Relying on the market to fight air pollution

February 24, 2021 Energy

How far should we go to improve air quality? Market instruments inform us about the costs of depollution. This information is useful for improving our public policies with regard to health and environmental damage.


A major health problem

Particulates, nitrogen oxides, sulfur dioxide, volatile organic compounds, these pollutants poison the air we breathe. Studies on the impact of bad air quality are, year after year, more and more alarming. In France, it causes around 48,000 premature deaths per year, 9% of the annual mortality, up to 2 years less life expectancy. Figures comparable to those of Covid in 2020 (54,000 deaths according to INSEE). On a global scale, it is about 4.2 million deaths per year. The air breathed by 91% of the world's population does not meet the criteria set by the World Health Organization. In emerging countries such as China and India, the situation is dramatic. It is the main cause of a drop in life expectancy, up to 10 years less in Delhi. 

Air pollution comes from the combustion of fossil fuels, waste and biomass. It is inherent to many economic activities such as transport, industry and agriculture, as well as  cooking and heating at the household level. However, it can be reduced by filter technologies and the use of less polluting inputs. These technologies have a cost that industrial polluters are reluctant to pay unless they are forced to do so by governments. The result is job blackmail, to which governments are sensitive, or even the circumvention of regulations, as in the automobile industry with the "dieselgate" and the resistance of manufacturers to the adoption of new emission standards. What should be the acceptable level of air pollution? At what cost and for which health and environmental benefits? Public policies based on market mechanisms provide answers to these questions.


Offset markets in the United States

When the authors of "The Simpsons Movie" imagined that an American city would be put under a giant dome by the Environmental Protection Agency (E.P.A.), they were not far from the truth, at least in the figurative sense. The Clean Air Act strictly limits air pollution from industrial sources in urban areas where air quality is bad. This restriction obliges any company wishing to set up in the area to offset its emissions with an equivalent reduction in emissions from other manufacturing firms locally. In practice, plants that reduce their own emissions by installing pollution control technologies obtain credits from the E.P.A. New entrants are required to purchase as many credits as the pollution they generate. Through a revealed preference argument, the price of the credit reflects the cost of pollution control for the industry.

A recent study collected credit prices for various pollutants (particulates, nitrogen oxides, volatile organic compounds) in various areas where offsetting is mandatory. By comparing these prices with the health and environmental costs of air pollution, the authors conclude that the cost of pollution abatement is well below the benefits to society. And therefore that the limits on air pollution in the areas considered should be tightened.

Surprisingly, it is in California, a Democratic state known for its ambitious environmental policies, that industrial pollution control efforts should be improved. Conversely, in Texas, a Republican state known to be pro-oil, the Houston metropolitan area has regulations on air pollution that are far too restrictive in relation to the benefits they generate.


The price of nitrogen oxide emissions in Sweden

Nitrogen oxide emissions from manufacturing production and the energy sector (power generation, district heating) are doubly regulated in Sweden. On a national level, installations producing more than 25 gigawatt-hours per year must pay a tax of 50 crowns (about €5) per kilo of nitrogen oxide.  At the local level, the authorities set emission limits not to be exceeded for each combustion boiler installed in their jurisdiction. These emission standards vary from site to site, jurisdiction to jurisdiction, and over time.

From an economic point of view, the tax on nitrogen oxide determines the price of emissions and therefore the maximum cost of depollution to be incurred per kilo. Indeed, it is in a company's interest to reduce its emissions as long as the cost per kilo is less than 50 crowns. Otherwise, it is more profitable to pay the tax than to install abatement technologies. Firms that reduce their emissions beyond the standards imposed by local authorities to pay less tax reveal that their abatement costs are low, less than 50 crowns per kilogram. 

One of the authors of this paper and Jessica Coria of the University of Gothenburg analyzed how the regulator can take advantage of the information generated by the tax on abatement costs to set the emission standard. The fact that emissions are reduced beyond what is required by the standard shows that the abatement costs are lower than expected. The regulator should therefore strengthen  the standard. The data analyzed in the article suggest that the Swedish authorities are moving in this direction. Indeed, after the introduction of the nitrogen oxide tax in 1992, boilers subject to the tax have seen their standard revised on average more frequently than those that are exempt. Moreover, the standard is more likely to be revised for the boilers that are emitting significantly less than what is allowed by the standard. 


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Air pollution and Covid have similarities. Both kill by hitting people with comorbidities such as respiratory or cardiovascular diseases. Fighting these two evils requires to take economically costly measures. But the comparison stops there. No saturation of emergencies, nor images of coffins being lined up for victims of air pollution.  The health impact being less visible, policy makers tend to be more sensitive to the industry lobbies on the economic costs of depollution. 

Market instruments make it possible to reveal, at least in part, the true cost of depollution. This can be done by setting a cap on emissions while allowing companies to trade offset credits, as in the United States, or by setting the price of pollution in the form of an environmental tax, as in Sweden. In both cases, the costs associated with cleaning up pollution have often proved to be much lower than anticipated. An argument for going further in improving air quality.