Market design for the environment, by Cantillon and Slechten

 Here's a recent NBER working paper, to start the year off on an optimistic note:

MARKET DESIGN FOR THE ENVIRONMENT, by Estelle Cantillon and Aurélie Slechten, NBER Working Paper 31987, http://www.nber.org/papers/w31987

Abstract: 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 bio-physical 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.

From the Introduction:

"This chapter reviews existing and developing uses of markets for natural capital from a market design perspective. We first provide a typology of environmental problems for which markets can provide a solution. This leads us to distinguish between overexploitation, degradation and underprovision problems. Overexploitation and degradation problems happen when the goods and services provided by Nature are not excludable and property rights are shared or nonexistent. Underprovision problems arise when the natural resource, over which well-established access and usage rights exist, creates positive externalities for agents who do not benefit from any property rights to the resource. We argue that each natural resource is characterized by its specific bio-physical process which constrains the definition of what can be traded and the choice of design to support the goals of the market.

"We illustrate these considerations in the context of climate change mitigation, where compliance markets for emissions reduction and voluntary carbon markets are playing an increasingly important role. The history of the EU emissions trading scheme over the past 20 years illustrates how apparently small design decisions can impact the performance of a market and the challenges of generating an informative and stable price signal, an important desideratum to foster cost efficiency. The current discussions around the integrity of voluntary carbon markets show the importance of the definition of what is traded, and how technology and nature constrain it."