Should the regulator allow citizens to participate in tradable permits markets?

Since the seminal paper written by Weitzman (1974), the “prices vs. quantities” debate regarding choice of policy instrument under imperfect information and uncertainty has been an ongoing concern for economists, especially in the field of the environment. In this debate, several papers have recommended that the regulator allow pollution victims (citizens) to participate in tradable permits markets. According to this literature, when pollution victims purchase and withhold (i.e. destroy) emission rights from polluting firms, this means that the overall quota is not efficient and that welfare gains will be realised. In this paper, we present further theoretical results showing that citizen participation in tradable quotas markets may become welfare decreasing. Indeed, citizens can aggravate the first error made by the regulator if they are also under uncertainty about the marginal benefit curve or if they exhibit strong enough risk aversion. Therefore, we recommend that the regulator limit citizen participation to a certain percentage of permits. In doing so, we extend the “prices versus quantities” debate to simultaneous uncertainty and risk aversion by showing that a marketable permits system offers the regulator an opportunity to control the negative effects of agents’ (citizens’ and firms’) risk aversion on welfare.