There are two main categories of economic instruments useful for controlling pollution; those that create property rights to environmental resources and those that act on prices (eg taxes). The property rights approach aims to provide incentives for individuals to conserve their environment by clarifying their rights to and responsibilities for common property. One way to do this is to create a system of tradeable permits. Tradeable permits are quotas, allowances or ceilings on pollution emission levels that, once allocated, can be traded subject to a set of prescribed rules. The ownership of a tradeable permit allows a firm to pollute up to a certain limit. If the firm wishes to expand production, then they must either invest in pollution control equipment or purchase more permits. Firms which choose to emit less than their allowance may sell their surplus permit to other firms or use them to offset excess emissions in other parts of the plant. In this pollution control regime, firms with the lowest abatement costs have an incentive to control more emissions, and those with high abatement costs have an incentive to buy permits instead of investing in costly pollution control equipment. The market is left to determine the most efficient way to control pollution within a regulatory framework.

The Kyoto Protocol required Annex 1 Parties (ie, industrialized countries) to reduce greenhouse gas emissions relative to a 1990 base. Australia was permitted to ‘reduce’ emissions to 108% of the 1990 level. The Protocol, which Australia has not ratified, established three mechanisms designed to help Annex 1 Parties cut the cost of meeting their emission targets. One of these was carbon emissions trading.

The European Union States have agreed to fulfil their commitments to reduce greenhouse gas emissions under the Kyoto Protocol jointly. The EU Emissions Trading Scheme was launched on January 1 2005. From this date, certain installations needed a greenhouse gas emissions permit. The scheme is the largest ‘cap and trade’ scheme in the world and is the core instrument for Kyoto compliance in the European Union. After 18 months of operation, one of the main lessons from the EU scheme is that the simplicity and predicability of the scheme needs to be improved. The scheme is growing in membership and coverage, with the aviation sector likely to be included in the scheme from 2011.

In Australia, proposals for a national emissions trading scheme have been put forward by the States and Territories. These proposals are reviewed, along with comments from industry and community groups. Whilst the Commonwealth Government has historically been critical of a domestic emissions trading scheme, it has recently announced a task force to assess what characteristics a global and domestic scheme should have. The Prime Minister has also stated that market mechanisms, including carbon pricing, will be integral to any long-term response to climate change.