When the Levee Breaks: Can Multi‐Pollutant Markets Break the Dam on Point–Nonpoint Market Participation?

16 Pages Posted: 24 Mar 2020

See all articles by Carson Reeling

Carson Reeling

Purdue University

Richard D. Horan

Michigan State University - Department of Agricultural Economics

Cloé Garnache

University of Oslo, Department of Economics

Date Written: March 2020

Abstract

High transaction costs and thin participation plague water quality trading and prevent markets from delivering expected efficiency gains. Little prior work explores the relationship between transactions costs and market performance. We develop a model of point–nonpoint trading that includes transactions costs. Point sources (PS) generate a single pollutant, whereas nonpoint sources (NPS) generate multiple, complementary pollutants. Trading occurs via bilateral negotiation: regulated PS must find and contract with unregulated NPS to obtain pollution offsets. Each PS bears search and contracting costs that depend on the number of potential trading partners. The NPS sector does not pay search costs but may incur some contracting costs. These costs may affect participation decisions. Transactions costs may generate strategic complementarities that lead to multiple equilibria, characterized by large or small levels of market participation. The equilibrium at which the market arrives depends on sources' expectations about others' participation. We explore the effect of different market structures on trading outcomes. Allowing NPS to participate in multiple, distinct markets for each pollutant they abate may have little effect on the basin of attraction for trading. In contrast, integrated markets—in which regulated polluters can meet their caps by holding permits generated from abatement of either pollutant—can reduce transactions costs for both sources. This generates a larger basin of attraction around the full‐participation equilibrium and thus may improve the efficiency of pollution trading.

Keywords: Credit stacking, multi‐pollutant trading, participation, strategic complementarities, transactions costs

Suggested Citation

Reeling, Carson and Horan, Richard D. and Garnache, Cloe, When the Levee Breaks: Can Multi‐Pollutant Markets Break the Dam on Point–Nonpoint Market Participation? (March 2020). American Journal of Agricultural Economics, Vol. 102, Issue 2, pp. 625-640, 2020, Available at SSRN: https://ssrn.com/abstract=3558927 or http://dx.doi.org/10.1002/ajae.12005

Carson Reeling (Contact Author)

Purdue University ( email )

610 Purdue Mall
West Lafayette, IN 47907
United States

Richard D. Horan

Michigan State University - Department of Agricultural Economics ( email )

303A Agriculture Hall
East Lansing, MI 48824
United States
517-355-1301 (Phone)
517-432-1800 (Fax)

Cloe Garnache

University of Oslo, Department of Economics ( email )

Postboks 1095
Oslo, 0317
Norway

HOME PAGE: http://www.cloegarnache.com

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