Environmental regulation incidence towards international oligopolies: pollution taxes vs emission permits

Transcription

1 Environmental regulation incience towars international oligopolies: pollution taxes vs emission permits Florent PRATLONG 22 ERASME an EUREQua Université Paris I Panthon-Sorbonne March, 2004 Preliminary Version Abstract: The purpose of this paper is to analyze whether the choice between two instruments of environmental policy (pollution taxes vs traable emission permits) affects the market shares in the presence of imperfectly competitive prouct markets. We consier two countries, referre to as the omestic country an the foreign country, agreeing on an equally stringent exogenous ceiling on total emissions. These countries are suppliers in the international market of two commoities prouce by two separate sectors competing à-la-cournot. It is further assume that prouction for both inustries is resulting in emissions of a common pollutant. Uner a similar ceiling level on pollution the measures taken by each government, through which environmental regulation is set, are ifferent. The omestic country implements a traable emission permits market, while the foreign country imposes aspecific pollution tax across each sector. As a result, the strategic interaction between the environmental regulatory regimes an international trae inuces a shift in market shares. Thus, the higher-abatement-cost (the lower) sector, regulate through a traable emission approach, in the omestic country increases (ecreases) its market share compare to its counterpart in the foreign country. JEL Classification: D43, F12, L51, Q50 Keywors: International trae, Cournot oligopoly, environmental policy 1 Corresponance: Laboratoire Economie, Ecole Centrale Paris, Grane Voie es Vignes, Châtenay-Malabry ceex, France, Phone: , fpratlong@ecp.fr 2 Acknowlegements to research support from the French Environmental an Energy Agency ADEME. Appreciation is extene to all participants in the EUREQua Environmental an Resources Economics seminar for helpful comments. I am also grateful to Christine Cros, Katheline Schubert an Paul Zagamé for focusing on etails necessary for policy implementation. The usual isclaimer applies. 1

2 1 Introuction Facing climate change problems, the inustrialize parties (known as Annex I parties) collectively ecie, uring the Kyoto conference in 1997, to stabilize their overall emission of greenhouse gases by at least 5,2% below their 1990 levels by the years At international level an particularly at the European one, environmental policies, which might be implemente, may be ifferent from one country to another. They might iverge owning to each country s collective choices an their specific characteristics. Then, it won t be surprising if the environmental regulatory regimes implemente in each country woul be ifferent in their esign an rules. This paper is concerne with the choice of two instruments to implement an emission constraint: pollution taxes or a traable emission permits system. The relationship between inustry oligopoly an environmental regulation has been wiely analyze. Simpson [1995] an Carraro et al. [1996] consiere pollution taxes inciences within Cournot oligopoly on output an profitability. In an international framework, Kenney [1994] an Barrett [1994] evelope a partial equilibrium moel of environmental regulation as strategic inustrial policy. On the other han, first propose by Dales [1968], the permits market represent a system of property rights for the management of environmental pollution. Beyon etermining the optimal level of emission permits, the policy makers face the ifficulty to fin an efficient mechanism of allocating the permits. Inee, the initial allowance of permits issue may lea to competitive istortions between firms on the international market prouct. As note by Van er Laan an Nentjes [2001], there are two interpretations of competitive market istortion concept: as inefficiency in allocation of resources an as inequity of firm s starting conitions. A government might allocate amount of granfathere permits to the omestic inustry whilst the others woul impose pollution taxes to their inustries, operating in the same international prouct market. That s the reason why we can woner as Woerman [2001] if granfathering istribution of permits coul be interprete as a form of implicit subsiization accoring tothewtorulesorasaformof StateAi 3 uner the European Community law (art. 87). In a partial framework Malueg[1990] an Sartzetakis [1997] investigate the interaction between the market for emission permits with an oligopolistic 3 The notion of State Ai is formulate in the Article 87(1) in the Treate of Amsteram as "... any state ai grante by a Member State or through State resources in any form whatsover which istorts or threatens to istort competition by favouring certain unertakings or the procution of certain goo shall, in so far as it affects trae between Member States, be incompatible with the common market" 2

