Free emission quotas, capital mobility and international environmental problems

This paper brings together two important questions in environmental policy. The first question is how to solve international environmental problems in a world where environmental policies are implemented by governments at the national level. The second is the question of how the government should allocate emission permits to private agents when environmental objectives are achieved through a system of tradable emission permits. It is shown that when international environmental problems are attempted solved through uncoordinated policies between countries, free emission quotas should be allocated based on domestic capital use in order to prevent leakage effects through international capital movements. The desirability of free emission quotas might however be reduced if there is ample opportunity to employ capital in non-polluting activities. It is also shown that it may be desirable to allocate a negative number of free emission quotas per unit of labour in the polluting sector, and that increased domestic abatement is no substitute for policies that deal with the leakage problem more directly, such as subsidies to internationally mobile production factors.