“Innovation Under the Tradable Sulphur Dioxide Emission Permits Program in the US Electricity Sector”

The 1990 US Clean Air Act Amendments instituted a national program in tradable sulphur dioxide (SO2) emission permits in the US electricity sector. This paper provides a survey and assessment of the SO2 program, with a focus on the role of innovation. Over the last decade the cost of compliance has fallen dramatically compared with most expectations and today the total cost of the program is 40 percent to 140 percent lower than projections (depending on the timing of those projections and the counter-factual baseline that is considered). Marginal costs of reductions are less than one-half the cost considered in most analyses at the time the program was introduced. Innovation accounts for a large portion of these cost savings, but not simply in the way that is typically formulated in economic models of research and development efforts to obtain patent discoveries. Innovation under the SO2 program involved organizational innovation at the firm, market and regulatory level and process innovation by electricity generators and upstream fuel suppliers. An important portion of the cost-reductions that are evident were already “in the works,” independent of the SO2 program. Nonetheless, the trading program deserves significant credit for providing the incentive and flexibility to accelerate and to fully realize exogenous technical changes that were occurring in the industry. This marks a significant departure from conventional approaches to environmental regulation, which would not be expected to capture these savings. The ongoing transition to restructuring of electricity markets and expanding competition in electricity generation complements the design of the SO2 trading program by providing firms with full incentives to reduce costs in pollution control. ψ The author owes a debt for many of the ideas in this paper to Curtis Carlson, Richard Newell and Karen Palmer. Responsibility for how these ideas have been portrayed rests solely with the author. C:\TEMP\Burtraw_paper_000729.doc 07/31/00