The conventional approach to environmental problems characterizes them as externalities that result from market failure. So conceived, these failures require governmental intervention, which historically has been through regulation.

This paradigm has produced some gains, particularly with the first generation of environmental regulations, but the approach also has limits. Regulatory strategies generally require centralizing information and developing rules or requirements that govern a broad range of private activities. They are thus subject to the same sorts of failings as economic central planning—only more so, given the added complexity of environmental concerns. These failings are exacerbated by the scale and scope of a problem like climate change. The knowledge problem (i.e., regulators can’t foresee all the consequences of their interventions), administrative transaction costs, and limits on regulatory throughput capacity all hamper the use of traditional regulatory tools to address the problem of climate change.

But what if the problem is not market failure, but a failure to have markets? If environmental problems are greatest where market institutions are least present and protected, then the answer may be to expand and enhance such institutions rather than to regulate and constrain them.

The Conventional Paradigm

The conventional way of conceiving environmental problems is that they are the result of various market failures. Many economic costs and benefits of economic activity are internalized into the prices considered in any given transaction, but some environmental effects are not. These effects are externalized (hence the moniker “externalities”) and are not considered by market actors making decisions.

Much environmental law and regulation is justified as an effort to internalize these sorts of externalities. Thus, we get regulations that mandate or prohibit the use of particular technologies, place limits on how much firms may emit, or require investments in offsetting activities.

Overwhelming conventional regulation / The conventional approach may be fairly workable when there is a discrete number of firms emitting a discrete number of pollutants from a discrete number of sources. Relatively blunt or inefficient measures may still be sufficient to capture low-hanging fruit. Thus, the initial air pollution and water pollution controls embodied in the Clean Air Act (CAA) and Clean Water Act produced some significant gains (even if those laws were less responsible for late 20th century environmental progress than many assume). But as these relatively easy environmental problems have been solved, the difficulty of using traditional regulatory strategies has increased. For instance, it has been much easier to control point source water pollution (e.g., discharge from a factory or sewer plant) than nonpoint source pollution such as runoff from streets, buildings, and agricultural production. As the low-hanging fruit has been picked, the environmental challenges that remain often defy easy administrative fixes.

Though some may be satisfied with the traditional approach to environmental problems as applied to traditional pollutants, attempting to apply this model to climate change—and the emission of greenhouse gases in particular—threatens to take these approaches past the breaking point. Indeed, that has been the experience with trying to use the nation’s most comprehensive environmental law, the CAA, as a means of greenhouse gas emissions control. Some aspects of the CAA’s regulatory scheme that target specific sectors of the economy may work tolerably well for greenhouse gas emission control, such as the provisions concerning emissions from automobiles and other mobile sources; however, the aggressive effort by the US Environmental Protection Agency (EPA) during the Obama and Biden administrations to use the CAA as a greenhouse gas emission control system was destined for failure.

One reason it is difficult to use the CAA as a means of addressing climate change is that the core of the act focuses on ensuring that ambient air quality in metropolitan areas meets federal air quality standards. Under these provisions, the EPA sets National Ambient Air Quality Standards (NAAQS) for criteria air pollutants. States are then required to develop implementation plans for the achievement of these standards within their borders. This approach is appropriate for traditional air pollutants for which it makes sense to talk about ambient concentrations in a particular area where such concentrations may affect the health of local inhabitants. Yet, this approach is fundamentally incompatible with the control of pollutants that are dispersed throughout the global atmosphere and for which it makes no sense to speak of local or ambient concentrations.

The source-specific regulatory provisions of the CAA are an even poorer fit for the control of greenhouse gas concentrations. These emissions—carbon dioxide in particular—are not emitted from a relatively discrete number of sources in easily measurable and monitorable amounts. Carbon dioxide emissions are, instead, a ubiquitous byproduct of modern civilization. Thus, when the EPA began considering how to apply the CAA to greenhouse gas emissions, it soon discovered that its stationary source programs would be overwhelmed by an explosion of permitting applications. Applying the act’s express statutory thresholds that trigger permitting requirements to greenhouse gases would have increased the universe of regulated facilities—and the number of permits that the EPA and state agencies would have to process—more than 100-fold.

