Economic consequences of permits allocation rules Julien Chevallier (Dauphine-LEDa), Pierre-Andr´ e Jouvet (Paris Ouest-EconomiX), Philippe Michel, Gilles Rotillon (Paris Ouest-EconomiX) Special Issue Economie Internationale: ‘Public environmental policies: Some insights from economic theory’
January 12, 2011
Research question
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Better understand the procedure of allocation of permits between countries/firms and its distributive consequences.
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Discuss the pros and the cons of various allocation rules (such as per capita emissions, per capita GDP, relative historical responsibility, or size of population).
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These choices are obviously not neutral!
Annex I United States European Union Austria Belgium Denmark Finland France Germany Greece Ireland Italia Luxembourg the Netherlands Portugal Spain Sweden UK Australia Canada Iceland Japan New Zealand Norway Switzerland Liechtenstein Monaco Transition Economies Bulgaria Czech Republic Estonia Hungary Latvia Lituania Poland Romania Russian Federation Ukraine Slovakia Croatia Slovenia Total 1990
1990 CO2 Emissions 4,957,022 3,288,667 59,2 114,41 52,025 53,9 366,536 1,014,155 82,1 30,719 428,941 11,343 167,6 42,148 227,322 61,256 577,012 288,965 462,643 2,172 1,155,000 25,476 35,514 45,07 208 n.a. 3,364,259 82,99 165,792 37,797 71,673 22,976 n.a. 414,93 171,103 2,388,720 n.a. 58,278 n.a. n.a. 13,675,067
Kyoto Target 93 92 92 92 92 92 92 92 92 92 92 92 92 92 92 92 92 108 94 110 94 100 101 92 92 92 103 107 92 92 110 92 92 108 107 100 100 92 95 92 95
EU Differentiated Agreements 87 92.5 79 100 100 79 125 113 93.5 72 94 127 115 104 87.5
Practical example: the EU ETS (2005-2012)
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Each country is required to develop a National Allocation Plan (NAP). The sum of NAPs determines the number of quotas distributed to installations in the EU ETS.
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2.2 billion allowances per year have been distributed during 2005-2007. 2.08 billion allowances per year will be distributed during 2008-2012.
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The allocation methodology consisted in a free distribution of quotas in proportion of recent emissions.
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Due to free allocation, several hurdles prevent the good functioning of a tradable permits market.
Nexus of the problem ◮
‘Any free allocation system will be deficient both in efficiency and equity terms yet the principle is strongly favored by a key stakeholder, namely business’.
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‘The sale of permits, with revenue recycling, has the potential to satisfy both efficiency and equity objectives but faces deep opposition from business’ (Report to the Australian Greenhouse Office, 2000).
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Therefore, the ‘grandfathering’ approach decided in Kyoto is understandable to achieve political acceptability .
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More generally, it appears problematic to distribute permits following the appropriate criteria, be it emissions (total or per capita), GDP (total or per capita), population size, or the historical relative responsibility in the growth of GHG emissions.
Permits vs. Taxes
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Weitzman: Taxes superior to permits unless MB of abatement steeper than MC.
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Newbery: CO2 is a global persistent stock pollutant.
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CO2 damage today effectively same as tomorrow → marginal benefit of abatement essentially flat
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marginal cost of abatement rises rapidly; future abatement costs very uncertain.
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therefore, carbon tax superior to tradable permits but permits easier to introduce.
Initial allocation
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According to Raymond (1996), initial allocation reveals social norms and what society considers acceptable on how to distribute the newly created permits.
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There is a need of specific allocation strategies according to socio-political settings: Possessory (Hume) Instrinsic (Locke)
Instrumental (Cohen) Egalitarian (Proudhon)
Initial allocation (ctd.)
Depending on the property theory, different allocation methodologies may be chosen from: ◮
Grandfathering is advocated by the possessory viewpoint;
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Auctioning is advocated by the instrumental viewpoint;
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Baseline emissions are advocated by the intrinsic viewpoint;
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Per capita allocation is advocated by the egalitarian viewpoint.
Outline
1. Permits allocation rules 1.1 Grandfathering vs. auctioning 1.2 Alternatives to grandfathering 2. Effects induced by permits allocation 2.1 On factors’ income inside firms 2.2 On world’s production and profits
1.1 Grandfathering vs. auctioning Parry (2002), Newell (2003): ◮
‘grandfathered permits create windfall gains for shareholders, who are concentrated in high-income groups, because such policies hand out a valuable asset to firms for free. There is no windfall gain to wealthy households under auctioned permits or emissions taxes; instead, the government obtains revenues that can be recycled in tax reductions that benefit everyone or disproportionately favor the poor ’
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’tradable permits create rents, and grandfathering distributes those rents to existing firms while also erecting barriers to entry. Direct allocation of grandfathered permits offers a degree of political control over the distributional effects of regulation, enabling the formation of majority coalitions.’
