Cap-and-trade: A sufficient or necessary condition for emission reduction?

Influenced by the success of emission trading in the US for sulphur dioxide (SO₂), some economists have argued for an upstream, economy-wide cap-and-trade scheme as the primary tool for achieving the required reduction in greenhouse gas (GHG) emissions. This paper addresses that argument and concludes that cap-and-trade will need to be accompanied by complementary regulatory measures. While it is a necessary component in a climate mitigation programme, it is unlikely to be sufficient by itself to accomplish the desired emission reductions. The paper reviews the evidence on how SO₂ emissions were reduced and the extent to which actual emission trading was responsible for the reduction as opposed to other innovations. It also identifies differences between the past regulation of SO₂ and other air pollutants and the challenges presented by the regulation of GHG emissions. What actually happened in the US with SO₂ emission trading deviated in several significant respects from what would be predicted based on the conventional theoretical analysis. While there was a dramatic reduction in SO₂ emissions, it occurred because of several factors, some of which are unlikely to apply for GHG emissions, and others of which argue for an activist regulatory policy by the government as a complement to the functioning of an emissions market for GHGs.