Florent Pratlong ERASME, Ecole Centrale Paris. EUREQua and PRISM LASI, Université Paris 1. Abstract

Transcription

1 Environmental regulation inciences towars international oligopolies: pollution taxes vs emission permits Florent Pratlong ERASME, Ecole Centrale Paris. EUREQua an PRISM LASI, Université Paris 1. Abstract The purpose of this paper is to analyze whether the choice between two instruments of environmental policy (pollution taxes vs emission permits) affects the market shares in the presence of imperfectly competitive prouct markets. We consier two countries, referre to as the Domestic country an the Foreign country, agreeing on an equally stringent exogenous ceiling on pollution. These countries are also suppliers on the international markets of two commoities prouce by two separate sectors competing àlacournot. The environmental policy taken by each government is ifferent. The Domestic country implements a traable emission permits market, while the Foreign country imposes a specific pollution tax across sectors. Thus, the HigherAbatementCost (the Lower) sector in the Domestic country increases (ecreases) its market shares compare to its counterpart in the Foreign country. Acknowlegements to research support from the French Environmental an Energy Agency ADEME. Appreciation is extene to an anonymous referee an the associate eitor (Hieo Konishi) for their constructive comments an suggestions. I am also grateful to Brigitte Desaigues, Christine Cros, Céline Maximin an Paul Zagamé for focusing on etails necessary for policy implementation. The usual isclaimer applies. Citation: Pratlong, Florent, (2005) "Environmental regulation inciences towars international oligopolies: pollution taxes vs emission permits." Economics Bulletin, Vol. 17, No. 6 pp Submitte: March 9, Accepte: March 9, URL: 05Q20002A.pf

2 1 Introuction The evelopment of environmental regulation is regare as an important policy concerninifferent countries. At the international level environmental policies, which might be implemente, may be ifferent from one country to another. They might iverge owing 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. Hence, Dijkstra [1999] emonstrates that ecisions in environmental policy are base on public-choice consierations an are heavily influence by the pleaings of special-interest groups, which result to the ifferent environmental regulations applie. This paper is concerne with the choice of two instruments to implement an emission constraint: pollution taxes or a traable emission permits (TEP) system. The relationship between inustry oligopoly an environmental regulation has been wiely analyze. Simpson [1995] an Carraro et al. [1996] consier pollution taxes inciences within Cournot oligopoly on output an profitability. In an international framework, Barrett [1994] evelope a partial equilibrium moel of environmental regulation stanars as a strategic inustrial policy - ealing with the concept of "ecological umping". In a partial framework Malueg [1990] an Sartzetakis [1997] also investigate the interaction between the market for emission permits with an oligopolistic prouct market an the comparison with a comman-an-control (CAC) approach. In the past, comman an control measures were mainly use to regulate pollution but more recently ecological taxes an emission permits have been implemente. The public choice approach aress the motivations of this wier acceptance for the use of market-base instruments in environmental policy. Use as policy instruments for regulating emissions, environmental market-base instruments (iscriminate pollution taxes or emission traing) have attracte inee much attention in many countries in orer to introuce more flexibility on pollution control. Actually, pollution taxes are implemente in a ifferentiate way between sectors for strategic exemption consierations. On the other han, a traable permits market represents a system of property rights for the management of environmental pollution. Beyon etermining the optimal level of emission permits, 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 an inefficiency in allocation of resources an as an inequity of firms starting conitions. A government might allocate emission permits to its omestic inustries, whilst the other woul impose pollution taxes to its inustries, operating in the same international prouct market. This is the reason why we can woner as Woerman [2001] if granfathering istribution of permits coul be interprete as a form of implicit subsiization accoring to the WTO rules or as a form of "State Ai" 1 uner the European law. 1 The notion of State Ai is formulate in the Article 87(1) in the Treate of Amsteram as "... 1

