Grandfathering or benchmarking? The impact of carbon quota allocation rule on the joint emission reduction supply chain

Abstract

The choice of carbon quota allocation rule (CQA rule) is crucial for the efficient operation of cap-and-trade policy. This paper analyses the impact of grandfathering (GF) rule and benchmarking (BM) rule on the joint emission reduction (JER) supply chain by using a differential game approach. In the proposed model, the upstream manufacturer achieves its emission reduction target through green technology and recycling, and the downstream retailer promotes these products. Our results show that compared with the benchmark case, both CQA rules do not always encourage the manufacturer to increase emission reduction investments. Moreover, the environmental and economic performance of different CQA rules is time-varying. For low-emission products, both CQA rules may yield higher total carbon emissions. For medium and high-emission products, the BM rule has a better short-term environmental performance, while the GF rule always has the best long-term environmental performance. As such, the government should prioritise the inclusion of medium and high-emission manufacturers in the carbon trading market and adopt the BM rule at the initial stage, and then transition to the GF rule. We also provide practical insights on the timing of transition, setting free carbon quotas, balancing economic and environmental performance, and dealing with uncertain market changes.