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Public Policy: Using Market-Based Approaches ● ‘cost-minimising’ (profit maximising) manipulations, which implies the ability to influence the transaction price of traded permits. A monopolistic seller sets the price at the level which maximises the difference between revenues from permits sales and its abatement costs. Similarly a monopolistic buyer manipulates the price in order to minimise the sum of expenditures from permits purchases and its abatement costs. In most cases, exclusionary manipulation is not a feasible strategy. In most markets for emissions trading, participants come from a very wide range of economic activities. This means that a new entrant into a given sector can obtain tradable permits from firms outside its own sector, which have no incentives to withhold the permits from the new entrant. 225 In practice therefore, an exclusionary manipulation strategy will be difficult to pursue. 226 However, the cost-minimising manipulation strategy could arise if either dominant buyers or dominant sellers could exercise their market power and thus alter prices. For instance, a dominant seller may set a high price and sell fewer permits than under competitive conditions. 227 In such a case emissions trading will not deliver the economic efficiencies expected, since the permit price would reflect market power and not the cost of pollution abatement. Firms would therefore be induced to undertake emission reduction strategies that are not cost effective. Hahn (1984) and Weskog (1996) predict that a dominant seller, or a coalition of them, would withhold supply from the market, resulting in smaller aggregate cost savings than if the market had been competitive. 228 However, Carlén (2003) in an experimental analysis focusing on the end of the emissions trading period, shows that in a dual auction market, where a dominant trader faces an opposite side of the market that is fairly competitive, the presence of a dominant trader does not affect market efficiency. 229 A possible way to prevent the exercise of market power is to extend the size of the trading market. The greater the trading market, the lower the problems of concentration. This can be achieved by extending trading on an international basis, perhaps with aggregate caps at an industry level. 230 Burniaux (1999) and Bader (1996), following Hahn (1984), find that international-level trading would greatly minimise the risk of market power. 231 225 See Baron (2000) 226 Westkog (1996) shows that an exclusionary manipulation may be unlikely even in the case that governments and not firms where the main traders, since conflicting interests by different firms within a country would make difficult for countries to arrive to an effective exclusionary manipulation. Westkog H. (1996) ‘ Market Power in a System of Tradable CO Quotas’. The Energy Journal, Vol. 17, No 3. 2 227 In the same way a monopsonistic firm may set the permit price lower compared with the competitive scenario and abate too much (buy too few permits) relative to the competitive case. 228 Hahn R.W.(1984), ‘ Market Power and Transferable Property Rights’, Quarterly Journal of Economics 99, pp 753-65. 229 Carlén B, ‘ Market Power in International Carbon Emissions Trading: A Laboratory Test. Global Change, MIT Report No. 96, January 2003. 230 ABARE (1995) Global Climate Change: Economic Dimension of a Cooperative International Policy Response beyond 2000, ABARE, Canberra. 231 Bader P. (1996): Emissions trading; country-model vs. industry-model’. Chair of Economics, University of Augsburg, Germany. 190
Taxes and subsidies MARKET FAILURES Buchanan (1969) shows that introducing a Pigouvian tax on a monopolist could reduce social welfare rather than improve it, even if it led to a reduction in pollution. 232 In the absence of an externality, monopolists restrict output to below socially optimal levels already. Taxing emissions would lead to further restrictions in output, and so could lead to welfare losses. However, this problem may be overstated as others have found that the welfare effects of output restrictions are likely to be less than the gains from reducing emissions even in the absence of perfect competition. 233 Lee (1975) and Barnett (1980) suggest a unit tax on emissions at a lower level than the unit tax for a perfectly competitive polluter to account for the output effect of the tax. The more price elastic the demand, the closer this second best tax will be to the perfectly competitive tax. This results occurs because, where demand is more elastic, distortions are reduced and the resulting output loss will be lower. MEASURING EMISSIONS Section 12 – Issues in the implementation of market mechanisms If emissions cannot be measured directly, the alternative may involve taxing an input or output closely related to pollutant emissions. 234 As a second best solution, this approach suffers a number of drawbacks. Because input taxes do not target emissions directly they may not provide the right incentives to reduce pollution using the most cost-effective method. For example, if firms do not have access to suitable less-polluting substitute inputs, the tax will only lead to higher producer costs with no discernible environmental impact. Even if a suitable input is available, an input tax suffers the drawback that it does not encourage investment in pollution abatement technology and so will not act as a stimulus to pollution-reducing innovation. 235 Furthermore, it may be difficult to distinguish between those usages of an input that contribute to pollution and those that do not. As an input tax would apply equally to all uses, this would result in suboptimal production of the non-polluting good. Input and output taxes may also lead to the standard problems of second-best taxation policy, in which an attempt to use a tax to correct an externality pushes the market even further away from its optimum because of additional distortions in the market being 232 Buchanan, J. (1969). ‘External Diseconomies, Corrective Taxes, and Market Structure,’ American Economic Review 59(1). 233 Oates, W. and N. Strassman, (1984), ‘Effluent Fees and Market Structure’, Journal of Public Economics 24(1). Asch, P. J. Seneca, (1976), Monopoly and External Cost: An Application of Second Best Theory to the Automobile Industry,’ Journal of Environmental Economic Management 3(2). 234 For papers on the use of input taxes for non-point pollution control see Griffin, R and D. Bromley (1982) ‘Agricultural Runoff as a Non-point Externality: A Theoretical Development’, American Journal of Agricultural Economics and Shortle,J. and J. Dunn (1986) ‘The Relative Efficiency of Agricultural Source Water Pollution Control Policies’, American Journal of Agricultural Economics 68. 235 See Blackman, A. 1999. ‘Informal Sector Pollution Control: What Policy Options Do We Have?’ Discussion Paper 00-02-REV, Resources for the Future 191
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DTI ECONOMICS PAPER NO.14 Public Po
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DTI ECONOMICS PAPER NO.14 Public Po
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Contents Acknowledgements vi Forewo
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Contents Section 11 Emissions Tradi
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Foreword There is increasing intere
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SECTION 1 Introduction and summary
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Public Policy: Using Market-Based A
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SECTION 2 Using market mechanisms U
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SECTION 3 Lessons for the design an
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SECTION 4 Introduction This part of
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SECTION 7 Market-Based Mechanisms W
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SECTION 8 Framework for assessing m
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Part IV Case Studies 73
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● the Green and White papers behi
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A prison failing to deliver on its
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Table 9.3 Companies providing priso
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Section 9 - Competitive Tendering o
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detect any deviation from a collusi
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at HMPS began as an equal mix of th
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(e.g. lighting). This impact could
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MARKET POWER The full benefits of c
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However, it should be noted that te
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on competition is uncertain. The ab
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Controlling for problems of asymmet
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Procurement process design One way
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however, financial deductions are m
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The Independent Monitoring Board at
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Figure 9.1: Difference between the
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‘While there were staff in the pu
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design the invitation to tender and
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and demand conditions. Second, we d
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DEMAND Anyone can apply to a local
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● Rent deposit guarantee by the l
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The Green Paper stated the Governme
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It was not an objective of ODPM or
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DESCRIPTION OF MARKET MECHANISM The
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Once the outcome is determined, fee
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DEVELOPMENTS OVER TIME The major mo
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Concerns about capacity constraints
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from those already located within t
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In several areas, registrations by
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Controlling for information problem
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extent though, it was competition b
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