A Note on International Emissions Trading with Endogenous Allowance Choices

In this note we extend the analysis developed by Helm (2003) and consider an international emissions trading system (ETS) where the initial allocation of tradeable permits may be chosen non cooperatively, as in Helm, or cooperatively. We first derive conditions guaranteeing that polluting firms located in a given country benefit from an increase in the received amount of emission permits; then, we compare the countries' allocation choices under both a non-cooperative (decentralized) and a cooperative (centralized) regime, showing that, both in each country and on aggregate, decentralization leads to a lower environmental quality than the "first best" that would arise under a centralized ETS. As a result, the equilibrium permits price in the latter case is higher than under decentralization. We show that this conclusions do not depend only on the presence of transboundary pollution, but also on the international dimension of emissions trading. Finally, although centralization leads to higher welfare and better environmental quality, we find that some countries might not consent to it and, moreover, we identify cases where consensus on centralization cannot be recovered by simply redistributing permits among countries.