On the free allocation of emission rights under endogenous lobby formation

This paper analyses emissions trading (cap-and-trade) in a political economy model with endogenous lobby group formation. The lobby group targets the initial allocation of permits for its members and each firm makes a decision as to whether to take part in such a group. It is found that, without full participation, the initial allocation of permits is extreme in the sense that either the lobbying firms obtain their maximal business-as-usual emissions or the non-lobbying firms are given zero permits. With full participation, the initial allocation of permits induces the same emission allocation as emission limits and the greatest aggregate emissions among all the possible lobby groups. In addition, a simple condition is derived for the existence of a non-null lobby group. Furthermore, it is shown that a full lobby group is stable when lobby group participation costs are relatively small. The analysis is extended to other instruments including emission limits and an emission tax, and it is shown that with these instruments aggregate emissions are increasing in lobby group size in contrast to emissions trading, where they can be non-monotonic.