Economic Consequences of Permits Allocation Rules

This paper investigates the economic consequences of permits allocation rules. Following the rapid development of the Kyoto Protocol and the EU Emission Trading Scheme, it appears critical to better understand the procedure of allocation of permits between countries/firms and its distributive consequences. Indeed, due to intense political lobbying, the free distribution of permits to existing users as a function of a given benchmark (“grandfathering”) appears as the best solution to facilitate the agreement to the scheme. This paper discusses the pros and the cons of various other allocation rules, such as per capita emissions, per capita GDP, relative historical responsibility, or size of population. The main lesson of this study is that 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, while a more equitable solution consists in distributing permits to each production factor proportionally to its share in production.