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The globalization of the carbon market: Welfare and competitiveness effects of linking emissions trading schemes

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Abstract

In the light of the prevailing goal to keep global temperature increase below 2° and recent challenges to reach a global climate agreement in the near term, linking emissions trading schemes has emerged as a prominent complementing policy option. To this end, we explicitly assess (1) the macroeconomic welfare impacts and (2) the trade-based competitiveness effects of linking the European Union (EU) Emissions Trading Scheme in the year 2020. A stylized partial market analysis suggests that, independently of regional cost characteristics, the integration of emissions trading schemes (ETS) yields economic welfare gains for all participating regions. A computable general equilibrium analysis confirms these findings at the macroeconomic level: The economic efficiency losses from emissions regulation are diminished for both EU Member States and non-EU regions by linking ETS. However, the quantitative analysis suggests opposite trade-based incentives for linking up: while EU Member States improve their terms of trade by integrating with emerging ETS, non-EU linking candidates face competitiveness losses by linking. We conclude that, for non-EU regions, the attractiveness of linking ETS is a matter of priorities for economic welfare or international competitiveness. If these priorities are hierarchized in favor of welfare, the globalization of the carbon market could become a promising policy option complementing the efforts to reach a global climate agreement in 2015.

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Notes

  1. The issue of stability of international environmental agreements goes beyond the scope of our analysis. The game theoretical extension of integrated assessment models has been recently proposed by Eyckmans and Finus (2006).

  2. At the Vienna Climate Change Talks 2007, the Parties to the Kyoto Protocol officially recognized that preventing the threats of climate change would entail emission reductions in the range of 25–40 % below 1990 levels by industrialized countries (UNFCCC 2007b). As these talks had a rather indicative character for post-Kyoto climate policy, we assume less stringent and—from our perspective—more realistic effective reduction requirements for our analysis.

  3. The phenomenon of excess emissions permits (or Hot Air) arises when business as-usual emissions of a region are lower than the target emissions level committed to.

  4. Two limitations apply here: Due to lacking information for Bulgaria and Romania, for these countries we start from an allocation factor equal to one in the second trading period. Moreover, as for new EU Member States, the 30 % decrease of relative allowance allocation implies an emissions reduction of the covered sectors that is larger than the national reduction requirement, for this aggregate region a minimal allocation factor of 0.81 was chosen. We assess the role of allowance allocation in greater detail by a sensitivity analysis in Section 5.4

  5. We also abstract from Hot Air in the context of allowance allocation, as the allocation of excess permits would imply an indirect subsidy for Russian installations (the allocated permits could be directly exported to other ETS regions). It is not unambiguous if such an ETS design may prevail or even be linked to an EU scheme.

  6. The magnitude of transaction costs is consistent with recent estimations (Michaelowa and Jotzo 2005).

  7. Note that for the emissions trading schemes of all linking candidates, we assume an identical sectoral coverage to the EU ETS, as well as the regulation of CO2 as the only greenhouse gas.

  8. For a macroeconomic impact assessment of government CDM under the Kyoto Protocol see Anger et al. (2007).

  9. For comprehensive assessments of marginal abatement costs across OECD countries, see Klepper and Peterson (2006) or Criqui et al. (1999).

  10. Our cost-effectiveness analysis quantifies adjustment costs of environmental regulation as compared to an unconstrained business-as-usual situation. The deliberate neglect of economic benefits from controlling global warming implies that the macroeconomic effects resulting from the imposition of emissions constraints on the respective economies will necessarily be negative. Welfare changes are expressed by the Hicksian Equivalent Variation (HEV) measuring the change in real income which is necessary to make the economy under regulation as well off as under BaU.

  11. Here, the RCA indicator relates the ratio of a region’s exports in a specific sector over the region’s imports of this sector to the ratio of exports over imports in all sectors of this region. The RWS indicator relates the ratio of a region’s exports in a specific sector over the world’s exports in this sector to the ratio of a region’s exports in all sectors over the world’s total exports.

  12. Two limitations apply here: The EU-15 region is assigned a minimal allocation factor equal to 0.3 in order to keep the computational problem tractable. Moreover, the EU-12 allocation factor remains unchanged as compared to the original allocation, as it already implied that ETS sectors account for the entire national reduction requirement.

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Acknowledgments

Parts of this article were completed during a research visit of N. Anger at the Graduate School of Business, Columbia University, U.S.. The authors would like to thank Christoph Böhringer and Sabine Jokisch for valuable scientific advice as well as Ulrich Oberndorfer for helpful comments. Funding by the European Commission under the framework contract B2/ENTR/05/091-FC is gratefully acknowledged.

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Correspondence to Niels Anger.

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The views expressed in this paper are the authors’ alone and do not necessarily correspond to those of the International Atomic Energy Agency or the European Commission.

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Alexeeva, V., Anger, N. The globalization of the carbon market: Welfare and competitiveness effects of linking emissions trading schemes. Mitig Adapt Strateg Glob Change 21, 905–930 (2016). https://doi.org/10.1007/s11027-014-9631-y

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