Emissions Trading and Intersectoral Dynamics: Absolute versus Relative Design Schemes

This paper examines the interdependence between imperfect competition and emis-sions trading in a two-sector (clean and dirty) economy. We compare the welfare implica-tions of an absolute cap-and-trade scheme (permit trading) with a relative intensity-basedscheme (credit trading). We nd unambiguously more clean rms in the long run undercredit trading. However, neither emissions trading con guration creates the rst-best out-come: there are too few (many) clean rms under permit (credit) trading. Permit tradingdominates credit trading in terms of overall welfare at the long run equilibrium, exceptwhen policy is relatively lenient. It is also demonstrated that stricter policy does notnecessarily induce the clean sector to grow relative to the dirty sector and we determineunder what conditions this holds.