Diffusion and adoption of advanced emission abatement technology induced by permit trading

• Author: Alfred Endres,Tim Friehe,Bianca Rundshagen
• Published date: 01 September 2020
• DOI: http://doi.org/10.1111/jpet.12430
• Date: 01 September 2020

J Public Econ Theory. 2020;22:1313–1337. wileyonlinelibrary.com/journal/jpet © 2020 Wiley Periodicals, Inc.

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1313

Received: 1 August 2018

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Accepted: 26 January 2020

DOI: 10.1111/jpet.12430

ORIGINAL ARTICLE

Diffusion and adoption of advanced emission

abatement technology induced by permit

trading

Alfred Endres

1

|Tim Friehe

2,3,4

|Bianca Rundshagen

5

1

Research Center for Energy, Environment

& Sustainability, University of Hagen,

Hagen, Germany

2

Public Economics Group, University of

Marburg, Marburg, Germany

3

CESifo, Munich, Germany

4

EconomiX, Paris, France

5

Department of Economics, University of

Hagen, Hagen, Germany

Correspondence

Tim Friehe, Public Economics Group,

University of Marburg, Am Plan 2, 35032

Marburg, Germany.

Email: tim.friehe@uni-marburg.de

Abstract

This paper analyzes firm incentives to diffuse and

adopt advanced abatement technology for three

different regimes of tradeable emission permits

(auctioning, benchmarking, and grandfathering). We

particularly consider technical change that decreases

marginal abatement costs (MACs) only at high

emission levels, whereas it increases them at low firm

emissions. We establish that the desirability of the

different regimes of allocating permits to firms is

critically influenced by how MACs are changed by

technological improvements.

1|INTRODUCTION

1.1 |Motivation and main results

A key role of environmental policy lies in the creation of incentives for firms to innovate,

diffuse, and adopt more advanced abatement technologies. The relative performance of dif-

ferent instruments of environmental policy has attracted great attention (e.g., D'Amato &

Dijkstra, 2018; Requate, 2005a). Market‐based instruments such as tradeable permits are

usually among the best performing instruments. In these analyses, it is commonly assumed that

technical change lowers the marginal abatement cost curve at all levels of emission. This

assumption has come under attack. Some contributors argue that technical change alters

marginal abatement costs (MAC) in a way that depends on the level of emissions such that

there will be a decrease for some and an increase for other levels of emissions (e.g., Amir,

Germain, & van Steenberghe, 2008; Baker, Clarke, & Shittu, 2008; Bauman, Lee, & Seeley, 2008;

Bréchet & Jouvet, 2008; Dijkstra & Gil‐Moltó, 2018; Perino & Requate, 2012). For example,

Amir et al. (2008) show that only innovation in end‐of‐pipe technology leads to a uniform

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This is an open access article under the terms of the Creative Commons Attribution‐NonCommercial‐NoDerivs License, which permits

use and distribution in any medium, provided the original work is properly cited, the use is non‐commercial and no modifications or

adaptations are made.

© 2020 The Authors. Journal of Public Economic Theory published by Wiley Periodicals LLC

downward shift of the MAC curve, whereas MACs may increase for high levels of abatement for

other types of innovation. Perino and Requate (2012) explain that MACs increase for high levels

of abatement when emissions are proportional to output and technological progress reduces

emissions per output. Empirically, Bauman et al. (2008) estimate MACs for sulfur dioxide in

Korea. Their regression results confirm that production process innovations did raise MACs.

This paper considers the incentives of polluting firms to diffuse and adopt a more advanced

abatement technology in a regime with tradeable emission permits. We follow Baker et al.

(2008), Bréchet and Jouvet (2008), Dijkstra and Gil‐Moltó (2018), and Perino and Requate

(2012), among others, in assuming that the advanced technology implies lower (higher) MACs

for large (low) emission levels. More precisely, following Dijkstra and Gil‐Moltó (2018), we

assume that there exists a critical emission level such that marginal technical change starting

from the current state increases (decreases) MACs at emission levels lower (higher) than that

critical level.

1

Regarding the tradeable emission permit scheme, we distinguish auctioning,

benchmarking, and grandfathering.

We analyze a simple framework to focus on selected mechanisms. Specifically, we analyze a

model in which one firm is endowed with advanced abatement technology and may diffuse this

technology to other firms (as in Endres & Friehe, 2011). The firms are interdependent because

they are active in the market for permits, but firms are not interacting on product markets. In

the market for permits, all firms—including the technology leader—are price‐takers. However,

by deciding about the diffusion of the advanced abatement technology, the technology leader

critically influences the other firms' abatement technology and thus the other firms' conduct in

the market for permits. Accordingly, the firm with the advanced abatement technology can

influence the permit price via technology diffusion. While presumably no exact match exists for

our framework in reality, our simplified setup allows us to clearly work out the firms' diffusion

and adoption incentives under the three allocation regimes—auctioning, grandfathering,

and benchmarking—stemming from the firms' concern about their own abatement costs and

permit‐market expenditures/receipts.

We find that the performance of the different regimes of permit allocation is decisively

affected by the way in which technical change influences the MACs. In all regimes, the firm

with the advanced abatement technology at hand will consider the repercussions of technology

transmission for the permit price in equilibrium. For example, under auctioning, every firm

must purchase the permits it needs to cover the emissions that are privately optimal. Accord-

ingly, all firms have an interest in low permit prices. In a setup with generalized technical

change, letting the advanced abatement technology diffuse to other firms can either decrease or

increase the permit price because it may either lower or raise MACs. Therefore, under auc-

tioning, allowing diffusion of the advanced abatement technology will be privately optimal to

the firm with the superior technology only when the MACs of other firms are thereby shifted

downward in the relevant range of emissions.

We contribute to the literature by investigating three different tradeable permit regimes and

how diffusion and adoption incentives depend on whether technical change influences MACs

in a traditional way (i.e., lowers MACs) or in a nontraditional way (i.e., increases MACs). Our

analysis highlights that the adoption incentive under auctioning and benchmarking is always

positive, whereas it may be negative under grandfathering. The diffusion incentive crucially

depends on the sign of the price effect. Whereas a price decrease is advantageous for the

1

Thus, the standard textbook stylization with technical change lowering MAC in the whole emission range is nested by having the critical emission level fixed

at zero for all possible technological states.

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ENDRES ET AL.