Pollution Markets with Imperfectly Observed Emissions

I study the advantages of pollution permit markets over uniform emission (or technology) standards when the regulator has incomplete information on firms' emissions and costs of production and abatement (e.g., air pollution in large cities). Because the regulator observes only each firm's abatement technology but neither its emissions nor its output, there are cases in which standards can lead to lower emissions and, hence, welfare dominate permits. If permits are optimally combined with standards, in many cases this hybrid policy converges to the permits-alone policy but (almost) never to the standards-alone policy.