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2006-10-01 | Discussion Paper

Output and Abatement Effects of Allocation Readjustment in Permit Trade

Sterner, Thomas and Adrian Muller. 2006. “Output and Abatement Effects of Allocation Readjustment in Permit Trade” RFF Discussion paper 06-49
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In permit trading systems, free initial allocation is common practice. A recent example is the European Union Greenhouse Gas Emission Trading Scheme (EU-ETS).

We investigate effects of different free allocation schemes on incentives and identify significant perverse effects on abatement and output employing a simple multi-period model. Firms have incentives for strategic action if allocation in one period depends on their actions in previous ones and thus can be influenced by them. These findings play a major role where trading schemes become increasingly popular as environmental or resource use policy instruments. This is of particular relevance in the EU-ETS, where the current period is a trial-period before the first commitment period of the Kyoto protocol. Finally, this paper fills a gap in the literature by establishing a consistent terminology for initial allocation.

Co-author:

Adrian Muller