Market Power and Hot Air in International Emissions Trading: The Impacts of U.S. Withdrawal from Kyoto-Protocol

Ten years after the initial Climate Change Convention from Rio in 1992 the industrialized world is finally likely to ratify the Kyoto Protocol, which will impose legally binding greenhouse gas emission reductions on the developed world. However, the Kyoto Protocol will enter into force without the U.S., which withdrew under President Bush in March 2001. Accounting for hot air and market power of the Former Soviet Union on emission permit markets, we show that U.S. withdrawal has important consequences on environmental effectiveness, compliance costs, and excess costs of market power under the Kyoto Protocol. Non-compliance of the U.S. implies a dramatic decrease in environmental effectiveness as well as compliance costs of OECD countries whereas the Former Soviet Union and transitional economies in Eastern Europe suffer from a huge decline in permit sales revenues. Excess costs of market power in permit trade increase in relative terms, but decline substantially in absolute terms due to U.S. withdrawal. We quantify policy options to bypass the problems of hot air and market power through compensation mechanisms.

Böhringer, Christoph and Andreas Löschel (2003), Market Power and Hot Air in International Emissions Trading: The Impacts of U.S. Withdrawal from Kyoto-Protocol, Applied Economics 35(6) , 651-664