Luca Taschini (LSE, Grantham Research Institute) on "Carbon Dating: When Is It Beneficial to Link ETSs?"

This paper proposes a simple framework to evaluate the economic advantage of regulating carbon emissions by linking the emissions trading systems (ETSs) of two jurisdictions versus operating them under autarky. The ETSs are linked if the permits issued in one, and traded competitively across both, can be surrendered against emissions in the other. The paper's main innovation is in analyzing the sensitivity of aggregate and jurisdiction-specific economic advantage to the properties of the shocks which affect the benefits of emissions in each jurisdiction. We decompose the economic advantage of linking into volatility and dependence effects. We show that when countries are ex ante identical and there are no tax distortions or sunk costs, the aggregate economic advantage is always positive, increases in the volatilities of jurisdiction-specific shocks, and decreases in their correlation. Moreover, it is equally shared. When there are differences in size, measured in emissions, we find that economic advantage of linking is not equally shared with a larger share going to the smaller jurisdiction. The implication is that the larger jurisdiction may be worse off under linking than autarky for small sunk costs even when aggregate economic advantage is positive. A similar conclusion emerges when there are unilateral distortions affecting international permit trade. We illustrate the implications of our results by calibrating the variance-covariance matrix of shocks to the observed fluctuations in emissions of 90 countries around the world. (The paper is available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2610076.)