Can pollution markets work in developing countries? Experimental evidence from India

Many lower-income countries struggle with severe air pollution, and enforcement of pollution standards can be challenging. In a study forthcoming in the Quarterly Journal of Economics, EGC director Rohini Pande, affiliate Nicholas Ryan, and coauthors examine an alternative: a cap-and-trade market for particulate pollution. Collaborating with regulators, they piloted the world’s first such market in a large Indian city, requiring industrial plants to install pollution monitors and trade emissions permits. The pilot led to cost-effective emission reductions. Similar programs are now expanding across India, demonstrating the global potential of market-based pollution controls. 

Extreme air pollution is a critical challenge in many low- and middle-income countries. In India, much of the population breathes air that is 10 times more polluted than what the World Health Organization considers safe. But traditional efforts to address it, often called “command-and-control” regulations, are frequently strict on paper but challenging to implement. Market-based approaches offer a cost-effective alternative, though rigorous evidence in the context of air pollution is limited. The new study by Pande, Ryan, and their coauthors – Michael Greenstone, the Milton Friedman Distinguished Service Professor in Economics at the University of Chicago, and Anant Sudarshan of the University of Warwick – sought to address this gap and explore the potential benefits of market-based pollution controls for low-income countries.  

“The problem places like India face is that monitoring and enforcing regulations has traditionally been costly, so industry doesn’t comply,” said Greenstone. “Our study showed that it does not need to cost a lot to reduce emissions. We’re now working to bring the success of this market to other states in India, and even other countries around the world. India has the potential to be a model for low- and middle-income countries, we hope to provide the toolkit.”   

The researchers worked with the Indian state of Gujarat to launch and evaluate the world’s first market for particulate matter emissions in Surat, a metropolitan area of 15 million people. The government mandated 317 large, coal-burning plants to install pollution monitors. From there, about half the plants were brought into the market while the rest were kept under traditional regulations. The plants in the market were given a cap on the total amount of pollution they could emit. Those that easily met the cap traded permits with those who could not meet the cap.  

“We have worked with the Gujarat Pollution Control Board for over a decade on testing policy interventions such as altering the incentives of third-party pollution monitoring and sharing emissions information with the public,” said Ryan. “This collaboration is setting a path for environmental policy across India.” 

The plants that participated in the market reduced particulate emissions by 20 to 30 percent overall, relative to plants that did not participate in the market. Further, it cost plants that participated in the market 11 percent less to abate emissions compared to those plants under the traditional regulations. 

The market also functioned almost perfectly, with plants holding enough permits to cover their remaining emissions 99 percent of the time. By contrast, those plants outside of the market met their pollution limit only 66 percent of the time. 

The researchers combined their pollution and cost estimates, including the fixed costs of setting up the market, to conduct a benefit-cost analysis of a potential market expansion. This analysis found that, under a range of assumptions on the mortality damages from pollution, the benefits of the market exceed the costs by at least 25 times. This reflects the high mortality costs of air pollution and the low costs of abatement in the market. 

“Under the market, both the efficiency of the trading platform and the higher level of compliance allowed regulators to reach their environmental goals, while lowering abatement costs for plants,” said Sudarshan. “The market is a win for both government and industry, and proved to be the most effective way to reduce emissions.”  

Because of the success of the market, the Gujarat government expanded it to include those plants originally left out of the pilot experiment. It also launched a second market in the city of Ahmedabad – Gujarat’s largest city and a major industrial hub – and is exploring expanding the market regime to additional industry clusters and pollutants, as well as to additional cities. Meanwhile, the research team is working with the Maharashtra government to develop a statewide market for sulfur dioxide emissions. Seeing these effective efforts, India’s central government is working to form a national carbon market. The research team is providing strategic advice to the central government and several other state governments on how to use markets to meet their environmental and climate goals. 

“The exciting part of the emissions trading scheme that we did for particulate matter,” said Pande, “aside from reducing emissions, is that it provides a proof of concept. Even in a setting with lower state capacity, a compliance market can work, and often will outperform the command-and-control approach.” 

The research team behind this work is affiliated with the Energy Policy Institute at the University of Chicago’s India program (EPIC-India), J-PAL South Asia, and the Yale Economic Growth Center. The research team was awarded funding to scale the market by J-PAL’s King Climate Action Initiative (K-CAI); J-PAL South Asia's Solutions and Advancements through Research for Water, and Air (SARWA); and Alliance for Scaling Policy Impact through Research and Evidence (ASPIRE).  

Research Summary by Victoria Ekstrom High and Vestal McIntyre.