3 prouct market an the comparison with a comman-an-control approach. The paper is organize as follows. Section 2 escribes the framework of the analysis an presents the trae equilibrium moel without any environmental regulation. We focus on Cournot-Nash inustry equilibrium in the two markets with pollution in the omestic country a, a traable emission permits scheme in the foreign country. Then, section 3 evaluates the inciences of the ifferent environmental regulation mechanisms on market shares an profits. Section 4 offers conclusion. 2 The moel There are two countries, inexe by i =, f, referre to as the omestic country an the foreign country respectively. Consier that these countries, constitute by two oligopoly inustries, inexe by j =1, 2, are suppliers in the international market of two ifferent commoities. Each inustry is consisting of a single representative firm. The inustry output of the goo j is enote by q j. It is further assume that all prouction is sol only in a thir country 4. The inverse eman function facing the inustry j is suppose linear such that the market price for the goo j is given by: P j = A j q j q fj.attheworlmarket,firms compete in Cournot-Nash fashion. For convenience each inustry has a constant marginal cost of prouction c j, equal among countries. 2.1 International competition without environmental regulation (the benchmark case) Before assessing the effects of the environmental regulation in these inustries, we characterize first as a reference case a situation in which the government oes not impose any constraint on the aggregate level of emission. Thus, each firm j locate in country i is maximizing its profits, taking as given the ecision of its rival in the other country: Max q ij Π ij =(P j c j )q ij =(A j q j q fj )q j c j q ij for i =, f an j =1, 2 (1) In the trae equilibrium without environmental regulation, the Cournot-Nash 4 This assumption, introuce by Braner an Spencer [1985] in their original moel of strategic trae policy, means that the effects on consumer surplus oes not have to be consiere. 3

4 output an price for the two goos are given by: qij = A j c j 3 Pj = A j + c j 3 an the profit earne by each inustry on the international market is: (2) (3) Π ij =(q ij) 2 (4) where the uperscript ( ) enotes the variables values in the benchmark case. 2.2 International competition with environmental regulation We aress here the issue of regulatory intervention regime to highlight the consequences of introucing ifferent environmental feebacks in the previous international oligopoly moel. Prouction for both inustries is resulting in emissions of a common pollutant, which generate a negative externality. Each inustry emission is increasing with output an is taken to be inversely proportional to the abatement effort. Our specification for polluting emission an abatement activities are base on Kenney [1994] an Nannerup [2001]. Let e ij = q ij a ij enotes the amount of pollutant emitte by inustry j locate in country i, witha ij representing the chosen level of abatement effort. Each inustry is also characterize by an asymmetric cost of abatement function, while a similar technology profile in controlling emissions is assume between country. Emission reuction imposes a cost either to reuce prouction or to unertake emission abatement activities. Firm j s total cost of abatement in country i, enotebyk ij (q ij,a ij )=γ 2 ja ij q ij, is suppose to be a non-ecreasing function of both its arguments. The technological parameter γ j is ifferent across inustry an captures the efficiency in controlling emissions. It enotes the change in inustry j 0 s marginal cost of abatement. Hence, each sector is characterize by a heterogenous cost of abatement profile within the same country an a symmetric abatement cost structure across countries. For simplicity, we assume that inustry 1 is referre to as the lower-abatement-cost sector, in the sense that γ 1 <γ 2 for a given level of output. Therefore inustry 1, having substantially a more efficient technology in abatement activities, is facing a lower expenitures in reucing emission ischarges. An international environmental agreement imposes a similar target level Ē = Ē = Ē f on pollution to these countries. However the measures taken by each 4

5 country, through which this level is achieve, are ifferent. The omestic country implements an economic incentive mechanism through a granfathering traable emission permits system., whereas the foreign country imposes a specific-inustry pollution tax across firms in a form of a ifferentiate emission tax per unit of waste ischarge in the global environment. Consier now, in this framework capturing the issue of ifferences in regulatory regime, the trae equilibrium to focus on output reistribution effects an on istortion of competition between countries The home country (traable emission permits) The home regulator aims at reucing emission to the target Ē efine in the International Environmental Agreement an implements a traable emission permits market. This latter approach requires all polluting inustries to obtain emission permits for the quantity of pollutant release. Each emission permits are istribute free of charge to the two omestic inustries by initiating a granfathering system, which allocates permits on the basis of their historic pre-regulation level of emissions. Inustry j is receiving an initial allocation of permits enote by ē j for j =1, 2. The total enowment of permits is equal to the aggregate emission ceiling set by the home regulator, efine as. e 1 + e 2 = Ē. After the initial allocation, inustry j s net eman for permits is etermine by NE j = e j ē j. Then, trae of permits is authorize. Now firm j choosing its output an abatement level maximizes its profits, taking the permits price p pen as given, accoring to: Max Π j = P j q j K j (q j,a j ) c j q j p pen q j,a (e j ē j ) (5) j Max Π j = (A j q j q fj )q j c j q j γ 2 q j,a j ja j q j p pen ( q j ē j ) (6) a j The necessary an sufficient first-orer conitions for the profit-maximizing choice of prouction q j an of abatement efforts a j imply: Π j = A j 2q j q fj c j γ 2 q ja j ppen =0 (7) j a j Π j = γ 2 a jq j + ppen j a 2 j q j =0 (8) 5