3 This paper intens to analyze the strategic trae implications of alternative choices for environmental instruments (pollution taxes vs emission permits). Over last ecae, pollution taxes have inee often be implemente in a ifferentiate way (OECD [1994], [1999]) between inustries ue to istributional concerns, leackage incentives or strategic trae consierations. This iea has been analyze in Hoel [1996]. He investigates the optimal tax ifferentiation across inustries. Nannerup [2001] consiers also environmental tax ifferentiation as a strategic environmental policy to extract foreign rents in an international prouct market. Sartzetakis an Constantatos [1995] examine how country s choice of environmental regulation (comman-an-control or permits) affects trae patterns. This paper iffers from these previous stuies as it compares in an international framework the implications of ifferentiate taxes vs emission permits. Our result are similar to Sartzetakis an Constantatos [1995] with a ifferentiate tax instea of using a CAC regulation. The shift of prouct market shares operates also when a country uses a price incentive for emission control (represente by pollution taxes) compare with a irect regulation (CAC). However marketbase instruments for pollution control is actually more commonly use an this paper reflects the public choice preferences. Pollution taxes introuce also more flexibility for a lower abatement cost inustry to increase its market share than in a CAC approach. Our work suggests that a high abatement cost inustry (regulate through a traable permits system) can increase its market shares compare to its rivals (regulate through pollution taxes system). Thereverseappliesforalow abatement cost inustry. It follows that a permits system is not always beneficial for each inustry. The paper is organize as follows. Section 2 escribes the framework of the analysis an presents the trae equilibrium moel without any environmental regulations. We focus on the Cournot-Nash inustry equilibrium on the international markets with pollution regulate in a Domestic country with ifferentiate pollution taxes an a traable emission permits scheme in the Foreign country. Then, section 3 consiers the inciences of the ifferent environmental regulation mechanisms on market shares an profits. Section 4 offers conclusion. 2 The moel Consier two countries, inexe by i =, f, referre to as the Domestic country an the Foreign country respectively. Each country is constitute by two oligopoly inustry sectors, inexe by j =1, 2, which are the sole suppliers on the international market of ifferent commoities. Each inustry is consisting of a single representative firm. Denote by q ij the output level of firm j locate in country i. Itisfurther assume that all prouction is sol for export in a thir country, in which inverse 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 prouction of certain goo shall, in so far as it affects trae between Member States, be incompatible with the common market". 2

4 eman is assume linear of the form: P j = A j q j q fj. The competition on thesieofeachexportingfirms is à-la Cournot-Nash. Firm ij faces a total cost of prouction C ij (q ij )=c j q ij,wherec j is a technological parameter representing the constant marginal cost of prouction in inustry j equal across oligopolists in the same sector an locate ifferent countries. 2.1 Trae equilibrium without environmental regulations Consier, as the benchmark case, a situation in which governments on t impose any constraints on the aggregate level of emissions. Thus, each representative firm j locateincountryi 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. In the trae equilibrium without any environmental regulations, the Cournot- Nash level of output, the level of price an the profit earnebyeachfirm in the international prouct market are respectively given by: q ij = A j c j 3, P j = A j+c j 3 an Π ij =(q ij) 2 (1) where the uperscript ( ) enotes the variables values in the benchmark case. 2.2 Trae equilibrium with environmental regulations Let s now turn to the trae equilibrium with environmental regulation. We aress here the issue of the regulatory intervention regime to highlight the inciences of introucing ifferent environmental feebacks in the previous moel. Suppose prouction for both inustries is resulting in emissions of a common pollutant, which generates a negative externality. The emissions in each inustry increase with the level of output an are taken to be inversely proportional to the level of abatement efforts. Our specification for the polluting emissions an the 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 interprete as the chosen outputemission ratio in inustry j. The emission reuction imposes a cost to unertake emission abatement activities. Firm j s total cost of abatement in country i, enote by K ij (q ij,a ij )=γ 2 ja ij q ij, is suppose to be a non-ecreasing function in both of 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 smarginal 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 refers to the Lower- Abatement-Cost (LAC) sector an inustry 2 to the Higher-Abatement-Cost (HAC) 3