Specifically, the EPA estimated that the number of facilities required to submit applications under the Prevention of Significant Deterioration program each year would increase from 280 to over 40,000, while the number of facilities subject to Title V permitting requirements would increase from approximately 15,000 to six million. The resulting influx of permit applications, the EPA concluded, would “paralyze” and “overwhelm permitting authorities’ administrative resources.” Purely to account for the costs and staffing requirements for regulatory agencies would cost over $15 billion. To address this problem, the EPA proposed rewriting the act’s requirements through regulation, but the Supreme Court concluded the EPA lacked any such authority under the text of the act.

Relying upon other provisions of the CAA does not provide a clearer path to stabilizing US concentrations of greenhouse gases. Under Section 111, the EPA can adopt “standards of performance” for various source categories of regulated pollutants, including greenhouse gases. But using this approach requires the EPA to go through the full rulemaking process for each source category it seeks to regulate. So, while the EPA could potentially achieve significant emission reductions from the power sector, it would have to repeat the full rulemaking process for each category of stationary source emissions over a period of many years, each of which would represent a shrinking slice of the nation’s overall emissions. Whatever is done with the energy sector, there are other sources of emissions that are unlikely to be reduced without substantial technological innovation, including aviation, cement production, and agriculture. Drafting and promulgating regulations governing each sector would take months (if not years) and each would be subject to legal challenge and judicial review, and not every significant source of emissions would even be subject to CAA regulation, as Section 111 only provides for regulation of source categories that contribute “significantly” to a given pollution problem.

The problem is not merely with the CAA, but with the underlying enterprise of trying to use regulations to control emissions of a substance that is so ubiquitous. Adopting legislation expressly authorizing the EPA to adopt greenhouse gas regulations would help protect resulting rules from some legal challenges, but it would not do much to reduce the daunting administrative task of proposing and promulgating the myriad regulations that would be required. The so-called CLEAN Future Act, for example, would have required the EPA and other federal agencies to adopt dozens of new regulations within the first two years after its enactment. Earlier climate legislation passed by the House during the Obama administration (but never passed by the Senate) would have required as many as 150 rulemakings to implement. It is fanciful to think the EPA would be able to fulfill such ambitions, as it is rare for the EPA to issue more than 10 major regulations in a year across all its program areas. Indeed, the EPA has only issued more than 10 major regulations in a single year twice in the 21st century: 11 in 2023 and 24 in 2024.

Requiring technological innovation / The challenge of climate change is not merely controlling emissions from discrete sources. Decarbonizing the economy—both in the United States and abroad—requires unleashing dramatic technological innovation. “Complete decarbonization of the global economy by 2050 is now conceivable only at the cost of unthinkable global economic retreat, or as a result of extraordinarily rapid transformations relying on near-miraculous technical advances,” warns energy analyst Vaclav Smil (2022). Yet, regulatory mandates are a poor means of spurring technological innovation generally, let alone fostering industrial transformations. Central planners cannot dictate when, where, or how innovation will occur. Where industrial transformations have occurred, they have been driven by market pressures, not dictated by government fiat.

Using traditional regulatory tools to drive technological innovation requires detailed knowledge about the desired course of technological change and what sorts of innovations are likely or foreseeable. Yet government regulators rarely have the necessary information or foresight to drive innovation this way. As Arrow et al. (2009) observe, “Regulators can find it difficult to obtain information about the status of technologies that is accurate enough to allow them to set standards that both can be achieved and will induce real innovation.” Even if regulators were to identify a proper target initially, the regulatory process changes so slowly that regulatory standards would be unlikely to keep up with technological change or account for new information.

It is one thing for the government to require (or subsidize) the adoption of a new technology to force its diffusion throughout an industry, but quite another to mandate production or pollution improvements that have yet to be achieved. This has been as true with regulatory efforts to spur innovation along a certain path as it has been with traditional research subsidies, and for the same reasons: Government officials, even those with the benefit of specialized technical knowledge, lack the foresight necessary to predict technological progress and the future path of innovation.

