Emission Constraints, Emission Permits and Marginal Abatement Costs

Abstract

Should the marginal cost of emission abatement be equalized across countries? Do markets for tradeable emission permits lead to Pareto efficient patterns of emission abatement? Until recently, the stock answers to both questions were “yes”. But Chichilnisky (1994), and then in a more general context Chichilnisky and Heal (1994), proved that the efficient abatement of carbon dioxide emissions does not require the equalization of marginal abatement costs across countries. Equalization is required if and only if it is possible to make unrestricted lump sum redistributions of wealth sufficient to equate the marginal social valuation of consumption in all countries. It follows almost immediately that markets for tradeable emission permits do not lead to Pareto efficiency, as shown in Chichilnisky et al. (1994). Chichilnisky et al. (1994) showed that if a market for emission rights is introduced, then the manner in which the emission rights are initially distributed between countries is important for efficiency. To be specific, they showed that only a finite number of ways of allocating a given total of emission rights between countries will lead to Pareto efficient outcomes. Distribution and efficiency are linked in competitive economies where one trades the right to produce privately-produced public goods (such as CO₂ emissions).

I am grateful to Graciela Chichilnisky, Peter Sturm and Joaquim Oliveira-Martins for comments and suggestions. Financial support from the OECD, the Global Environment Facility of the World Bank and the NSF on grant 93-09610 is also acknowledged. This paper replaces an earlier paper entitled “Political Targets and Marginal Abatement Costs”. This version was written while the author was visiting the Beijer Institute in Stockholm: I am grateful to Karl-Göran Mäler for his hospitality and comments.