The problem with internationally tradeable emission permits for greenhouse gas abatement

Abstract

The next major round of international negotiations on controlling global climate change is to be held later this year in Kyoto. The focus of talks to date has been on policies to reduce worldwide carbon dioxide emissions to 1990 levels and hold them there. A proposal by the United States would achieve this by creating a system of internationally tradable emissions permits. Although the U.S. proposal has attractive features and has been endorsed by a number of prominent economists, it has several serious flaws that would prevent the treaty from being ratified and implemented. One particular problem that we highlight is the potential instability this could cause to global financial markets and the world trade system. This paper outlines these flaws. We then propose an alternative policy regime that involves setting up a coordinated system of national permits and emission fees. Since this alternative does not focus on stabilization and instead aims at the more modest goal of reducing emissions where it can be done at low cost, and it includes an allowance for 1990 emissions, it is far more likely to be ratified and implemented. It would give firms an incentive to reduce emissions without causing huge international transfers of wealth and would avoid causing havoc in the system of world trade. Because the fee would be uniform throughout the world, the emissions reductions would be accomplished at minimum cost. Finally, the revenue raised by emissions fees would provide an incentive for individual governments to enforce the policy.