There is little empirical evidence that regulations are a reliable method of encouraging technological innovation, particularly revolutionary breakthroughs of the sort necessary to address climate change. Regulations are more suited to incremental technological change and the diffusion or deployment of preexisting innovations than they are to fostering invention and innovation in the first place. The CAA’s acid rain program, for instance, is widely credited with achieving substantial pollution reductions at a relatively low cost, yet it does not appear to have spurred much invention. While California is often heralded for its leading role in developing vehicle emission standards, its 1990s effort to induce the development of zero-emission vehicles was a failure.

Not only is regulation a poor means of fostering discovery and innovation, but it can even get in the way, blocking cleaner technologies and discouraging their development. If a regulation embraces a given technological approach, there is little incentive to develop alternatives or improve upon the technology. Even performance-based standards can discourage innovation because such standards may be based upon established reference technologies to facilitate implementation and enforcement. By increasing the costs of modifying and enhancing existing industrial facilities and of replacing older, dirtier technologies with newer, cleaner ones, regulatory mandates may work at cross-purposes with the goal of developing less-polluting and less-energy-intensive means of production.

The Market Liberal Paradigm

The conventional regulatory approach to environmental protection is particularly unsuited to addressing the problem of climate change. Centralized regulatory authorities lack the information and capacity to address the numerous sources of and contributors to greenhouse gas emissions. And prescriptive regulations are unlikely to encourage anywhere near the degree of technological innovation necessary to decarbonize the United States, let alone the world. What, then, is the alternative?

The market liberal paradigm starts with the observation that markets facilitate the discovery and transmission of human needs and wants through prices. This incentivizes efforts to meet such demands through the reallocation of resources and the development of new technologies or techniques.

Through the creation and dissemination of information and the resulting economic incentives, markets create economic pressure for more efficient resource use, encourage technological and institutional innovations that reduce the adverse consequences of productive activity, and create incentives for firms to satisfy the environmental preferences of individuals—preferences that appear to increase as people become wealthier.

Both economic growth rates and key measures of environmental quality are greater in countries where property rights are protected. Greater protection of property rights not only fosters economic growth and the accumulation of wealth necessary for much environmental progress, but it also has been found to correlate with a decline in deforestation and enhanced access to safe drinking water and sanitation services.

If markets have not fully facilitated the achievement of environmental outcomes, the problem may not be in market institutions as such, but in the failure to extend such institutions to incorporate environmental resources and values. From this perspective, the role of government is not to identify and address each and every environmental effect of productive activity, but to provide and preserve the underlying institutional framework that protects the persons and property of individuals while extending such institutions to allow people to pursue and advance environmental values.

As a general rule, where resources and environmental values are incorporated into market institutions through property rights and voluntary exchange is protected by the rule of law, those resources tend to be better protected and are more likely to be utilized in a sustainable fashion. For example, privately owned forests exhibit higher rates of forest growth and tree planting than those managed by government agencies. Similarly, private oyster beds tend to be healthier and more productive than their publicly managed counterparts. There have also been economic and ecological gains from the development of markets in water through the recognition of transferable property rights and the adoption of market pricing.

Perhaps the clearest evidence for the value of creating property rights in ecological resources comes from marine fisheries, where the adoption of property-based management has been shown to enhance sustainability. The creation of property-based management systems encourages greater stewardship among fishery participants, including efforts to maintain and enforce sustainable limits on the total catch. Property rights have made fisheries more sustainable, even as population growth and economic development have increased demand for fish.

Property-based reforms have not been as widely successful at controlling pollution. In theory, the allocation and enforcement of property rights should fully internalize any potential externalities; however, the ubiquity of transaction costs makes this more of an aspiration than a reality. While there are examples illustrating how well-defined and well-defended property rights could constrain polluting activity, it is not a principle that can be applied universally. Empirical research suggests that where property rights are poorly defined or enforced, an increase in property rights protection can increase the pressure to dispose of wastes in unowned environmental commons. Thus, increases in the security of property rights in land can correlate with increases in air pollution. Market pressure for more efficient resource use contributed to pollution decline, but it is more difficult to attribute water and air quality improvements to the operation of property rights and markets.