5 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, faces a lower expenitures in reucing emission ischarges. An international environmental agreement imposes a similar target level on pollution Ē = Ē = Ē f to these countries. However the measures taken by each country, through which this level is achieve, are ifferent. The Domestic 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. In this framework consier now the international trae equilibrium to focus on output reistribution effects an on istortion of competition between countries The Domestic country: the traable emission permits case The Domestic regulator aims at reucing its emissions to the target Ē efine in the international environmental agreement an implements a traable emission permits (TEP) market. This latter approach requires all polluting inustries to obtain emission permits for their quantity of pollutant release. 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 receives an initial allocation of permits enote by ē j for j =1, 2. The total enowment of permits is equal to the aggregate emissions ceiling set by the omestic regulator, efine as e 1 + e 2 = Ē. After the initial istribution, 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 level of output an abatement effort, maximizes its profits taking the permits price p pen as given accoring to: Max q j,a j Π j = P j q j K j (q j,a j ) c j q j p pen (e j ē j ) (2) 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 (3) j a j Π j = γ 2 a jq j + ppen j a 2 j q j =0 (4) In equation (3), the initial enowment of permits oesn t affect sector j s marginal ecision since the permits price is consiere as given. As pointe out in the latter conition of equation (4), inustry j traes permits until its marginal cost of abatement is equal to the opportunity cost of holing an aitional permits, represente by the permits price p pen. This price reflects inee the global emission 4

6 target. Thus, this optimality rule leas to the fact that the permits price provies the correct incentive for inustries to arrange their emission levels. From equation (4), the following abatement effort in inustry j yiels to: ā j = p p pen γ j for j =1, 2 (5) Uner a traable permits market these conitions imply that, in equilibrium, the two inustries marginal costs of abatement are equal to the permits price. As γ 1 <γ 2, then ā 2 < ā 1. The LAC sector (whose marginal cost of abatement is lower) unertakes more emission reuctions an sells its permits to the HAC sector 2. Moreover, equalization of marginal abatement costs yiels an efficient istribution of abatement efforts across inustries in the Domestic country. We obtain inustry j s best reaction function by rearranging conitions (3) an (4). This reaction function is erive for a given permits price. If the omestic permits price is reuce, the omestic 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 (6) The above remarks emonstrates that both market eman an cost function are moifie by the introuction of a traable emission permits regulation The Foreign country: the pollution taxes case The Foreign regulator imposes a ifferentiate specific-inustry tax rate per unit of waste release regaring its emissions target Ē. Lett fj enote 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 [1994,1999]) or the incentive to aopt strategic environmental policy for controlling pollution (Nannerup [2001]). As inustry 1 -the LAC sector - is assume to be more efficient than inustry 2 - the HAC sector - in controlling emissions (ie. γ 1 <γ 2 ) the foreign regulator ecies to levy a lower tax for this former inustry. Then, t f1 <t f2. Confronte with t fj, each firm j chooses its level of output an abatement efforts by maximizing its profit: Max q ij,a ij Π fj = P j q fij c j q fj K fj (q fj,a fj ) t fj e fj for j =1, 2 (7) The first-orer necessary conition for Cournot-Nash equilibrium choice of output an abatement can be written as: Π fj = A j 2q fj q j c j γ 2 q ja j t fj =0 (8) fj a fj Π fj = γ 2 a jq fj + t fjq fj =0 (9) fj a 2 fj 5

7 From equation (9), we obtain the level of pollution abatement in the Cournot- Nash equilibrium for inustry j as: a fj = tfj γ j for j =1, 2 (10) Uner a given inustry-specific taxrate,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 (11) The foreign reaction function for inustry j is ecreasing with the foreign environmental specific tax rate Trae equilibrium Uner a Cournot-Nash competition in each international proucts market j =1, 2, the trae equilibrium implies: q j = qj + 2γ q j 3 (p t fj 2 p tep ) (12) q fj = q fj + 2γ j 3 ( q p tep P j = P j + 2γ j 3 (p t fj + 2 p t fj ) q (13) p tep ) (14) where the uperscipt ( ) enotes the variables values at the trae equilibrium with environmental regulations. Comparison of equations (1) an (12)-(14) reveals how environmental regulations affect inustry j s output compare to its preregulation level. The permits price is etermine by the market clearing conition: P 2 q j j=1 a j = Ē. p tep = γ1 (A 1 c 1 )+γ 2 (A 2 c 2 )+2t f1 γ t f2 γ 2 2 3Ē +4γ γ 2 2 The equilibrium permits price epens on the aggregate emission stanar level Ē an remains inepenent from the initial istribution between inustries. This is not surprising since each inustry is price taker in the permits market an their permits enowments are exogenous. The equilibrium permits price also increases with the value of the ifferentiate taxes in the Foreign country. In the Domestic country, both inustries have an incentive to trae their permits at a price p tep. In fact, traing of emission permits in the Domestic country implies a reistribution of abatement activities from the less efficient sector - the HAC inustry - to the more efficient sector - the LAC inustry. This latter inustry 2 (15) 6

