The Economic Effects of the European Ceilings Proposal

Abstract

Current and prospective EU members have recently proposed a set of guidelines for trade with emissions reductions within the Kyoto Protocol. The European proposal effectively eliminates exports of hot air and limits imports of emissions reductions by Annex B countries to 50% of their total abatement requirement. We analyze the economic effects of the European proposal in the EDGE model, a dynamic multi-region general equilibrium model.

In the short run, the proposal increases the prices for emissions reductions as the elimination of hot air reduces the total supply of emissions reductions. In the longer run, the proposal decreases the prices for emissions reductions as binding ceilings on imports of emissions reductions reduce the demand for emissions reductions.

In comparison with both free Annex B and free global trade, the European proposal increases global welfare costs by 10-15 bn€ per year. Relative to free Annex B trade, the elimination of hot air accounts for most of the cost increases. Relative to free global trade, the large supply of low-cost emissions reductions in non-Annex B countries implies binding import ceilings, which in turn increases global welfare costs.

Neither the EU nor the US experience significant welfare losses. Either because the import ceilings are not binding (the case of Annex B trade), or because binding import ceilings decrease the prices for emissions reductions (the case of global trade). Russia and other countries with exports of hot air lose unambiguously from the proposal, but they lose even more if free Annex B trade is extended to free global trade.