When regulated firms are offered compensation to prevent them from relocating, efficiency requires that payments be distributed across firms so as to equalize marginal relocation probabilities, weighted by the damage caused by relocation. We formalize this fundamental economic logic and apply it to analyzing compensation rules proposed under the EU Emissions Trading Scheme, where emission permits are allocated free of charge to carbon intensive and trade exposed industries. We show that this practice results in substantial overcompensation for given carbon leakage risk. Efficient permit allocation reduces the aggregate risk of job loss by more than half without increasing aggregate compensation.

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Ralf Martin, Mirabelle Muûls, Ulrich J. Wagner and Laure B. de Preux

1 August 2014

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American Economic Review 104(8) , pp.2482-2508, 2014

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DOI: 10.1257/aer.104.8.2482

https://www.aeaweb.org/articles?id=10.1257/aer.104.8.2482

This Journal article is published under the centre's Growth programme.

This publication comes under the following theme: Clean growth