Abstract
In this paper we incorporate tradable permits in a model of strategic environmental policy as an alternative policy scheme. In particular, we develop an international oligopoly model, where governments issue non-cooperatively a number of permits and then allow their trading by their polluting firms. Permits trading is a dominant strategy and it ensures that welfare is strictly higher than in a situation where permits are non-tradable. When the permits market is efficient, exporting countries have an incentive to tighten regulation in order to enhance their firms’ competitiveness. Allowing for market power in the permits market, the incentive to relax regulation may re-appear, yet it is comparatively weaker relative to the case of non-tradable permits. The benefits of this policy scheme disappear if the governments along with emission permits adopt an emissions subsidy.
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