1.1 Grandfathering vs. auctioning (ctd.)
Jouvet, Michel and Rotillon (2002) : ◮
According to production optimization decisions, the capital return is determined not only by the capital marginal productivity, but also by the market value of the free endowment of pollution permits given to the firm, valued at the market price.
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The latter represents what is called windfall profits in the literature.
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Source: Sijm et al. (2006).
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At 20 EUR/ton of CO2 , the windfall profits vary between 5.3 and 7.7 billion EUR.
Technology Allocation Nuclear Coal Gas
Production (TWh) 998 1001 664
Rents due to ETS Grandfathering Auctioning 5465 5465 6520 -2573 3569 701
Diff. G/A 0 -9093 -2868
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Source: Keppler and Cruciani (2010).
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Annual impact on profits of European power producers in Phase I (million Euros, average price of 12 Eur/ton of CO2 ).
1.1 Grandfathering vs. auctioning (ctd.)
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With free permits, the rent is given to the firms, which distorts the capital market. This adverse effect would not appear with price or command-and-control regulations.
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If all the permits were auctioned, then the regulation with tradable emissions permits would be strictly equivalent to a regulation with an emissions fee.
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Do not debate about price vs. quantities, but about the assignment of property rights on the pollution.
1.2 Alternatives to grandfathering
Jouvet, Michel and Rotillon (2002,2005,2010): ◮
General equilibrium framework.
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Define the productivity of one unit of work (with reference to human capital stocks) H as being efficient labor.
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In a world without permits, in equilibrium, production levels, emissions and capital stocks are proportional to efficient labor H and the world production is maximal.
1.2 Alternatives to grandfathering (ctd.)
Consider the effects of a rule proportional to efficient labor: ◮
H2 Setting the ratio of permits EE12 = H affects the equilibrium by 1 reducing proportionally world’s production due to the environmental constraint.
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The level allocation rules proportionally reduce output in different countries whatever their relative wealth.
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Such an allocation rule is efficient, i.e. it allows maximum production for a given total world allocation of permits
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World production can be increased by reallocating capital and keeping the same level of world’s total emissions.
1.2 Alternatives to grandfathering (ctd.)
Consider the effects of a rule proportional to population: H2 N2
H1 N1 ,
E2 E1
N2 N1 ,
E2 E1
H2 H1
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If h2 =
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This allocation is beneficial for the developing country, increasing capital and production.
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Moreover, the South is net seller of permits, which provides an additional income.
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However, the per capita income remains lower in the South, and world’s production is reduced more than in the case of a level allocation rule. This is due to capital reallocation.
< h1 =
then
=
but
>
1.2 Alternatives to grandfathering (ctd.)
Consider the effects of a rule proportional to per capita variables: ◮
Such a rule is in favor of the smallest country in terms of population, be it North or South.
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Giving the same number of permits to 2 countries having the same per capita variables, but very different in terms of size, is not credible.
2.1 Effects on factors’ income inside firms
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JMR (2005, 2010) consider the effects of free allocation vs. other rules on the earning of production factors and wealth distribution.
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The underlying production function has 3 factors (capital, labor and emissions) and the effect on the marginal productivities comes from the emissions cap.
2.1 Effects on factors’ income inside firms (ctd.)
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The marginal productivities of capital and labor are reduced in a similar way.
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Giving permits for free to the firm (and thus to shareholders) allows to compensate the decrease of marginal productivity of capital in terms of return.
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Without allocation of permits to workers, labor income decreases more than capital income.
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Hence, a suggestion could be to distribute free permits to workers.
2.2 Effects on world’s production and profits
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A positive value for permits induces a reduction in world’s production, even in the case where production capacities are fully used in each country.
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If all permits are given to poor countries, which are characterized as being less productive, a huge reduction in world’s production will occur because of capital reallocation in favor of the less productive firms.
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If we consider the case of an effective but weak environmental constraint, with an important share of permits distributed freely to firms, then the value of permits given to firms will more than compensate production losses linked to environmental regulation.
2.2 Effects on world’s production and profits (ctd.)
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There exists a possibility to distribute permits freely while equating production factors’ marginal productivities and their earning.
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1/3 of permits shall be distributed freely to firms (as the share of capital in production), while 2/3 shall be distributed directly and freely to workers as the share of labor in production.
Concluding remarks ◮
The most efficient free allocation methodology (maximizing world’s production for a given emissions level) consists in distributing permits based on the quantities of efficient labor.
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A more equitable solution consists in distributing permits to each production factor proportionally to its share in production.
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Grandfathered permits do not necessarily create windfall gains for shareholders if their allocation is judiciously made to all production factors.
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High level of uncertainty towards 2012 (no post-Kyoto agreement, shift to auctioning within the EU ETS and inclusion of the aviation sector, . . . ).
