Transitional restricted linkage between Emissions Trading Schemes
by Simon Quemin and Christian de Perthuis
Linkages between Emissions Trading Systems can be an important element in forging the future global climate change architecture, but remain few and far between. This article develops a deterministic partial equilibrium model of bilateral linkage to compare various link restrictions in facilitating linkage negotiations, namely quantitative restrictions, border permit taxes, exchange and discount rates, and unilateral linkage. Because restrictions undermine cost-efficiency and generate rents, they should be used as transitory mechanisms to full linkage. Trial restricted-link periods may allow to test the effects of the link while containing its reach, spur cooperation and provide more time and flexibility in circumventing impediments to full linkage.
While quantitative restrictions seem to be the natural route to a full link, they can lead to uncertain distributional effects and weakened price signals. These aspects are mitigated under a border tax on permits, but this policy seems harder to implement. Exchange rates have potential to adjust for programmes’ stringencies and increase overall ambition, but are challenging to select. As experience corroborates, unilateral linkage may constitute a practical and promising approach.
Keywords: Climate change; Climate policy architecture; Emissions trading; Linkage; Permit trade restrictions
JEL Classification codes: Q58; H23