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What Is the Cap and Trade Approach?

Cap and trade is an approach to reducing greenhouse gases and similar pollutants.
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  • Written By: Jason C. Chavis
  • Edited By: Bronwyn Harris
  • Last Modified Date: 26 June 2014
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Cap and trade is a pollution control system in which economic benefits are established in an effort to limit the emission of greenhouse gases and other pollutants. A government body or some other authority sets a limitation on the amount of pollution certain regions or businesses can emit. Each of these groups are issued credits equaling the amount of pollution acceptable by law. If an organization is able to reduce its pollution level, it can transfer the credits to other companies which have not, usually for a financial incentive. In this way, a cap and trade system creates a marketplace for pollution, benefiting those groups better able to reduce emissions, while financially penalizing those that cannot.

The theory behind the emissions cap and trade approach is designed to limit the impact of greenhouse gases on the planet, while preventing excessive investment from the public sector. Instead, nearly all cost is transferred to the private sector in the reward structure. This approach also acts as a free market option within society, creating a marketplace for pollution credits. Essentially, it creates a financial system out of the global problem of potential climate change.

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A number of countries around the world have established different programs and markets for the cap and trade objectives. The most important international treaty ratified for this purpose is the 1997 Kyoto Protocol. A majority of the major industrialized nations signed onto the treaty, establishing quotas and a system of emission credits. One notable exception to this is the United States, which failed to ratify the Kyoto Protocol.

Many different systems of cap and trade exist throughout the world. Australia and New Zealand have two of the most advanced systems, while the European Union has established a marketplace throughout its member states that allows trading of credits across borders. Various states in the US have also taken part in the creation of credit-based systems. Each of these different platforms enable trading to occur across individual marketplaces, creating a system geared towards the free market approach. Essentially, this creates an opportunity for nations with the most advanced progress to benefit from selling and trading emission credits to nations with less success at reducing pollution emissions.

By far, the largest market for emission credits are those geared towards carbon dioxide production. Since global warming is highly linked to the release of carbon dioxide, these credits have become the most highly valued worldwide. The World Bank has confirmed that the cap and trade system of carbon credits has the potential to be worth hundreds of billions of US Dollars worldwide. One challenge behind the global cap and trade system, however, is the fact that certain countries have an easier time mitigating carbon production. For example, China can limit its carbon footprint at a lower cost than the United Kingdom, meaning the country can profit from selling carbon credits at a higher rate than other nations.

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