Dematerialization / While there are few examples of broad property-based pollution control regimes, markets may tend to reduce environmental effects by pressuring to increase efficiency. In the simplest of terms, market competition creates pressure for firms and individuals to minimize costs while maximizing output—that is, to do more with less. Firms pay for the resources they consume and (where markets are robust and complete) for disposing of those resources they fail to use. This creates incentive to economize on all fronts. Over time, such pressures have led to a consistent decline in the material and energy inputs required for a unit of economic output. Such gains come not only from increases in productive efficiency, but also from the discovery of new resources and the substitution of scarce resources with more readily available alternatives.

These market pressures have helped produce what may be the most important (and least heralded) environmental trend of the 21st century: dematerialization. Resource consumption is being decoupled from economic growth such that as mature, market-oriented economies grow, they not only use fewer resources per unit of output, but they also consume fewer resources overall, year over year. Consumption of all but six (diatomite, industrial garnet, gemstones, salt, silver, and vanadium) of the 72 resources tracked by the US Geological Survey is declining, even as the economy continues to grow.

Consider that the first aluminum beer cans, introduced in the 1950s, weighed 85 grams. By 2011, the average can weighed less than 13 grams, meaning the metal that once was used for a single can now yields seven. Cans today are not only thinner and lighter, they are produced more efficiently, with fewer separate sheets of metal. Such changes were driven by the simple desire to discover ways to do more with less (and thus at less cost) in a competitive market.

Substitution can be an even more powerful source of dematerialization. Consider telecommunications. A single fiber optic cable made from less than 150 pounds of silica can carry the same volume of information as multiple one-ton copper cables. This reduction not only represents dramatic dematerialization, it also reduces other environmental impacts because obtaining the sand necessary for fiber optics is far less energy intensive and environmentally disruptive than mining and smelting copper. And the dematerialization of telecommunications did not stop there. Satellite and wireless technologies enable us to bypass the use of physical cables altogether. We can communicate more and yet use vastly less material to do so. This not only saves copper, but other resources, too. Think of all the paper saved by e‑mail, e‑banking, e‑readers, and smart phones. The point is not that these new technologies do not require resources or impose environmental costs; they do. The point is that these technological changes, driven by competitive pressures in a relatively free market, have led to dramatic dematerialization and a lessening of the associated environmental effects of meeting the world’s telecommunication needs.

What the world has experienced (and is still experiencing) in the telecommunications sector is the sort of transformation needed in the energy sector: a dramatic reduction in the consumption of material inputs—in this case, carbon—and the associated environmental effects. Robust market institutions, not regulatory mandates, are what make this sort of transition possible. No government agency decreed that copper wire would be replaced by fiber optics or that fiber optics would in turn be replaced by wireless transmission. The challenge is to identify where market institutions are incomplete, where existing incentives are inadequate, and adopt appropriate remedial measures.

Climate Liberalism

Dematerialization provides a roadmap for decarbonization. By more fully incorporating carbon into the market to ensure that those who consume carbon-based fuels and use portions of the atmosphere for carbon disposal must bear those costs, it is possible to replicate the same sorts of incentives that have produced dematerialization. If such incentives are insufficient, they can be further supplemented with technology-inducement prizes for low-carbon technologies and the use of procurement policies to facilitate market-driven deployment of decarbonizing technologies. But such market-driven innovation and deployment can only happen if markets are allowed to operate—if they are sufficiently unregulated in the relevant spaces so that innovators, entrepreneurs, and others can develop and deploy decarbonizing technologies.

Decarbonization lags behind dematerialization because users of carbon-based fuels do not pay to dispose of the carbon they emit. It is tremendously expensive, given current technologies, for firms to collect and sequester the carbon dioxide generated by the combustion of fossil fuels. Emitting carbon dioxide into the global atmosphere, on the other hand, is free. Because the atmosphere is unowned, emitters need not compensate anyone for their emissions. The global atmosphere is the ultimate open-access commons.

Creating greater incentives to decarbonize, without erecting barriers to innovation or technological deployment, could be achieved through the imposition of a carbon tax. Such a tax could be conceptualized as a fee for using the common atmosphere for carbon disposal or even as an effort to “internalize” the “externalities” of greenhouse gas emissions. However it is conceptualized, placing a fee on the emission of carbon dioxide would make existing energy markets compete more in ways that would encourage greater conservation and innovation than do existing regulatory alternatives.

