By Michael Greenstone, Rohini Pande, Nicholas Ryan and Anant Sudarshan
Many low- and middle-income countries today suffer from extraordinarily high air pollution. For example, in India, nearly the entire population of 1.4 billion people breathes air more polluted than what World Health Organization standards allow for particulate matter, often by a factor of 10 or more. To address this crisis, India relies on command-and-control environmental regulations akin to those adopted in the United States prior to 1990. Under this system, the government mandates that plants install pollution-control equipment (the command) and penalizes plants that emit particulates above a limit (the control). These limits are often similar across plants that may differ in age, size, fuel type, or existing pollution-abatement equipment. However, though the penalties are stringent on paper, in practice, they are weakly enforced. Several reasons for this include limited monitoring capacity, high costs, and the difficulty of deploying strict punishments, such as imprisonment at scale. Crucially, in the status quo, civil fines are not an option for the regulator. Lastly, the uniform emissions limit ignores differences in abatement costs between plants and provides no incentive for plants to overperform even when it would be relatively cheap for them to reduce pollution.
A powerful alternative to this system is to regulate pollution using markets of tradable pollution permits. The standard justification for markets is that trade allows greater flexibility, reducing the overall cost of pollution abatement by enabling plants that can cut emissions more cheaply to do more of the work. The United States and the European Union have had great success in using permit markets to reduce air pollution, but low- and middle-income countries have rarely used them. Indeed, the precise effects of markets have been difficult to quantify anywhere in the world because there is rarely a suitable comparison group available. A key question is how markets might perform in places with lower state capacity, considering that they place different burdens than command-and-control regimes on both regulators and plants.
Our research examines how a new permit market in India—the world’s first market for particulate matter emissions—impacted plant compliance, pollution emissions, and abatement costs. This market was introduced through an experiment that randomly assigned some plants to the market while keeping other similar plants under existing command-and-control regulations. The market and accompanying experiment emerged from a decade-long collaboration between our research team and the Gujarat Pollution Control Board (GPCB)—the environmental regulator in Gujarat, India—to build the institutions to support an emissions market: infrastructure to continuously measure pollution, new market regulations, and a platform to enable trade.
In 2019, the GPCB launched the permit market for industrial plants in and around Surat, Gujarat, a rapidly growing city of 7 million people. The board mandated that over 300 large, coal-burning plants install continuous emissions-monitoring systems to measure the total mass of particulate matter emitted. Then the board randomly assigned 162 of these plants to the permit market (i.e., market plants), while 156 plants stayed under the command-and-control regime (i.e., control plants).
The GPCB set a cap on the total mass of particulates that could be emitted by all market plants over a compliance period. Before each period began, the board freely distributed permits accounting for 80 percent of the emissions cap in proportion to each plant’s emissions potential; permits representing the final 20 percent of the emissions cap were sold in weekly auctions. Thereafter, market plants could trade permits with one another. After each compliance period, any treatment plants that did not hold enough permits to cover their emissions were fined based on the size of the shortfall. Our evaluation ran from September 2019 to April 2021, with an interruption due to the nationwide COVID-19 lockdown (though the market continues to operate today). The experiment comprises 10 compliance periods, each with a duration of four to six weeks.
The experiment produced three main findings. First, the permit market increased compliance with emissions restrictions. Market plants held enough permits to cover their emissions 99 percent of the time. By contrast, the compliance rate under the command-and-control system was 66 percent. The regulator established a reputation for enforcement in the market regime early on by fining two plants that did not buy enough permits in the first compliance period. Additionally, the permit market appeared to have low transaction costs; plants traded often, and daily trading volume reached 20 percent of the emissions cap. After each compliance period, many plants held permits different from their initial allocations, and plants had few unused and unsold permits.
Second, particulate emissions from market plants fell by 20 to 30 percent relative to control plants. The regulator initially set the cap to try to match the stringency of the command-and-control regulation. Emissions from market plants fell because the initial cap turned out to be stricter than the command-and-control regulations in practice, and the regulator reduced the cap over the first several compliance periods, likely in response to the relatively low costs of compliance in the market regime.
Third, the permit market made pollution abatement cheaper. Although emissions decreased in the market regime, we found no evidence of increases in costs for plants. Furthermore, using data on plants’ bids to buy and sell permits, we calculated that this regime would have reduced abatement costs by 11 percent if emissions were held constant compared with the command-and-control regime. Plants with relatively high abatement costs purchased pollution permits from plants with relatively low abatement costs. This decreased the total cost of reducing emissions compared with the command-and-control regime because plants for which emissions reductions would be relatively costly were allowed to pollute above the previously uniform limit, while plants that could reduce emissions at relatively low costs sold their permits and reduced emissions.
Finally, we conducted a cost–benefit analysis of expanding the permit market to all 906 plants that burn coal and other solid fuels in Surat. We combined our findings with the costs of setting up the permit market and estimates of the effect of air pollution on mortality. Our analysis finds that the benefits of the permit market exceed its costs by at least 25 times.
NOTE
This research brief is based on Michael Greenstone et al., “Can Pollution Markets Work in Developing Countries? Experimental Evidence from India,” Quarterly Journal of Economics 140, no. 2 (May 2025): 1003–60.