Water-Quality Trading: Can We Get the Price of Pollution Right?

Figure 3: Total supply of permits and relative performance of TRS and DTRSefficient trades while the DTRS promotes inefficient trades. These results indicate, in this sense, theimpossibility of getting the spatially explicit prices of pollution right under either system. However,our computational results do indicate the possibility that the two systems may still approximatethe socially efficient optimum sufficiently closely if the total allowable permits are set initially atlevels sufficiently close to the optimum. The (maximum) efficiency loss due to mis-specifying thetotal supply of permits was much larger than that from mis-specifying the spatial prices of permits.Interestingly, the magnitude of inefficiency due to incorrect signals may also depend on the totalsupply of permits. Thus our paper suggests the importance of getting the quantity of pollutionright even while striving to get the spatial prices of pollution right.Though we kept the assumptions of our model as general as possible with respect to waterpollution and watershed characteristics, like Hung and Shaw and also Farrow et al. we ignored theproblem of nonpoint-source pollution (NSP). Nonpoint sources can of course play an importantrole in a watershed. It is usually difficult and costly to identify and monitor the level of NPSpollution-causing activity (or discharge levels), because land-use practices (for example, fertilizerapplication) or land use itself (for example, buildings and parking lots) are the major sourcesof such pollution. If the discharge from each source is difficult to identify, neither trading nordirect control would achieve the efficient outcome. However, in recent years substantial efforts havebeen devoted to transforming nonpoint sources into point sources. Scientists of various disciplinescontinue to improve their ability to identify and monitor pollution levels from nonpoint sources.As our understanding of NPS improves, the present study could have important implications forthe optimal management of nonpoint-source pollution.In the case of nonpoint pollution, the business of getting the spatial prices of pollution rightbecomes even more difficult for two reasons. First, because water pollution can travel through mul-21