Permits would ensure that emissions do not exceed a given level. They are not as good as carbon taxes, however, at guaranteeing that the costs of abatement will be neither too large nor too small. So in choosing between the two main market-oriented approaches of tradable entitlements and carbon taxes , a government must decide whether it is more important to be certain of the quantity of reduced emissions or of the costs involved.
Tradable permits are already being used to address several other environmental problems. For example, the US regulates chlorofluorocarbons (CFCs) with tradable emissions entitlements, and it is introducing a similar system to limit emissions of pollutants that cause acid rain. The 1987 Montreal Protocol on Substances that Deplete the Ozone Layer also includes provisions for the international trading of emissions permits, although no such trades have yet taken place.
To be successful, a permit scheme would have to be carefully designed. If the rules governing trading are complex, or if the market for permits consists of only a few players, trading may not be efficient. This will also be true if trading involves substantial transaction costs. On the other hand, even an inefficient permits system may be a more cost-efficient way to reduce emissions than using most forms of regulatory control.
If implemented internationally, tradable permits could lead to resource transfers from rich countries to poor ones. International trading could take place between governments as well as between firms. But before trading could begin, governments would have to agree on how to make the initial allocation of permits. One proposal calls for allocating entitlements on an equal per-capita basis.1 Such an allocation would guarantee resource transfers from the North to the South because, having fewer greenhouse gas emissions per capita than do industrialized ones, developing countries would be net sellers of permits, while rich countries would be net buyers. However, it is highly unlikely that such an allocation would be acceptable to the rich countries. They would probably prefer to have no agreement at all than to make such large transfers.
To win broad acceptance, an international scheme for tradable permits could not allocate quotas on a simple per-capita basis. The problem is that OECD countries have high per-capita emissions, the developing countries have low per-capita emissions, and the former Communist countries are somewhere in between. An allocation based on population would be attractive to developing countries, but probably unacceptable to OECD countries because it would require them to make huge transfers to poor countries (assuming that the agreed goal was to reduce global emissions on a large scale). Allocating entitlements according to a slightly more complex formula could reduce these transfers and ensure that every party to the agreement is better off than it would be without the agreement. Agreement would be far more likely if the entitlements were initially allocated according to a formula that reflected the different circumstances of these country groups. For example, the OECD could receive somewhat fewer permits than would be required for current emissions levels, and the poor countries a slight surplus, with the total quantity of entitlements being somewhat below current global emission levels. One study estimates that such an allocation would lower resource transfers to a fraction of current overseas development assistance.2
International tradable permits could be effective even if implemented on a small scale. Economists analysing schemes for emissions permits have usually focused on international agreements for making large-scale reductions in global greenhouse gas emissions. But trading may also be effective in more limited circumstances. For example, a country facing high abatement costs may meet its own national target for emissions reduction by providing incentives for other countries with low abatement costs to undertake abatement on its behalf. Such bilateral agreements (known as "offsets") may involve relatively high transactions costs, but their small scale may make them easier to negotiate and implement, at least in the short run.
For further reading:
S. Barrett (1991), "Economic Instruments for Climate Change Policy," in OECD, Responding to Climate Change: Selected Economic Issues, Paris: OECD.
S. Barrett (1991), "ÎAcceptableâ Allocations of Tradable Carbon Emission Entitlements in a Global Warming Treaty," United Nations Conference on Trade and Development, Geneva.
M. Grubb (1989), The Greenhouse Effect: Negotiating Targets, London: Royal Institute for International Affairs.
Notes:
1 Grubb (1989).
2. S.Barrett (1991), "Transfers and the Gains From Trading Carbon Emission Entitlements in a Global Warming Treaty," UNCTAD, Geneva.