Flexible climate policy mechanisms and induced technical change

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The author examines the effect of restricting international emissions trading on the development of low-carbon technologies. He extends an integrated assessment model to include endogenous investments in carbon energy productivity. The question of whether or not restrictions on international emissions trading enhance the development of low-carbon technologies is in fact a question of how to distribute abatement efforts and of stringency of the target. Depending on the initial allocation of permits, restrictions on international emissions trading change the burden sharing regime, leading to a re-allocation of investment efforts in fossil fuel productivity. Permit demanding regions raise these investments while permit supplying regions reduce them. The effect in the former dominates the latter in the presence of excessive allocations of permits (hot air) in the trading system. Since the effect on overall welfare in small, the issue is mainly a distributional one.