Cap-and-Trade Policy Challenges: A Tale of Three Markets

Abstract

Cap-and-trade policy instruments have been applied to a number of environmental problems, with varying success. This article examines cap-and-trade programs for SO2 allowances, fishery quotas, and water rights. Design and implementation of cap-and-trade mechanisms involves challenging policy tradeoffs: accommodating equity concerns, balancing use levels with resource conditions, facilitating transactions, accounting for externalities, assuring adequate monitoring, and documenting welfare gains. Efficient trading mechanisms are more readily implemented when there is a strong political or legal mandate to cap resource use and trades are perceived as a means to ease adjustment to use limits.