Pollution permits and environmental innovation

Jean Jacques Laffont, Jean Tirole*

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

109 Scopus citations


This paper starts with a warning about the negative impact of plain pollution allowance markets on environmental pollution innovation. Stand-alone spot markets enable the government to expropriate an innovation by offering a competing 'technology' (pollution permits) that puts an arbitrary downward pressure on the licensing price. Advance allowances reduce expropriation but still create suboptimal incentives for innovation. They have the further drawback that permits are inefficiently used when the innovation occurs. Options to pollute at a given striking price fare better than allowances because they create private incentives to phase out pollution in the case of innovation. We characterize the social optimum and show that it can be implemented by issuing options to pollute, inter alia. Finally, the paper compares ex ante and ex post government procurement. Surprisingly, ex post licensing by the innovator to the government may yield a higher licensing fee than an ex ante contract.

Original languageEnglish (US)
Pages (from-to)127-140
Number of pages14
JournalJournal of Public Economics
Issue number1-2
StatePublished - Oct 1996
Externally publishedYes


  • Asymmetric information
  • Environment
  • Innovation
  • Regulation

ASJC Scopus subject areas

  • Finance
  • Economics and Econometrics


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