Complementarity of inspections and permits as leverages for capping emissions: experimental evidence

Abstract

Recent analysis on the cost-effectiveness of inducing perfect compliance in cap and trade programs is based on the possibility that a regulator has of inducing each individual firm to emit the same level of pollution by altering the supply of permits and the monitoring probability according to theoretical models that assume rational and risk-neutral agents. In this paper we test this possibility based on a series of laboratory experiments. Contrary to what theory predicts, our experiments suggest that a regulator cannot manipulate the supply of permits and the monitoring probability as suggested by these models and keep the level of emissions of each individual firm constant. This result does not depend on whether or not we control for risk aversion. Policy implications are discussed.