Cooling Down Hot Air A Global

The Kyoto Protocol marks a break-through in global warming mitigation policies as it sets legally binding emissions targets for major emitting regions. However, realisation of the Protocol depends on the clarification of several issues one of which is the permissible scope of international emissions trading between signatory countries. Unrestricted trade produces hot air when signatory countries whose Kyoto targets are well above their business as usual emissions trade in larger amounts of “abundant” emission rights. Concerns on hot air motivated proposals for caps on emissions trading by the EU. These caps are strictly refused by the USA and other non-European industrialized countries who want to exploit the full efficiency gains from trade. In this paper we show that there are cooling down strategies which can reconcile both positions. International permit trade provides enough efficiency gains to make all signatory countries better off than without permit trade while mitigating hot air. In other words, part of the efficiency gains from free trade could be used to pay for higher abatement targets of signatory countries which assure the same environmental effectiveness as compared to strictly domestic action or restricted permit trade. JEL classifications: Q2, Q4, D58 Acknowledgement Helpful comments were received by Thomas Osang and Marcus Stronzik. None of the views expressed here should be attributed to any of our employers or research sponsors Non-technical Summary National parliaments of major emitting industrialized countries such as the USA, Japan, Canada or the Russian Federation have put acceptance of the Kyoto Protocol under condition that emissions trading among signatory countries can be used as a flexible mechanism to meet national reduction targets. While this stipulation has a clear efficiency rationale, opponents of emissions trading systems such as the EU refer to potential loopholes. International trade in permit rights may lead to an effective increase of global emissions when signatory countries whose baseline emissions are below their Kyoto entitlements sell large amounts of their abundant emission rights. This phenomenon has been referred to as hot air. It is particularly relevant for the Russian Federation and Ukraine where projected emissions for the Kyoto budget period are well below the assigned amount of emission rights due to the break-down of domestic economies. In order to mitigate hot air, the EU and its associates stress the principle of supplementarity and call for restrictive ceilings on the amount of tradable emissions. However, these caps are strictly refused by the USA and other nonEuropean industrialized countries who want to exploit the full efficiency gains from trade. In this paper we show that there are cooling down strategies which can reconcile both positions. International permit trade provides enough sufficiency gains to make all abating countries better off than without permit trade while mitigating hot air. To put it differently, part of the efficiency gains from free trade could be used to pay for higher average abatement targets of signatory countries which assure the same environmental effectiveness as under strictly domestic action or restricted trade.