Emissions markets to reduce air pollution

Building on a longstanding partnership with the Gujarat Pollution Control Board (GPCB), J-PAL affiliated researchers evaluated the impact of the world’s first emissions market for particulate pollution from industries. A pilot market in the city of Surat reduced air pollution and was highly cost-effective, with projected health benefits surpassing costs by at least 25 times. In 2023, the market was scaled up to other industrial areas in Gujarat to reach approximately 15.3 million people, with plans to expand to four other cities by 2026.

The Problem

Traditional regulatory approaches are often ineffective at lowering pollution emissions, especially in low-capacity settings.

India has one of the highest rates of air pollution in the world, with a national average pollution concentration over three times the WHO’s recommended safe limit. Particulate matter—small solid particles floating in the air, mostly generated by fossil fuel combustion—makes up a large share of air pollution in and around industrial areas. It can cause lung and cardiovascular diseases when inhaled and absorbed into the bloodstream. Research indicates that particulate pollution is the most significant health threat in India, reducing average life expectancy by 5.3 years.

As a lower-middle-income country with 1.4 billion people, India faces the dual challenge of fostering robust economic growth while addressing severe environmental degradation. The existing approach for regulating pollution from industries is known as command-and-control regulation. The regulator mandates that industrial plants install specific abatement equipment (the "command") and imposes penalties on plants that exceed pollution limits (the "control"). 

Unfortunately, this approach has seen limited effectiveness due to weaknesses in enforcement and monitoring, industry pushback because of high compliance costs, poor quality data, legal transaction costs when implementing penalties etc. Penalties are often only imposed for large violations, allowing smaller violations to escape enforcement¹. 

Emissions markets could provide a solution to meet the dual challenge of economic growth and environmental quality by providing economic incentives for reducing emissions. 

In an emissions market, a government issues a limited number of emission allowances via permits to companies, which they can trade with each other. Plants are required to hold enough allowances to cover their pollution, but the flexibility afforded by trade helps reduce costs. This is because companies for whom cutting emissions is very cheap can overperform and sell excess permits for profit to other participants. This means that more of the total reduction in pollution is done by those for whom it is cheap. A failure to hold enough permits is penalized by automatic fines that are in proportion to emissions overages, providing an automatic financial incentive to comply. Over time, the number of permits issued by the government can be decreased to further limit emissions. 

While market-based solutions have been shown to reduce CO2 emissions in high-income contexts, there are virtually no pollution markets in use in low and low-middle-income countries. Therefore, there is little evidence on whether they are effective in settings with limited enforcement capacity.

The Research

The world’s first emissions market for particulate matter cost-effectively reduced pollution in Surat.

In 2009, the GPCB partnered with J-PAL Director Esther Duflo (Massachusetts Institute of Technology) and J-PAL affiliated researchers Michael Greenstone (University of Chicago), Rohini Pande (Yale University),  Nicholas Ryan (Yale University), and Anant Sudarshan (University of Warwick) to test a series of reforms, including independent audits, to strengthen enforcement of command-and-control regulation. Based on findings that more independent audits reduced pollution, the GPCB integrated the reforms into its statewide Environmental Audit Scheme.

Following the success of the audit reform, India’s Ministry of Environment, Forests, and Climate Change and the Central Pollution Control Board initiated a collaboration with the researchers to develop and test market-based approaches that would address the limitations of existing command-and-control policies. 

Researchers conducted an initial baseline study in three states—Tamil Nadu, Gujarat, and Maharashtra. After selecting an industrial area in Surat, Gujarat for the study, researchers collaborated with the GPCB to launch and evaluate the world's first particulate matter emissions market. In 2013, the research team worked with the GPCB to introduce India’s first standards and specifications for continuous emissions monitoring systems (CEMS). The next year, GPCB began mandating that industrial plants in Surat install CEMS in their chimneys to collect real-time pollution data.

The emissions market was launched in 2019 in Surat. Researchers used real-time CEMS data transmitted to the GPCB from 292 factories, 156 of which were randomly enrolled in the market. Each permit allowed the factory to emit one kilogram of particulate matter, and factories could buy and sell permits. The researchers and the GPCB worked with the NCDEX e-Markets Limited, a subsidiary of India’s National Commodity and Derivatives Exchange that develops and operates several commodity exchanges, to establish an online platform where industries could trade permits and monitor their emissions in real-time.

Plants actively participated in the market. Few plants emitted above their permit holdings, and the GPCB was able to identify and fine violators quickly. Plants participating in the market reduced their particulate matter emissions by 20 to 30 percent compared to plants under the traditional command-and-control regulation.

Factories participating in the market also did not spend more on pollution abatement on average, despite the large reductions in emissions. Many already had the equipment needed to reduce their pollution emissions, but were not running it or maintaining it. The option to sell permits incentivized those firms to use the equipment more consistently. 

The pilot market covered only a fraction of sources of pollution; nevertheless, the research team estimated that the health benefits associated with lower particulate matter pollution as a result of the market exceeded firms’ costs of monitoring and reducing pollution by at least 25 times. The flexibility of being able to trade did reduce costs of compliance—as textbooks would predict—allowing more efficient firms to cut their pollution and then sell permits to those for whom reducing pollution was expensive. The findings indicate that if monitoring is robust and regulation is enforced, markets can effectively address pollution in low-capacity settings.

For more detailed information on the research, see the evaluation summary.

From Research to Action

Based on the results of the evaluation, the GPCB scaled the emissions market to all industries in Surat as well as an additional city, reaching over 400 plants and at least 15 million people.

The decade-long relationship between the research team and the GPCB was instrumental in designing the market and, once it was found to be effective, bringing it to scale. The research team collaborated extensively with the government, technology service providers, industries, and other key stakeholders across disciplines to develop protocols for emissions data use and reporting, market rules, and trading platform used in the emissions market. 

Anant Sudarshan and a team from J-PAL South Asia were a part of the committee that formulated the first technical standards for CEMS data in India in 2013. J-PAL South Asia also hired embedded staff with strong engineering and climate science backgrounds to work directly with the GPCB to monitor the CEMS installation and rollout of the market. CEMS data made permit holdings and real-time emissions information available to participating plants through the online trading platform. This transparency helped the GPCB scale the market to other industries.

In 2020, based on these promising findings, the research team shared preliminary results with the MoEFCC and the GPCB. The same year, the research team and J-PAL South Asia received funding from J-PAL’s King Climate Action Initiative (K-CAI) to support the government to expand and adapt the market to new cities in Gujarat as well as other states. 

Once the randomized evaluation concluded in 2022, the pilot emissions market scaled to include more industries in Surat, bringing the total number of industries participating from 156 to 298. In September 2023, following the success of the Surat emissions market expansion and with additional support from K-CAI and ASPIRE, the GPCB launched a new market in Ahmedabad, Gujarat’s largest and most polluting city, consisting of 120 industries.

The researchers estimate that the emissions markets have already improved the air quality for over 15.3 million people living in the airsheds surrounding Surat and Ahmedabad as of 2023. With support from J-PAL’s newly launched Air and Water Lab in India, Solutions and Advancements through Research for Water and Air, researchers and the Government of Gujarat are continuing to collaborate to expand the market for particulate matter further. The Government of Gujarat aims to reach more industries and cities by 2025, with the potential to reach up to 21.1 million people by 2026.