"Pollution Emission Rights" Trading Makes the Environment Cleaner [Song Seungseop's Financial Light]

Economist Contemplating "How to Solve Environmental Pollution"
Beyond Regulation and Taxes, "Let's Trade Rights Among Ourselves"
Emission Trading Recognized in Kyoto, Japan in 1997
Korea Introduced It in 2015, Market Activation Remains a Challenge

"We will introduce a Blue Carbon Emissions Trading System." This was stated by Kang Do-hyung, Minister of Oceans and Fisheries, on the 10th at Pohang City Hall in Gyeongbuk. Carbon emissions trading is a system where companies buy and sell the rights to emit carbon. It is already applied in the private market, and now they plan to utilize it for marine environmental cleanup as well.

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It may be an unfamiliar term, but the Ministry of Environment regards carbon emissions trading as a very important policy to reduce carbon emissions. But doesn't something seem odd? Even though companies should be reducing carbon emissions, the government is giving them the 'right to emit.' Companies that buy many emission rights would presumably release a lot of pollutants, so how can this help the environment?

In Korea, carbon emissions trading is called the 'Emissions Trading System.' Emission rights are given to workplaces obligated to reduce greenhouse gases, and they can buy and sell these rights among themselves. For example, if a company reduces its greenhouse gas emissions, it can sell its emission rights to another company and make money. The opposite is also possible. If a company needs to emit more greenhouse gases, it can buy emission rights from another company without hesitation. This means companies can emit carbon freely as much as the emission rights they hold.

"Solving Environmental and Social Issues Through Buying and Selling"

But how does the emissions trading system help environmental conservation? The idea of emissions trading was first conceived by British economist Ronald Coase, who won the Nobel Prize in Economics in 1991. Coase was a scholar who pondered why social problems like environmental pollution occur. He believed that social problems arise because it is unclear who should bear the costs and how much. He argued that if property rights, responsibilities, and costs are clearly defined, environmental pollution can be resolved naturally.

Ronald Coase, former professor at the University of Chicago Law School. He won the 1991 Nobel Prize in Economics for his 1960 paper "The Problem of Social Cost." Photo by Nobel Foundation Archives.

Let's take 'noise between floors' as an example. Suppose there is Mr. A, who plays loud music, and Mr. B, who suffers from the noise. Mr. A enjoys the 'right to play music comfortably' and gains happiness worth 1 million KRW per month. On the other hand, Mr. B suffers damage worth 700,000 KRW per month due to the infringement of his 'right to rest comfortably.' Coase says that if A and B negotiate, the problem can be solved. If Mr. A pays Mr. B an amount between 700,000 and 1 million KRW, neither party will have complaints.

The environment is the same. How can we solve a situation where fish die due to wastewater discharged from a factory, causing damage to fishermen? If the factory gains 1 million KRW from discharging wastewater and fishermen suffer damage worth 500,000 KRW, the factory can pay the fishermen between 500,000 and 1 million KRW. From the factory's perspective, it is buying the right to discharge wastewater with money. Conversely, if the fishermen's damage amounts to 2 million KRW, they might pay more than 1 million KRW to prevent the factory from discharging wastewater or pressure the factory to stop discharging.

This idea led to the emissions trading system. Instead of scrutinizing how much carbon companies emit, the system allows those who want emission rights to buy and sell them freely. Suppose country C emits 1,000 tons of carbon monthly and wants to reduce it to 900 tons. In a country with an emissions trading system, the total amount is set at 900 tons. Companies in country C can choose either to reduce emissions or buy emission rights from other companies. Companies freely choose, and the government prevents environmental pollution.

More Effective at Reducing Total Pollutants Than 'Carbon Tax'

Introducing an emissions trading system can reduce the total amount of pollutants compared to before the system was implemented. Photo by Ministry of Environment

If the emissions trading system is allowed for everyone, environmental pollution can be reduced more boldly and quickly. Environmental groups usually criticize, point out, and protest companies with high carbon emissions. However, if environmental protection groups can participate in the emissions trading system, problem-solving becomes easier. They can gather money and buy emission rights in bulk. The more emission rights environmental groups buy, the more companies reduce carbon emissions. Consequently, the total amount of pollutants emitted by our society will decrease accordingly.

Some might think, "Why not just impose taxes instead of creating a complicated trading market?" If a tax is levied on each carbon emission, companies feeling the burden would uniformly reduce carbon emissions, which would be more beneficial for the environment. In fact, the 'carbon tax' is a system introduced in several countries and has clear advantages.

However, the carbon tax also has clear drawbacks. It is difficult to respond actively with a carbon tax. If new pollutants are discovered or certain substances are no longer considered pollutants, the carbon tax rate must be adjusted. Raising or lowering taxes is a very complicated and delicate issue that takes a long time. From the perspective of developing pollution reduction technologies, the emissions trading system is useful. In the emissions trading system, companies can earn additional profits by selling emission rights if they reduce carbon emissions. On the other hand, the carbon tax offers no such benefit.

In December 1997, at the 3rd Conference of the Parties to the Kyoto Protocol on Climate Change held in Kyoto, Japan. Al Gore, then Vice President of the United States, delivering the opening address at the meeting. Photo by Britannica

The emissions trading system was first applied in reality after theoretical research at the 3rd Conference of the Parties to the Climate Change Convention held in Kyoto, Japan, in December 1997. The protocol adopted at that time recognized emissions trading as one of the efficient ways to reduce greenhouse gases. Subsequently, the European Union first implemented the emissions trading system in 2005 to reduce carbon emissions by 8% compared to 1990. Australia, Japan, and New Zealand followed and introduced the emissions trading system. Korea first introduced the emissions trading system in 2015.

Price Collapse and Low Trading Volume... Challenges in Market Activation

However, experts agree that more improvements are needed for the emissions trading system to contribute effectively to reducing environmental pollution. Emission rights are granted by the government to companies either by 'paid allocation' or 'free allocation.' Free allocation is given to companies with high carbon emissions and high cost burdens, and in Korea, the paid allocation ratio is about 10%. To reduce environmental pollution, companies should buy emission rights with money, but currently, since they are given for free, companies are less likely to reduce emissions.

Low trading volume and low prices are also problems. Carbon emission rights must be expensive and actively traded to succeed. This encourages companies to sell emission rights to other companies as much as possible and voluntarily reduce carbon emissions. However, the price of carbon emission rights in Korea is trending downward. As of the 17th, the closing price of carbon emission rights (KAU23) was 8,950 KRW. Compared to 11,250 KRW a year ago, it has decreased by about 20%.

Price trend of domestic Assigned Amount Units (KAU) from January 2015 to January 2023. Photo by Korea Exchange Emissions Trading Market Information Platform.

There are also calls to relax regulations on emissions trading. Unlike other countries, Korea makes it difficult to buy emission rights in advance and use them later. As a result, companies do not actively buy and sell emission rights. Even if they predict that emission rights will be needed more in 10 years, emission rights purchased now are useless, so they do not attempt to buy them. Experts say that if companies are allowed to accumulate purchased emission rights, they will trade emission rights more actively.

Yoon Yeo-chang, a KDI research fellow, analyzed in last year's report titled "Measures to Improve Market Function of Emissions Trading System" that "the restriction on carryover is a major cause of the decline in emission rights prices," and "it is necessary to promptly ease carryover restrictions so that greenhouse gas reduction targets can be reflected in the emission rights market."

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