On the Effects of Linking Cap‑and‑Trade Systems for CO2 Emissions

Abstract

Linkage of national cap-and-trade systems is typically advocated by economists on a general analogy with the beneficial linkage of free-trade areas and on the specific grounds that linkage will ensure cost effectiveness among the linked jurisdictions. The paper analyses the less obvious effects of linkage with the bottom-up approach of the Paris Agreement where each country sets its nationally determined contribution for its own carbon dioxide ( CO 2) emissions. An appropriate and widely accepted specification for the damages of CO 2 emissions within a relatively short (say 5-10 year) period is that marginal damages for each jurisdiction are constant (although they can differ among jurisdictions). With this defensible assumption, the analysis is significantly clarified and yields simple closed-form expressions for all CO 2 permit prices. Some implications for linked and unlinked voluntary CO 2 cap-and-trade systems are derived and discussed. A numerical example illustrates the results.