While carbon taxes are often unpopular, existing evidence suggests they are more effective at driving down carbon emissions than other policies. One reason for this is that, unlike proscriptive regulations, carbon taxes create an incentive without creating specific requirements for how the incentive is addressed. Taxes increase the price of the taxed item, generating economic pressure to reduce consumption, but the taxes do not dictate the margin on which such reductions occur. Thus, the imposition of such a tax may encourage energy conservation or efficiency enhancements within firms. Taxes also can induce other changes, such as fuel switching or the restructuring of industrial processes. Indeed, the imposition of a tax places no limit on the ways in which its costs can be avoided, leaving firms and individuals free to innovate ways of doing more with less. Carbon taxes are also easier to implement than regulatory alternatives and are less vulnerable to legal challenge.

What about cap-and-trade? / In theory, there is not much difference between a pollution tax and a tradable emission credit regime. A supply limitation can operate as a tax, and vice versa.

In practice, however, the two programs are not equivalent. Among other things, policy makers lack the necessary information to know what tax level would be equivalent to what supply constraint, but this is hardly the only difference. Another meaningful difference is that implementation of a cap-and-trade regime requires many more decisions about regulatory design than a tax regime, and each decision presents the opportunity for rent-seeking behavior. For these reasons (among others), a carbon tax is easier to implement and administer. It is also possible to offset the costs of such a tax by rebating revenues on a per-capita basis, effectively shifting the tax burden away from income and wealth generation and onto consumption.

Is a carbon tax practical? / Given political constraints, it is unlikely a carbon tax would be adopted that fully captures all the costs associated with greenhouse gas emissions. There also are serious questions about the “proper” level of a tax. Tol (2024), a literature review of estimates of an appropriate carbon tax, found they range from –$355 a ton of emissions to +$587, with a weighted average of +$59. Tol noted there are reasons to suspect many of the surveyed studies underestimate the potential costs of climate change and that such estimates can mask the unequal distribution of climate change’s effects.

Even a properly calculated tax might not create sufficient incentives for the development of decarbonizing technologies and other innovations. One policy that could help fill this gap would be the creation of technology inducement prizes to reward the invention and development of needed technological breakthroughs. One reason prizes would be superior to traditional research and development grants is that they do not seek to predict which experiments, theories, or prototypes will lead to desirable innovation, and thus they do not depend upon centralized knowledge or effective prognostication. Rather, like markets themselves, they reward those who come up with previously undiscovered ways of meeting identified wants—in this case, the wants specified in the prize parameters. As such, they seek to capitalize and augment market dynamics, and they recognize the nature of breakthrough innovation is that it is unanticipated or unplanned. In effect, government-funded prizes of this sort can be understood as efforts to subsidize the production of public goods through market processes rather than through direct government provision.

While a carbon tax and technology inducement prizes could spur needed decarbonizing innovations, even the most miraculous breakthroughs will do little to address climate change if they cannot be deployed. For this reason, it is also important to unshackle constraints on markets that inhibit the development and deployment of these technologies. One reason that the market forces driving dematerialization have been so powerful and effective is that much of the relevant innovation is not constrained by prescriptive regulations and permitting requirements. Many energy technologies, on the other hand, are mired in regulatory constraints that delay deployment, inhibit investment, and discourage the development of needed technologies. Promising projects, such as a proposed wind energy facility on Lake Erie, are left stillborn. Something as straight-forward and essential as permitting the transmission lines necessary for low-carbon power sources to be utilized can take a decade. No less important, the prospects of delay—and the resulting uncertainty about whether investments will ever generate a return—discourage some projects from even starting. Thus, permitting reform and other measures designed to unleash market forces that can drive decarbonization are a necessary part of unleashing innovation in the energy sector and meeting climate goals.

While the bulk of this essay has focused on mitigation, climate adaptation measures will be important, too. Here, again, markets have much to offer. Where private markets can respond to observed and projected changes caused by climate change, they will do so more effectively and efficiently than centralized administrative agencies. In the case of water, for example, facilitating water reallocation through markets and water conservation through market pricing will do more to address the dynamic changes wrought by climate change than administrative planning or infrastructure construction.

