Carbon leakage: Grandfathering as an incentive device to avert relocation

Robert C. Schmidt

Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems from Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich

Abstract: Emission allowances are often distributed for free in an early phase of a cap-and-trade scheme (grandfathering) to reduce adverse effects on the profitability of firms. If the grandfathering scheme is phased out over time, firms may nevertheless relocate to countries with a lower carbon price once the competitive disadvantage of their home industry becomes sufficiently high. We show that this is not necessarily the case. A temporary grandfathering policy can be a sufficient instrument to avert relocation in the long run, even if immediate relocation would be profitable in the absence of grandfathering. A necessary condition for this is that the permit price triggers investments in low-carbon technologies or abatement capital.

Keywords: climate policy; emissions trading; grandfathering; leakage; cap-and-trade (search for similar items in EconPapers)
JEL-codes: Q55 Q58 L51 (search for similar items in EconPapers)
Date: 2010-01
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