Chapter 2: Market Design for the Environment

The main argument in favor of markets in environmental contexts is the same as in other contexts: their ability to promote efficient allocations and production. But environmental problems bring their own challenges: their underlying biophysical processes — and the technologies to monitor them — constrain what is feasible or even desirable. This chapter illustrates the main design dimensions in environmental markets, the trade-offs involved and their impact on performance, through the lens of a regulated market for pollution rights (the EU emissions trading scheme) and a voluntary market for the provision of environmental services (the global market for carbon credits). While both markets eventually contribute to climate change mitigation, their organisation as a “pollution market” for the former, and as a “provision market” for second, means that different design considerations take precedence. Both markets also face challenges: volatile prices in the EU emissions scheme and low trust for voluntary carbon markets. We discuss how alternative design options could address those.