It is also important that government policies not inhibit the transmission of accurate market signals about climate change threats and effects. Subsidies to development in coastal areas, for instance, discourage market responses to the threat of increased coastal damage from hurricanes and tropical storms. Regulations on the development and use of various risk instruments can inhibit proper risk management. Limitations on liability for identifiable contributions to climate change risks inhibit the proper market responses to tort liability. Limitations on such litigation will also impair efforts to identify and defend property interests that are potentially harmed by climate change. Climate attribution is difficult, but one way it will get better will be through allowing entrepreneurial plaintiffs lawyers to experiment and innovate and invest in improvements in attribution.

Conclusion

Stabilizing atmospheric concentrations of greenhouse gases as a means of addressing climate change is a daunting challenge. It is a challenge for which the conventional approach to environmental regulation is unfit.

Wholesale decarbonization requires revolutionary changes through the economy and the development of technologies and innovations that can be deployed throughout the world. This is not something that can be mandated or planned, nor is it something that will happen without policies designed to take advantage of dynamic market processes and their potential to drive transformational change. As Smil cautions:

We are a fossil-fueled civilization whose technical and scientific advances, quality of life, and prosperity rest on the combustion of huge quantities of fossil carbon, and we cannot simply walk away from this critical determinant of our fortunes in a few decades, never mind years.

Only a wholesale rethinking of our approach to environmental protection that accounts for the power of market institutions to induce change will be sufficient to get things right.

Readings

• Adler, Jonathan H., 2008, “Warming Up to Water Markets,” Regulation31(4): 14–18.
• Adler, Jonathan H., 2009, “Taking Property Rights Seriously: The Case of Climate Change,” Social Philosophy & Policy 26(2): 296–316.
• Adler, Jonathan H., 2011, “Eyes on a Climate Prize: Rewarding Energy Innovation to Achieve Climate Stabilization,” Harvard Environmental Law Review 35(1): 1– 47.
• Adler, Jonathan H., 2012, “Is the Common Law a Free-Market Solution to Pollution?” Critical Review 24(1): 61–85.
• Adler, Jonathan H., 2021, “The Legal and Administrative Risks of Climate Regulation,” Environmental Law Reporter 51: 10485.
• Adler, Jonathan H., 2023, Climate Liberalism: Perspectives on Liberty, Property and Pollution, Palgrave Studies in Classical Liberalism, Springer Nature.
• Adler, Jonathan H., and Nathaniel Stewart, 2014, “Learning How to Fish,” Regulation37(1): 46–51.
• Anderson, Terry L., 2021, Adapt and Be Adept: Market Responses to Climate Change, Hoover Institute.
• Arrow, Kenneth, et al., 2009, “A Statement on the Appropriate Role for Research and Development in Climate Policy,” Economists’ Voice, February.
• Hsu, Shi-Ling, 2021, Capitalism and the Environment: A Proposal to Save the Planet, Cambridge University Press.
• Hsu, Shi-Ling, 2020, “Prices Versus Quantities,” in Policy Instruments in Environmental Law, Kenneth R. Richards and Josephine van Zeben (eds.), Edward Elgar.
• Kahn, Matthew, 2021, Adapting to Climate Change: Markets and the Management of an Uncertain Future, Yale University Press.
• Kemp, David, 2025, “Did Climate Change Do That?” Regulation48(2): 26–32.
• Kerekes, Carrie B., 2011, “Property Rights and Environmental Quality: A Cross-Country Survey,” Cato Journal 31(2): 315–338.
• McAfee, Andrew, 2019, More from Less: The Surprising Story of How We Learned to Prosper Using Fewer Resources—and What Happens Next, Scribner.
• Smil, Vaclav, 2022, How the World Really Works: The Science Behind How We Got Here and Where We’re Going, Viking.
• Smith, Fred L. Jr., 1992, “A Free Market Environmental Program,” Cato Journal 11(3): 457–475.
• Tol, Richard S.J., 2024, “A Meta-Analysis of the Total Economic Impact of Climate Change,” Energy Policy 185.
• Van Doren, Peter, 2024, “The West Needs Water Markets, but Achieving That Is Tough,” in The War on Prices, Ryan Bourne (ed.), Cato Institute.