Limited trading of emissions permits as a climate cooperation mechanism? US-China and EU-China examples

Recent multilateral climate negotiations have underlined the importance of international cooperation and the need for support from developed to developing countries to address climate change. This raises the question of whether carbon market linkages could be used as a cooperation mechanism. Policy discussions surrounding such linkages have indicated that, should they operate, a limit would be set on the amount of carbon permits that could be imported by developed regions from developing countries. This paper analyzes the impact of limited carbon trading between an ETS in the EU or the US and a carbon market covering Chinese electricity and energy intensive sectors using a global economy-wide model. We find that the limit results in different carbon prices between China and Europe or the US. Although the impact on low-carbon technologies in China is moderate, global emission reductions are deeper than in the absence of international trading due to reduced carbon leakage. If China captures the rents associated with limited permit trading, we show that it is possible to find a limit threshold that makes both regions better off relative to carbon markets operating in isolation.