Testing the Dynamic Theory of Emissions Trading: Experimental Evidence for Global Carbon Trading

Simulation models and theory prove that emission trading converges to market equilibrium. This paper sets out to falsify these results using experimental economics. Three experiments are conducted for the six largest carbon emitting industrialized regions. Two experiments use auctions: the first single-bid auction and the second a Walrasian auction. The third relies on bilateral, sequential trading. The paper finds that, in line with the standard theory, both auctions and bilateral, sequential trading capture a significant part (88 to 99 percent) of the potential cost savings of emission trading. As expected from dynamic trade theory, all experiments show that the market price converges (although not fully) to the market equilibrium price. In contrast to the theory, the results also suggest that not all countries will gain from trading. In both the bilateral trading experiment and the Walrasian auction, one country will actually be worse off with trade. In particular, bilateral, sequential trading leads to a distribution of gains significantly different from the competitive market outcome. This is due to speculative behavior, imperfect foresight and market power

Incomplete Information and the Cost-Efficiency of Ambient Charges

The established opinion is that in the face of uncertain information on pollution control costs, environmental agencies cannot set levels of ambient charges enabling the reaching of desired concentration levels at receptor sites in a cost-effective way. Although a trial-and-error procedure could finally result in the attainment of concentration standards this is generally not cost-effective. This paper proves that environment agencies can develop adaptive procedures that enable the achievement of the standards at minimum costs. The proof is based on ideas of non-monotonic optimization. The adaptation mechanisms are applied in a case study of charges for acidification in the Netherlands. The results show that the iterative procedure approaches the cost-minimum fairly quickly but that over and undershooting may occur underway. The number of iterations and extent of overshooting can be reduced by using available knowledge on the violation of ambient concentrations at receptors and by a simulation of polluters responses to charges

Financial Instruments for the Control of Transboundary Pollution

International agreements to protect the environment usually have the form of promises between countries to reduce pollution on a reciprocal base. Such a solution can be Pareto-efficient if transboundary pollution is reciprocal and, on top of that, negotiators reveal truly the preferences of their governments for environmental quality and the national costs of pollution control. However, there are conditions under which the outcomes in terms of welfare gains can be improved by making payments between countries a part of the deal. The paper discusses the following categories: (1) International money payment in exchange for additional pollution control abroad and simultaneous reduction of control effort at home as a complement to existing international agreements: Joint Implementation. (2) Money transfers as an instrument to make an agreement on transboundary pollution feasible: control of unidirectional pollution and (ambitious) proportional reciprocal reduction of emissions belong to this class. (3) International care. A country cares about the environment, or about the standard of living in another country. At first sight such considerations of international care seem to offer an argument for international subsidies. However, it will be shown that this is not necessarily so, since care considerations are already reflected in the 'rates of exchange' of the agreement to reduce emissions reciprocally

Searching Market Equilibria under Uncertain Utilities

Our basic model is a noncooperative multi-player game in which the governments of neighboring counties trade emission reductions. We prove the existence of a market equilibrium (combining properties of Pareto and Nash equilibria) and study algorithms of searching a market equilibrium. The algorithms are interpreted as repeated auctions in which the auctioneer has no information on countries' costs and benefits and every government has no information on the costs and benefits of other countries. In each round of the auction, the auctioneer offers individual prices for emission reductions and observes countries' best replies. We consider several auctioneer's policies and provide conditions that guarantee approaching a market equilibrium. From a game-theoretical point of view, the repeated auction describes a process of learning in a noncooperative repeated game with incomplete information

Macroeconomic Impacts of an EEC Policy to Control Air Pollution

The OECD INTERLINK model was used to assess the macroeconomic impacts of a European Community directive to control air pollution. For this purpose the model was adapted. To meet the directive the EC would have to invest some 15 billion ECU. The annual cost would be 3.4 billion ECU in 1993. The simulation results suggest that the macroeconomic impacts are small and are positive during the investment period and more negative in the subsequent period. Differences in results among EC countries are expected. These are not only due to differences in pollution control costs but also result from indirect impacts of coordination