The Indian state of Gujarat launched the world’s first market for particulate pollution—the deadliest form of air pollution—in the city of Surat. The now award-winning market has reduced pollution by about 20 percent and is now expanding to other cities within Gujarat and beyond. It is a model of success as the state prepares to launch the first carbon market among emerging economies outside of China. The market has the potential to be twice the size of the Regional Greenhouse Gas Initiative, a carbon market run by a collection of states in the U.S. northeast and mid-Atlantic, and about 60 percent the size of the California cap-and-trade market.
“Countries around the world are trying to find the right balance between the need for inexpensive and reliable energy and environmental quality. Gujarat is a leader in using evidence to find ways to make the trade-off less sharp. Their award-winning approach of developing new ideas, testing them in the most rigorous ways, and then using the results to shape policy is a global model. They are now turning to CO2 and the results seem destined to benefit Gujarat, as well as other Indian states and other countries.”
– Michael Greenstone, the Milton Friedman Distinguished Service Professor in Economics
Emerging economies like India face a dual challenge: Maintain strong economic growth while limiting the pollution and carbon emissions generated by industrialization. As one of the most polluted countries in the world, India declared a “war against pollution” in 2019 and launched a National Clean Air Program to bring down levels of deadly particulate pollution by 20-30 percent by 2024. If successful, this progress in reducing air pollution would extend the life expectancy of the average Indian by about 1.3 years.
At the same time, India is the third-largest carbon emitter in the world. If the world is to hold future warming to 1.5 degrees Celsius, India and countries like it must identify a cleaner model of growth that dramatically reduces emissions. Among its climate pledges, India has committed to reduce total projected carbon emissions by 1 billion tons and reduce the carbon intensity of the economy to less than 45 percent by 2030. To meet this national target, the central government has given states their own targets.
India needs strong policies that reduce pollution and carbon emissions at an affordable cost for industry. Historically, however, the country’s environmental regulations have produced just the opposite. Blunt, inflexible regulations have proven costly for industry and difficult for the government to implement and enforce, resulting in poor compliance and dangerously polluted air. Markets based on an emissions trading approach provide an alternative that could meet the challenges of continued economic growth, improved air quality, and reduced carbon emissions.
Under a cap-and-trade market, the regulator first decides and caps the aggregate quantity of a pollutant emitted by a group of polluting industries. Next, the regulator issues a set of permits denominated in tons of the pollutants. The total value of all permits is equal to the market cap. Third, these permits are distributed and-or auctioned to the industries. Fourth, industries can freely buy and sell these permits such that at the end of a compliance period of specified length, all plants must have enough permits to cover their emissions. Finally, permit pricing and ownership across plants is market-determined by their free decisions to buy and sell. Like any other traded commodity, these trades are made on a commodity exchange.
Markets have been proven effective in reducing pollution at a low cost in countries around the world. One of the largest such programs in history, the U.S. sulfur dioxide emissions trading scheme, slashed pollution by 40 percent between 1980 and 2003. Analysts have shown that the program’s benefits exceeded its costs by a 40:1 ratio. Based in part on this example, successful trading markets have been adopted for a variety of pollutants in Canada, Europe and recently in China. But no markets to this point had targeted deadly particulate pollution, and no carbon markets have been created in emerging economies outside of China.
The idea for introducing a market for pollution in India came from evidence generated by a path-breaking study of existing regulations in the state of Gujarat. In 2010, regulators in Gujarat faced a confounding problem: They had strong air-quality standards on the books, and the tens of thousands of industrial facilities in the region were reported by their auditors as being in compliance. And yet, air quality in cities in Gujarat was among the worst in India. When the regulators asked University of Chicago researchers, and their colleagues, to work with them to explore how this could be the case, they discovered that plants selected and paid their own auditors, creating a clear conflict of interest. And sure enough, when the researchers double-checked auditors’ work, it turned out that they often ignored or misreported violations. By modifying this structure, and instead having auditors randomly assigned and paid out of a central fund, the conflict of interest was eliminated. Pollution fell by 28 percent among the affected plants over the following year—at no extra cost to regulators and with no new technology. In 2015, the reforms were permanently adopted across the state of Gujarat and four years later the Ministry of Environment, Forests, and Climate Change cited the changes as a compelling case for other states.
