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The dynamics of linking permit markets

Author

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  • Katinka Kristine Holtsmark
  • Kristoffer Midttømme

Abstract

This paper presents a novel benefit of linking emission permit markets. We let countries issue permits non-cooperatively, and with endogenous technology we show there are gains from permit trade even if countries are identical. Linking the permit markets of different countries will turn permit issuance into intertemporal strategic complements. The intertemporal strategic complementarity arises because issuing fewer permits today increases investments in green energy capacity in all permit market countries, and countries with a higher green energy capacity will respond by issuing fewer permits in the future. Hence, each country faces incentives to withhold emission permits when permit markets are linked. Even though countries cannot commit to reducing their own emissions, or punish other countries that do not, the outcome is reduced emissions, higher investments, and increased welfare, compared to a benchmark with only domestic permit trade. We also show that permit market linking can arise as an equilibrium outcome.

Suggested Citation

  • Katinka Kristine Holtsmark & Kristoffer Midttømme, 2019. "The dynamics of linking permit markets," CESifo Working Paper Series 7548, CESifo Group Munich.
  • Handle: RePEc:ces:ceswps:_7548
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    References listed on IDEAS

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    More about this item

    Keywords

    international agreements; permit markets; dynamic games; green technology investments;

    JEL classification:

    • F55 - International Economics - - International Relations, National Security, and International Political Economy - - - International Institutional Arrangements
    • Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters and their Management; Global Warming

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