6 Equation (3) shows that the initial enowment of permits oesn t affect sector j s marginal ecision because the permits price is consier as given. So far, the latter conition in equation (4) points out the optimality rule such that inustry j traes permits until its marginal cost of abatement equals the opportunity cost of holing. Uner this conition, the permit price, reflecting the global emission target, provies the correct incentive for inustries to arrange emission levels. Solving equation (4) yiels the following abatement effort ā j in inustry j: an aitional permits, measure by the permits price p pen ā j = p p pen γ j for j =1, 2 (9) This result implies that in equilibrium, uner a traable permits market, the two inustries marginal cost of abatement is equal to the permits price. As γ 1 <γ 2, then ā 2 < ā 1. The low-abatement-cost sector 1, whose marginal cost of abatement is lower, unertakes more emission reuctions an sells its permits to the higherabatement-cost sector 2. Moreover, equalization of marginal abatement cost yiels to the efficient istribution of abatement effort across inustries in the home country. Rearranging conition (3) an (4), we obtain inustry j s best reaction function. This reaction function is erive for a given permits price. If the omestic permits price is reuce, the firms reaction function is shifte outwars. q j = r j (q fj )= 1 q 2 [A j 2γ j p pen c j q fj ] for j =1, 2 The above remarks emonstrates that both market eman an cost function are moifie by the introuction of environmental taxes The foreign country (Pollution taxes) The foreign regulator imposes a specific-inustry tax rate per unit of waste release in the global environment in orer to implement the International Environmental Agreement regaring the emission target Ē. Let t fj efine the specific pollution tax for inustry j. This assumption of ifferentiating tax uties among the two foreign inustries reflects the consieration of realistic environmental policy on tax exemption requirement (OECD [1999]) or the incentive to aopt strategic environmental policy for controlling pollution (Nannerup [2001]). As inustry 1 is assume 6

7 to be more efficient than inustry 2 in controlling emissions, ie. γ 1 <γ 2,theforeign regulator ecie to levy a lower tax for this former inustry, then t f1 <t f2. Each firm j, confronte with t fj, chooses output an abatement level by maximizing its profit: Max Π fj = P j q fij c j q fj K fj (q fj,a fj ) t fj e fj for j =1, 2 (10) q ij,a ij Max Π fj = (A j q j q fj )q fj c j q fj γ 2 q fj q ij,a ij ja fj q fj t fj (11) a fj The first-orer necessary conition for Cournot-Nash equilibrium choice of output an abetment can be written as: Π fj = A j 2q fj q j c j γ 2 q ja j t fj =0 (12) fj a fj Π fj = γ 2 a jq fj + t fjq fj =0 (13) fj a 2 fj From equation (13), we obtain the level of pollution abatement in the Cournot- Nash equilibrium for inustry j: a fj = tfj γ j for j =1, 2 (14) Uner a given inustry-specific tax rate, we erive the following reaction function for inustry j: q fj = r fj (q j )= 1 2 [A j 2γ j p tfj c j q j ] for j =1, 2 (15) Trae equilibrium Uner Cournot-Nash competition, trae equilibrium implies: q j = qj + 2γ q j 3 (p t fj 2 p tep ) (16) q fj = q fj + 2γ j 3 ( q p tep P j = P j + 2γ j 3 (p t fj p t fj ) q (17) p tep ) (18)

8 where the uperscipt ( ) enotes the variables values at the trae equilibrium with environmental regulation. Comparison of equation (2)-(3) an (16)-(18) reveals how environmental regulation affects inustry j s level of output compare to the pre-regulation level. Π j = 1 9 Π fj = 1 9 A j c j +2γ j ( p q ) 2 t fj 2 p tep + p tep q A j c j +2γ j ( p tep 2 p 2 t fj ) ēj (19) (20) Replacing these optimal values of inustry s ecision variables in clearing conition of emission permits market, P 2 q j j=1 a j = Ē, we obtain the following equilibrium permits price. p tep = γ1 (A 1 c 1 )+γ 2 (A 2 c 2 )+2t f1 γ t f2 γ 2 2 3Ē +4γ2 1 +4γ (21) Permits price epens on the aggregate emission stanar level Ē an remains inepenent from the moe if initial istribution. This is not surprising because both inustry are price takers in permits market an their permits enowment are exogenous. The equilibrium permits price is increasing with the value of ifferentiate tax in the foreign country. Uner a TEP regulation, since inustry 1 is more efficient in controlling emissions, which yiels a lower implicit price in the case of ifferentiate pollution tax, with t f1 <t f2. Therefore in the omestic country, both inustry will have a strong incentive to trae permits at a price p tep, such that t f1 <p tep <t f2. In fact, traing of emission permits implies reistribution of emission abatement activities from the less to the more efficient inustry in the omestic country. Then, inustry 1 increases its abatement per unit of output, an thus its marginal cost of abatement. The two inustry trae permits to the point that marginal costs are equalize. The reistribution of emission control effort has two effects. First, aggregate cost of abatement for a given level of output ecreases. Secon, market share is reistribute between firms in the international market. 8

