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Industry-Level Emission Trading in the EU

industrial permit trade nearly vanish. The reason for this is that grandfathered permits work
as distortionary subsidies on the output side. Grandfathered permits yield the smallest
adverse effects on the electricity sectors, with power generation exceeding even BaU levels
for most countries. The latter could provide an incentive for the European power industry
to act as a first mover on the basis of grandfathered permits.

(iii) While all other EU member states face welfare losses, Austria, France, and Germany
benefit from emission constraints under the Kyoto Protocol. As these countries have
relatively low effective reduction targets, they gain competitiveness over other EU
countries that face much higher emission constraints: The implied change in the terms of
trade more than offsets their domestic abatement costs.

(iv) Full trade in permit rights does not provide a Pareto-improvement as compared to the
no-trade case. Austria, France, and Germany suffer from terms-of-trade losses when
abatement costs get equalized across regions which dominate their primary gains from
emission sales. On the other hand, restricted emission trading across EU power sectors
makes Austria, Germany, and France better off than they would be in the no-trade case:
EU-wide trade in the electricity sector still leaves huge differentials in the marginal
abatement costs of the non-electric sectors across EU countries. Austria, France, and
Germany, then, further experience gains in competitiveness, i.e. secondary terms-of-trade
benefits, while making additional income from sales of permits on the electricity market.

Our insights emerge from numerical simulations with a large-scale CGE model for the
world economy. The model developed not only incorporates all EU member countries, but

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