The cost of sectoral differentiation: The case of the EU emissions trading scheme

Abstract

It is often assumed in the economic literature that the Kyoto Protocol will be implemented through a cost-efficient, comprehensive emissions trading system. However, the general experience from implementation of environmental policies suggests that governments will adopt a more differentiated approach. Emerging evidence on how the Kyoto Protocol will be implemented confirms this: climate commitments will be differentiated between sectors. This paper assesses the welfare effects associated with implementing the EU emissions trading Directive – or a similar scheme for other regions. It also analyses how differentiation of commitments affects the sectors that have a permit obligation compared to those that are exempted from it. Findings indicate that sectoral differentiation comes at a relatively high welfare cost – in all scenarios more than tripling the cost of implementing climate policy, with only limited benefits to the sectors that are granted concessions.