8 increases its abatement per unit of output an, thus, its marginal cost of abatement. The omestic inustries trae permits until equalization of their marginal cost of abatement. Since the omestic HAC sector (regulate through a TEP system) is less efficient in controlling its emission, it faces a lower implicit price for pollution p tep than with a regulation through pollution taxes, such that p tep <t f2. The same relation applies to the LAC sector. Hence, it follows that the permit price is between the higher an the lower pollution tax, such that t f1 <p tep <t f2. This reistribution of emission control efforts among the omestic inustries has two effects. First, the aggregate cost of abatement for a given level of output ecreases. Secon, market shares are reistribute between firms in the international proucts market. 3 Interpretation an comments At this stage, let s have a closer look at the market shares shifting effect. The incience of ifferences in environmental regulatory regimes on the trae equilibrium is illustrate as follows. Since environmental regulations increase marginal cost of each inustry, firm s reaction function are shifting ownwars. However, the effect of environmental regulations on market shares are ifferent in each inustries. Proposition 1 The omestic HAC (the LAC) sector, regulate through a traable emission approach, in the Domestic country increases (ecreases) its market shares compare to its foreign counterpart. As t f1 <p tep <t f2, marginal cost of the omestic LAC inustry increases more than its foreign rival. Then the LAC inustry s reaction function shifts more inwars than its foreign competitor, while the reverse applies in the HAC inustry. The level of output in the omestic LAC inustry ecreases while the omestic HAC inustry increases its level of output compare to the pre-regulation equilibrium. Compare to Sartzetakis an Constantatos[1995], this result shows that a traable permit system oes not systematically shift international trae patterns in favor of the omestic inustry. It appears also that omestic inustries, regulate by a granfathering permits system, on t nee to acquire their emission level up to their initial permits enowment contrary to the foreign inustry regulate by a specific pollution tax. Since the granfathere inustry obtains a winfall profit in the form of a capital gift, the omestic permits system implies a competitive istortion. Thus, the omestic inustry has more financial resources than its foreign competitor. It can be argue that the international ifferences in environmental regulations change inustry s starting conition, inucing thus an inequitable istortion in trae patterns. From equation (2) an (12)-(14), the profits earne by each inustry j =1, 2 in the Domestic an the Foreign country are given by: Π fj = 1 9 q A j c j +2γ j ( p tep 2 p 2 t fj ) (16) 7

9 Π j = 1 9 A j c j +2γ j ( p q ) 2 t fj 2 p tep + p tep ēj (17) Proposition 2 Granfathering permits can be regare as "State Ai, in the sense that it grants a lump-sum subsiy to the omestic inustries since the initial allocation implies for them a financial avantage. Nevertheless, a granfathering emission permits system may not alter trae efficiency, since granfathering permits generate an opportunity cost 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 itsopportunitycosts isalsoreflecte in the prouct price. These interpretations are only vali when the Foreign country implements iscriminate pollution taxes across inustries for exemption concerns. In the case of a uniform pollution tax, market shares among countries wouln t have been moifie since the foreign permits price woul be equal to the pollution tax rate. Then, eviating from a uniform environmental tax an implementing ifferent market-base instruments to control pollution have istributional implications in the international proucts market. 4 Conclusion This paper has shown that if the environmental regulators in the Domestic an the Foreign country aopt ifferent regulatory regimes to control emissions, then competition in the international proucts market is istorte. This argument can support a claim that governments may engage in environmental policy coorination to prevent from altering global international trae conitions. 5 References Barrett S. [1994]: "Strategic Environmental Policy an International Trae", Journal of Public Economics; n 54(3) : Carraro C. an A. Soubeyran [1996]: "Environmental taxation, market share an profits in oligopoly", Environmental Policy an Market Structure, Carraro C., Y. Katsoulakos an A. Xepapaeas (es), Kluwer Acaemic Publishers. Dijkstra B.R. [1999]: The Political Economy of Environmental Policy: A Public Choice Approach to Market Instruments, Ewar Elgar Publisher. Kenney P. [1994]: "Equilibrium pollution taxes in open economies with imperfect competition", Journal of Environmental Economics an Management, n 27 :

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