From straying cattle to pay-as-you-go polluters

In the 1960s a British economist published an article that would change the way EU oil and electricity companies work 40 years later. Nobel prize laureate Ronald Coase in his ‘The Problem of Social Cost’ argued that many problems, from noisy neighbours to straying cattle, could best be solved through the use of property rights.

Coase said if the problem was looked at in terms of its economic value, either the value of cakes produced by noisy machinery or the value of meat produced by straying cattle, a solution could be more easily negotiated than by relying on regulators and legal authorities.

The idea quickly came to be applied to a range of environmental problems. Pollution had to be looked at in terms of how much it cost. The concept is now widely known as the polluter-pays principle, or more clumsily as ‘internalising externalities’ (ie, the external cost of cattle destroying crops or chemicals produced near a stream).

Today Coase’s thinking is often seen as the foundation for emissions trading, a market solution to environmental problems, developed by economists in the 1970s.

The US was among the first to take up the idea, introducing a successful trading scheme for sulphur dioxide emissions (SO2) in the 1990s.

SO2 trading was even more successful than predicted, with costs far lower than anyone expected. Faced with the price of installing desulphurisation equipment, companies were quick to develop lower sulphur fuels.

California and parts of the US east coast took up the idea for nitrogen oxides (NOx) trading and witnessed a similar surge in innovation.

It was also the US that in 1997 insisted countries should be allowed to use emissions trading to meet carbon dioxide (CO2) reduction targets under the Kyoto Protocol.

The EU for a long time continued to favour regulation over relying on the market to clean things up. When it did edge towards market-based mechanisms, as with a 1990s proposal for a tax on CO2 emissions, member states refused to give their support.

But because of the Kyoto reference to emissions trading, the EU began properly to analyse the costs and benefits of the idea.

The Commission in 2003 won EU support for an emissions trading directive and saw a trading scheme up and running two years later.

The US has not yet ratified Kyoto and has no trading scheme for CO2.

In the 1960s a British economist published an article that would change the way EU oil and electricity companies work 40 years later. Nobel prize laureate Ronald Coase in his ‘The Problem of Social Cost’ argued that many problems, from noisy neighbours to straying cattle, could best be solved through the use of property rights.