Competitive Distortions In An International Emissions Trading Market

The objective of this paper on international greenhouse gasemissions trading is to find the conditions, if any, under which internationaldifferences in domestic permit allocation procedures lead to competitivedistortions.The paper finds that grandfathered firms or sectors do not have a costadvantage over identical auctioned firms or sectors abroad, as long asmarkets are perfectly competitive, because they have to include theopportunity costs of using the permits in the product price. However,grandfathered permits are a capital gift to the firm, inducing a windfallprofit, which implies that a similar firm abroad which has to buy its permitshas a higher cash outflow and hence less financial resources. This aspect ofgrandfathering becomes relevant when considering imperfect competitionor equity.Firstly, it is concluded that competitive distortions may arise underimperfect competition, mainly because the grandfathered firms can outlastthe auctioned firms abroad in a price war. Secondly, it appears thatcompetition (or: the level playing field) is distorted in terms of equity,because the mere process of permit allocation gives the grandfathered firmsa stronger financial position and thus an unfair competitive advantage overtheir auctioned competitors abroad.In legal terms, these findings imply that grandfathering is WTO compatibleif one is only willing to consider efficiency and assume perfect competition.However, grandfathering constitutes an actionable subsidy under WTO lawif one also considers equity or if competition is imperfect, which couldnecessitate some level of international harmonization of domestic permitallocation rules.