2.6.5 Economic efficiency and eventual trade-offs with equity

For more than a decade the literature has covered studies that review the economic efficiency of climate change mitigation policies and, to some extent, also discuss different emission allocation rules and the derived equity consequences (IPCC, 1996, Chapter 11; IPCC, 2001, Chapters 6 and 8). Given that markets for GHG emission permits work well in terms of competition, transparency and low transaction costs, trade-offs between economic efficiency and equity (resulting from the distribution of emission rights) do not need to occur. In this ideal case, equity and economic efficiency can be addressed separately, where equity is taken care of in the design of emission allocation rules, and economic efficiency is promoted by the market system.

In practice, however, emission markets do not live up to these ideal conditions and the allocation of emission permits, both in international and domestic settings, will have an influence on the structure and functioning of emission markets, so trade-offs between what seems to be equitable emission allocations and economic efficiency can often occur (Shukla, 2005). Some of the issues that have been raised in relation to the facilitation of equity concerns through initial emission permit allocations include the large differences in emission permits and related market power that different countries would have (Halsnæs and Olhoff, 2005).