Lessons for Theory and Practice
Edited by Michael Faure and Marjan Peeters
Onno Kuik and Frans Oosterhuis 1. INTRODUCTION Emissions trading has always been advocated by many economists as a more cost-effective instrument to reduce emissions in comparison with direct regulation. The basic idea, developed by Dales,1 is that a cap on total emissions, combined with free trading in emission allowances between polluters, ensures that pollution abatement will take place where it can be done at the lowest costs. In principle, therefore, emissions trading will always lead to net efficiency gains and have a positive impact on overall welfare, unless transaction costs are very high or serious market failures exist. Nevertheless, there has been much discussion about possible negative economic impacts of the EU ETS. Clearly, it was not the instrument of emissions trading itself that was expected to adversely affect industry’s production costs and competitiveness. What raised concern was the mere fact that restrictions were imposed on emitting CO2, whereas in the past this could be done freely, and whereas the global competitors as well as most sectors outside the large energy intensive industry were not confronted with such restrictions. This competitive advantage for industries outside the EU might lead to a shift of ‘carbon-intensive’ production to those countries, implying ‘carbon leakage’ with no net reduction of global CO2 emissions as a result. The (almost completely) free allocation of allowances in the first stages of the EU ETS has done much to make emissions trading an acceptable instrument to industry.2 Moreover, the private sector has discovered the inherent ‘business opportunity’...
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