The Dynamics of Linking Permit Markets

By Katinka Holtsmark, Kristoffer Midttomme

Abstract

This paper presents a novel benefit of linking emission permit markets. We let countries issue permits non-cooperatively, and with endogenous technology we show that there are gains from permit trade even if countries are identical. Linking the permit markets of different countries will turn permit issuance into intertemporal strategic complements. This happens because issuing fewer permits today increases  investments in green energy capacity in all permit market countries, and countries with a higher green energy capacity will respond by issuing fewer permits in the future. Hence, each country faces incentives to withhold emission permits.