Emission trading systems and the optimal technology mix

Cap and trade mechanisms enjoy increasing importance in environmental legislations worldwide. One of the important aspects of designing cap and trade mechanisms is the possibility of authorities to grant emission permits for free. Unlike analyzed in the seminal contributions on cap and trade systems, in reality free allocations are not made lump sum, but are updated contingent on firms’ actions, i.e., contingent on production decisions and contingent on facilities entering the market or retiring (see IEA, https://www.oecd-ilibrary.org/content/publication/b7d0842b-en, 2020). As it has already been shown in the literature, such updating yields distorted production decisions of firms (see e.g., Böhringer and Lange in Eur Econ Rev 49(8):2041–2055, 2005, Mackenzie et al. in Environ Resour Econ 39(3):265–282, 2008, or Damon et al. in Rev Environ Econ Policy 13(1):23–42, 2019). The impact of updating on firms’ investment and retiring decisions and the resulting technology mix has received much less attention up to now, however. It is the purpose of the present article to shed light on this aspect and to study the impact of a cap and trade mechanism not only on firms’ output decisions, but also on their investment incentives in different technologies and to analyze the optimal design of emission trading systems in such an environment.

Focusing climate negotiations on a uniform common commitment can promote cooperation

International cooperation on the reduction of greenhouse gas emissions, disarmament, or free trade needs to be negotiated. The success of such negotiations depends on how they are designed. In the context of international climate change policy, it has been proposed [e.g., M. L. Weitzman J. Assoc. Environ. Resour. Econ. 1, 29–49 (2014)] that shifting the negotiation focus to a uniform common commitment (such as a uniform minimum carbon price) would lead to more ambitious cooperation. Yet, a proof-of-concept for this important claim is lacking. Based on game theoretical analyses, we present experimental evidence that strongly supports this conjecture. In our study, human subjects negotiate contributions to a public good. Subjects differ in their benefits and costs of cooperation. Participation in the negotiations and all commitments are voluntary. We consider treatments in which agreements are enforceable, and treatments in which they have to be self-enforcing. In both situations, negotiating a uniform common commitment is more successful in promoting cooperation than negotiating individual commitments (as in the Paris Agreement) and complex common commitments that tailor the commitment to the specific situation of each party (as attempted with the Kyoto Protocol). Furthermore, as suggested by our model, a uniform common commitment benefits most from being enforced.