9 3 Interpretation an comments Let s now take a closer look at market share shifting effect. The effect of ifferences in environmental regulatory regimes on the trae equilibrium is illustrate in the following tow figures. Since environmental regulation increases marginal cost of each inustry, firm s reaction function are shifting ownwars. However, the effect of environmental regulation on market shares are ifferent. Proposition 1 The higher-abatement-cost (the lower) sector, regulate through a traable emission approach, in the omestic country increases (ecreases) its market share compare to its counterpart in the foreign country. Market share inciences Inustry 1 The lower-abatement-cost sector Inustry 2 The higher-abatement-cost sector Domestic country Emission permits & % % & Foreign country Pollution taxes As t f1 <p tep <t f2, marginal cost of inustry 1 in the omestic country increases more than its foreign rival. Then, inustry 1 s reaction function shifts more inwars than its foreign competitor while the le contrainre s applique pour l autre inustrie. In the omestic country, inustry 1 s output ecreases while inustry 2 increases its output level compare to the pre-regulation equilibrium. 9

10 q f1 r 1 r f1 q 1 q f2 r 2 r f2 q 2 It appears that the omestic inustry, regulate by a granfathering permits system, on t nee to acquire their emission up to permits initial enowment contrary to the foreign inustry regulate by a specific pollution taxes. Since the granfathere inustry obtains a winfall profit in the form of a capital gift, the granfathering emission permits imply a competitive istortion. Thus, the omestic inustries have more financial resources, than its foreign competitor abroa. It can be argue that 10

11 the international ifferences in environmental regulation change inustry s starting conition inucing an inequitable istortion of trae patterns. Proposition 2 Granfathering permits can be regare as State Ai, in the sense that it grants a lump-sum subsiy to the inustry since the initial allocation implies a financial avantage to the two omestic inustries. Nevertheless a granfathering emission permits system may not alter trae efficiency because granfathering permits have an opportunity cost, which is equal to the permits price. Inee, granfathering permits are use for covering the emissions of the permits owners. Instea of using them, the omestic inustry coul have sol them. From this perspective, granfathering permits oes not istort efficiency as its opportunity costs is also reflecteintheprouctprice. 4 Conclusion This paper has shown that if the environmental regulator in the omestic an the foreign country aopt ifferent regulatory regime to control emissions, then competitionintheinternationalprouctmarketisistorte. Thisargumentcansupporta claim that governments may engage in environmental policy coorination to prevent from altering global international trae conitions. 5 References Braner an Spencer [1985]: "Export subsiies an international market share rivalry", Journal of International Economics, n 18 : Cramton P. an S. Kerr [2002]: " Traeable carbon permit auctions: How an why to auction not granfather", Energy Policy, Volume 30, Issue 4, March 2002, Pages Fischer C., S. Kerr an M. Toman [1998]: "Using emission traing to regulate U.S greenhouse gas emissions: an overview of policy esign an implementation issues", Resources for the Future, Discussion paper 98-40, Washington D.C. Gouler L. H. an L. Bovernberg [1996]: "Revenue-raising vs. other approaches to environmental protection: the critical significance of pre-existing tax istortions". NBER working paper 5641, Cambrige MA 11

12 Kling C. L. an J. Zhao [2000]: "On the long-run efficiency of auctione vs. free permits", Economics Letters, n 69 : Kenney, P. W. [1994]: "Equilibrium pollution taxes in open economies with imperfect competition", Journal of Environmental Economics an Management, n 27 : Nannerup, N. [2001]: "Equilibrium pollution taxes in a two inustry open economy", European Economic Review, n 45 : Malueg, D. A. [1990]: "Welfare consequences of emission creit traing programs", Journal of Environmental Economics an Management, n 19 : Pratlong, F. [2003]: "Plan stratégique allocation es permis émission négociables", Cahiers e la MSE n , Série Verte, Université Paris 1 Panthéon- Sorbonne Sartzetakis, E. S. [1997]: "Traeable emission permits regulations in the presence of imperfectly competitive prouct markets: welfare implications", Environmental an Resource Economics, n 9:65 81 Van er Laan R. an A. Nentjes [2001]: Competitive istortions in EU environmental legislation: inefficy vs inequity, European Journal of Law an Economics, n 11(2) : Woerman E. [2001]: Developping a European carbon traing market: will permit allocation istort competition an lea to state ai, Nota i Lavaro n , Fonazione Eni Enrico Mattei. 12