Emissions Trading: Design, Diffusion, and Drawbacks

Emissions trading is a market-based instrument aimed at achieving environmental targets in a cost-effective way by allowing legal entities, primarily firms, to buy and sell emission rights. The limited but steadily growing international diffusion of emissions trading schemes underlines the political relevance of this instrument. There are three basic design variants of emissions trading: cap-and-trade, credit trading, and international offsets. They operate differently in terms of effectiveness, efficiency, and political acceptability. A few greenhouse gas emissions trading schemes have already been linked to increase low-cost abatement opportunities and to work towards a global carbon price. Nevertheless, doubts about emissions trading schemes remain, mainly due to the many implementation problems they face, including an emissions price that is either too volatile or too low to incentivise environmentally-friendly technologies. Despite these drawbacks, emissions trading schemes are functioning with moderate success and continue to spread across the globe.