In this paper we examine an alternative policy scenario, where governments allow polluting firms to trade permits in a strategic environmental policy model. We demonstrate, among other things, that with no market power in the permits market, governments of the exporting firms do not have an incentive to under-regulate pollution in order to become more competitive. This strategic effect is reversed and leads to a welfare level closer to the cooperative one and strictly higher to that when permits are non-tradable. Allowing for market power in the permits market, the incentive to under-regulate pollution re-appears regardless of whether permits are tradable or not. With tradable permits, however, the incentive to under-regulate pollution is comparatively weaker relative to the case of non-tradable permits. This entails potential benefits for the exporting firms and countries since the prisoners’ dilemma is moderated.
Panos Hatzipanayotou, Fabio Antoniou, and Phoebe Koundouri,
"Tradable Permits vs Ecological Dumping"
(February 5, 2010).
Fondazione Eni Enrico Mattei Working Papers.
Working Paper 392.