Multistage Investment Actions with the Emission Cap

Abstract

To achieve the emission reduction target in 2020, China plans to establish a nationwide carbon trading market during 2016-2019. It is therefore an important but difficult task for policymakers to set emission allowances and allocate them among entities. There are three alternative allocation rules, which vary from free of charge to full auctioning. For business managers, the question is whether one of these rules meets the emission cap at the minimum cost. Based on China's emission-abatement target, this paper examines the optimal investment and analyzes its implementation in different allocation rules. A new model is developed to formulate enterprises' emission reduction pathways and the cost-minimization problem with the emission cap. The results show that the magnitude of enterprises' emission reduction is positively related to their innovation potential; neither auctioning nor being free of charge can make enterprise's individual emission-abatement investment in accordance with the optimal level; enterprise's individual emission-abatement investment is sensitive to efficiency, budget cap, and environmental benefit. This paper discusses simultaneously their policy implications for China.