Potential integration of Chinese and European emissions trading market: welfare distribution analysis

Abstract

Central to the aims of the Paris Agreement, an integrated carbon market could potentially be a practical bottom-up option for effective and efficient mitigation. This paper quantifies the welfare effects of integration of Emission Trading Scheme (ETS) between the European Union (EU) and China. Using the European version of the computable general equilibrium model GEMINI-E3, our assessment reveals that integrating trading markets benefits both regions through the decrease welfare costs from abatements. China’s welfare improves through net gain of selling the allowance, while the EU experiences lower deadweight loss. This effect is stronger to some notable countries in the EU, with high energy-intensive industries such as Poland and the Czech Republic. While a few others, such as Netherlands and Ireland, face higher welfare costs from negative trade gain. Limiting the trade quotas to 40% captures most of the EU welfare gain coming from CO2 trading. Further analysis at the sectoral level reveals that market integration significantly minimizes the loss of competitiveness of European energy-intensive industries and reduces international leakage. Our finding thus confirms the potential of the emissions trading market as an effective instrument to facilitate multilateral coordination in global mitigation.