Pollution permits and compliance strategies.

Summary The paper analyzes the impact of current (spot) and future tradable pollution rights markets on the decisions of potential polluters. Polluters can buy permits, invest in pollution control, or stop production. We show that current markets induce excessive investment in pollution control. The introduction of a future rights market reduces the incentive to invest, but it is not the optimal way to control pollution. A menu of pollution rights options today for the future, possibly combined with joint sales with pollution rights today leads to higher welfare. Because of its emphasis on long-run demand elasticities, and on rent extraction, the results obtained can be applied in a variety of situations such as electricity demand management, public transport, bypass in telecommunications, or future sales of a private monopoly.