Problems of Equity and Efficiency in the Design of International Greenhouse Gas Cap-and-Trade Schemes
This article argues that international greenhouse gas (GHG) cap-and-trade schemes suffer from inherent problems of enforceability and verifiability that both cause significant inefficiencies and create inevitable tradeoffs between equity and efficiency. A standard result in the economic analysis of international GHG cap and trade schemes is that an allocation of initial permits that favors poor, developing countries (making such countries net sellers in equilibrium) may be necessary not only to further redistributive goals but also the efficiency of the GHG cap and trade scheme. This coincidence of equity and efficiency is, however, unlikely to be realized under more realistic assumptions about enforcement and monitoring. Both economic theory and evidence from the European Union’s emission trading scheme strongly suggest that under an international cap-and-trade scheme, high-marginal-cost GHG emission abaters will not face binding caps that are enforced against them by their national governments. The failure of such high-cost abaters to participate in cap-and-trade schemes causes significant inefficiencies. The prospect of enlisting the participation of such high-abatement-cost, developed-world GHG emitters and restoring efficiencies by opening up trading to include low-cost GHG abatement projects in the developing world is appealing, but ultimately doomed by the inability to verify that such developing world projects generate real GHG emission reductions. Due to inherently imperfect and limited verifiability, there is an inevitable tradeoff between efficiency and equity: the broader the coverage of an international GHG cap-and-trade scheme, the greater its potential to redistribute income to people in poor countries, but the less likely it is to efficiently generate reductions in GHG emissions.