure to use the initial allocation to protect equity concerns has caused other means to be introduced to protect equity considerations (such as restrictions of transfers). The additional restrictions generally do lower the value of the resource. In practice, therefore, tradable permits systems have not avoided the trade-off between efficiency and equity so common elsewhere in policy circles.

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