Competitive Permit Markets and Vertical Structures: The Relevance of Imperfectly Competitive Eco‐Industries

• Published date: 01 February 2014
• Author: HUBERT STAHN,SONIA SCHWARTZ
• Date: 01 February 2014
• DOI: http://doi.org/10.1111/jpet.12048

COMPETITIVE PERMIT MARKETS AND VERTICAL

STRUCTURES:THE RELEVANCE OF IMPERFECTLY

COMPETITIVE ECO-INDUSTRIES

SONIA SCHWARTZ

CERDI, Universit´

e d’Auvergne

HUBERT STAHN

Aix Marseille School of Economics, CNRS, EHESS

Abstract

Permit markets lead polluting firms to purchase abatement

goods from an eco-industry which is often concentrated.

This paper studies the consequences of this sort of imper-

fectly competitive eco-industry on the equilibrium choices

of the competitive polluting firms. It then characterizes the

second-best pollution cap. By comparing this situation to

one of perfect competition, we show that Cournot compe-

tition on the abatement good market contributes not only

to a nonoptimal level of emission reduction but also to a

higher permit price, which reduces the production level.

These distortions increase with market power, measured by

the margin taken by the noncompetitive firms, and suggest

a second-best larger pollution cap.

1. Introduction

Since the U.S. Acid Rain Program, an increasing number of countries

have opted for pollution permit markets to address pollution problems. In

particular, the European Union Emission Trading Scheme (EU ETS) was

Sonia Schwartz, Universit´

e d’Auvergne, 65 boulevard Franc¸ois Mitterand, 63000 Clermont-

Ferrand, France (sonia.schwartz@udamail.fr). Hubert Stahn, Aix Marseille School of

Economics, Chˆ

ateau Lafarge, route des Milles, 13210 Les Milles, France (hubert.stahn@

univ-amu.fr).

This work was supported by the Agence Nationale de la Recherche of the French gov-

ernment through the program Investissements d’avenir (ANR-10-LABX-14-01). We are

grateful for helpful comments from anonymous reviewers.

Received May 6, 2011; Accepted November 23, 2011.

C2013 Wiley Periodicals, Inc.

Journal of Public Economic Theory, 16 (1), 2014, pp. 69–95.

69

70 Journal of Public Economic Theory

implemented in 2005 and the Kyoto Protocol establishing an international

carbon market came into force in 2006. Both are intended to fight global

warming. The EU ETS, for instance, covers over 11,500 energy intensive

installations representing nearly half of the EU’s emissions of carbon diox-

ide (Ellerman, Convery, Buchner, and Carraro 2007; Ellerman, Convery, and

De Pertuis, 2010).

Since the seminal contributions of Crocker (1966)andDales(1968), it is

well known that by setting a price signal for pollution, this kind of instrument

encourages polluting firms to reduce their emissions by purchasing abate-

ment goods and services. This specific demand appeared notably with the

Acid Rain Program (Joskow, Schmalensee, and Bailey 1998), which has led

coal-fired power stations to invest heavily in scrubbers, a technology allow-

ing for reduction in sulfur emissions.1More recently, the EU ETS has led to

annual spending for pollution reduction representing €2.9–3.7 billion, also

mainly invested in abatement goods and services. And this demand grows

quickly, since firms must comply with more and more stringent environmen-

tal policies. This phenomenon largely contributes to the development of an

“eco-industry”2supplying these products to polluting firms.

This new industry covers pollution and resource management activities,

ranging from the development of clean technologies to the optimization of

methods for monitoring and managing environmental impacts. From that

point of view, the eco-industry represents one of the biggest industrial sec-

tors: since 2005, it matches the aerospace and pharmaceutical sectors in size.

However, these activities often remain highly concentrated. Vivendi Environ-

ment and Ond´

eo (Suez Lyonnaise des eaux) are, for instance, the inter-

national leaders in wastewater treatment. Even in the more general waste

treatment sector, the key players CGEA-Onyx, Sarp, Dalkia, Sita, and Elyo

are easily identified. The air treatment sector, in which the French firm LAB

is the European leader, seems more competitive, but cooperation with the

French firm CNIM (Constructions Industrielles de la M´

editerran´

ee) may

change this situation.

This suggests that perfect competition is an unsuitable assumption for

modeling an “eco-industry.” Besides, Perino (2010b) provides empirical evi-

dence that eco-industry charges mark-ups and that their size depends on the

choice and stringency of environmental regulation. In this case, it is obvious

that the abatement good price does not completely reflect its marginal cost.

This clearly affects the decision of the polluting firms, i.e., their production

1Scrubber systems are a diverse group of air pollution control devices that can be used to

remove some particulates and/or gases from industrial exhaust streams. Flue-gas desulfu-

rization devices have high removal rates of up to 98%.

2This notion was introduced in an OECD report (1999). It consists of activities that mea-

sure, prevent, limit, minimize, or correct environmental damages. The reader is also re-

ferred to Sinclair-Desgagn´

e(2008) for historical facts in Europe and North America or to

the European Commission reports (Ernst and Young 2006, European Commission 1999,

2007, 2009).