Reforming the audit system gave regulators a much better picture of the air pollution levels in their constituencies. But this picture was still based on manually gathered samples, which were vulnerable to human error and offered at best a snapshot of air pollution from a given site. For a complete picture of industrial emissions regulators needed a new technology. The researchers began working with the Central Pollution Control Board (CPCB) and the Ministry of Environment, Forests, and Climate Change to develop new standards and specifications that would allow for the use of Continuous Emissions Monitoring Systems (CEMS). These systems provide regulators with a stream of real-time measures of the concentration of pollution from a given smokestack, providing them with uninterrupted and reliable access to huge amounts of new data.
In 2013, the Indian government introduced the first standards document for CEMS, focusing on their use for emissions trading schemes. The researchers went to work testing whether better data would in fact reduce pollution from factories. They gathered manual samples to establish baseline pollution levels, and then worked with the local government to install CEMS devices inside the smokestacks of about 300 factories in the city of Surat in Gujarat. Comparing the CEMS data to data delivered by auditors confirmed the vital importance of CEMS in providing accurate pollution information. Trusting that these manual test results were representative of actual emissions levels rested on the rather optimistic assumption that a factory undergoing a test behaved in exactly the same way when it was not being watched. CEMS revealed that was not always the case.
Although CEMS clearly improved the quality of data, the evidence gathered by the researchers suggested that mandating these devices did not by itself lead to significant reductions in plant pollution. This finding suggested that without regulatory reform, better data could only go so far. The next step therefore was to use the CEMS infrastructure to implement modern, market-based regulation in Surat.
EPIC researchers and their colleagues worked closely with the Gujarat Pollution Control Board and the Central Pollution Control Board and solicited input from industry. Together, they designed a trading platform and auction design alongside partners at the National e-Markets Ltd (NeML), which runs one of India’s largest commodity exchanges. In early 2019, the Ministry of Environment, Forests, and Climate Change (MoEFCC) approved the local pollution board’s request for the Surat market.
The Surat market began on July 15, 2019, with two months of mock-trading to allow for intensive stakeholder capacity building before coming into full force. During this time, the Gujarat Pollution Control Board issued detailed rules that included the level of the initial cap (280 tons per month), the length of the first compliance period (one month), and the dates on which permit auctions would be held. These parameters were set by the market oversight committee.
On September 16, 2019, the Surat clean air market officially began trading. More than 300 plants are participating. Trading occurs every day, and the auctioning of permits occurs each week. As part of their work with the government, EPIC researchers and their colleagues are conducting a large-scale pilot study of the market’s impacts on pollution. Early results from the Surat market suggest that industries regulated using a market may have already cut their emissions by roughly 20 percent, with no significant increase in operating costs. Indeed, many market participants were seen to earn additional revenue through permit sales, made possible by cutting pollution well below existing standards. Further, industry output is higher than it was in the year before the market was in place, and the plants have still met the pollution cap each month since trading began.
“With this program, we are kicking off a new era of cleaner production, while lowering industry compliance costs and rewarding plants that cut pollution in low-cost ways. We believe using this market-based system will prove that rapid economic growth, ease of doing business, and breathing clean air can all be achieved at the same time.”
– Dr. Rajiv Kumar Gupta IAS, chairman of the Gujarat Pollution Control Board (GPCB).
The program was recognized as the Best Governance Initiative by the prestigious SKOCH awards in February 2022. The SKOCH Awards are one of the most prestigious governance awards in India given by an independent organization and based on a third-party assessment of projects and institutions working to improve India. Since its launch, Indian and international media have extensively reported about the Indian clean air markets. They have been quoted by the media close to 200 times resulting in outreach to millions of citizens in India and around the world. This includes all leading English, Hindi, Gujrati and Punjabi news houses. This pathbreaking initiative has also attracted attention from international publications like BBC, WSJ and Forbes, among others.
The pollution market is now expanding to other cities within Gujarat and beyond. For example, in June 2022, the Chief Minister of Gujarat announced a market in Ahmedabad that would include about 130 plants. The market is set to begin trading in the fall of 2022. The state of Punjab has also joined hands with EPIC researchers to start a market.
Building off the success and significant infrastructure of the pollution market, in May 2022, the state announced plans to launch a carbon market in Gujarat. The market would be the first of its kind among emerging economies, outside of China. It is set to be twice the size of the Regional Greenhouse Gas Initiative, a carbon market run by a collection of 10 states in the U.S. northeast and mid-Atlantic.
“The cap-and-trade market is a vital part of Gujarat’s climate strategy, and a vital part of our economic strategy. With the introduction of this carbon market, Gujarat is continuing its legacy of pioneering innovative policy solutions, leading the way for others to follow in India and throughout the world.”
– Gujarat Chief Minister Bhupendrabhai Patel