Pricing Pollution

How much is clean air worth? That's a question Richard Sandor, founder of the Chicago Climate Exchange (CCX), thinks the free market can answer best. The exchange , which started trading on Earth Day in April 2003 , takes aim at global warming by allowing members to trade credits earned for reducing their greenhouse-gas emissions. Sandor, an economist, is no stranger to novel—and controversial—financial products. In the 1970s, he developed the financial futures market on the Chicago Board of Trade to take advantage of newly deregulated interest rates. In the early 1990s, Sandor proposed a "cap and trade" system to reduce the pollutants that caused acid rain. Companies able to exceed reduction targets set by the 1990 Clean Air Act could sell emission credits to those who didn't, creating cost incentives for clean technology and leading to an overall decline in emissions years ahead of schedule.

The Chicago Climate Exchange is based on a similar principle. Members agree to cut their emissions by a certain target. If they exceed the target, they can sell their credits on the exchange. If they fail, they buy credits. Although CCX is a purely voluntary system, since the United States is not a signatory to the 1997 Kyoto protocol, Sandor anticipates that the U.S. will soon enact a cap—or overall limit—on greenhouse-gas emissions, which scientists say are a major cause of global warming. Already, several Fortune 500 companies, including Ford, Dupont and Motorola have joined CCX, along with cities, utility companies and major energy consumers such as universities, all trying to position themselves for a "carbon-constrained" future. Sandor spoke with NEWSWEEK's Karen Breslau about the birth of the climate exchange. Excerpts:

Sandor: 'If you align financial incentives with social objectives, you create value'

NEWSWEEK: How does the market work?

Richard Sandor: The job of the Chicago Climate Exchange is to put a price on a scare resource like air or water, that was previously unpriced. The way you do it is to set a cap; the idea is create scarcity. Clean air is scarce. It can't be like a buffet, the great American barbeque, where you get all you can eat. It has to be priced accordingly.

How can you, or anyone—or any market—put a price on air and water?