A Market-Based Environmental Policy Experiment in Chile

Abstract

We evaluate the performance of an environmental market in a less developed country based on the experience from Santiago-Chile's particulate matter control program. We find that grandfathering the permits has created economic incentives for incumbent sources to more readily declare their (historic) emissions in order to claim any permits. In addition, the market has not fully developed because of transaction costs, regulatory uncertainty and incomplete enforcement. Nonetheless, it has provided firms with flexibility to adapt to new market conditions. Our analysis of this particular experience indicates that market-based policies can provide important advantages over traditional command-and-control policies even under limited institutional capabilities.