Salmons, R.; (1999) Performance-based credit trading. (CSERGE Working Papers GEC 99). Centre for Social and Economic Research on the Global Environment (CSERGE): London, UK.

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Abstract

It is well established that - in the absence of market distortions - permit trading provides a cost efficient implementation mechanism for a range of different environmental policy issues where objectives can be set - either explicitly, or implicitly - in absolute terms (e.g. tonnes of carbon). However in many policy areas, objectives are formulated in relative terms (i.e. as rates). For example, objectives may be set for energy efficiency rates in certain industrial sectors (i.e. energy consumption per unit output), or for the mix of secondary and primary materials used in the manufacture of certain products. Furthermore, in a second-best setting with distortionary taxes, there may be significant social cost advantages to using rate-based instruments, even when the underlying policy objective is expressed in absolute terms. This paper extends the analysis of the cost efficiency of trading schemes to encompass a broader range regulatory rules. It is demonstrated that for a generic form of trading - performance-based credit trading (PBCT) - a market equilibrium will always exist, and that it will achieve the cost efficient outcome for any policy objective that can be expressed in the form of a linear perform-ance rule. The general formulation of this rule is very flexible, and it can incorporate both absolute performance targets, and rate-based targets. In the case of an absolute performance target, it is shown that while PBCT is functionally equivalent to permit (i.e. allowance) trading, it has different implications for property rights. In relation to rate-based regulation, an application of PBCT to an energy efficiency target for a particular sector is used to demonstrate how performance adjustment factors can be used to different-iate individual firm targets while ensuring that the overall sector constraint is satisfied.

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