Balancing Equity, Efficiency, and Stability: Designing Permit Trading Schemes for Sustainable Climate Cooperation

Journal of Environmental Economics and Management. 2025.

Bakalova I., Eyckmans J.

This paper demonstrates how emission permit trading systems, with strategically designed initial allocations, can simultaneously balance the competing goals of economic efficiency, distributional equity, and coalition stability. We develop a novel theoretical framework that embeds participation constraints into the welfare optimization problem, ensuring countries voluntarily join a coalition. Using numerical simulation results of a RICE type of integrated assessment model, including climate-induced capital depreciation and total factor productivity growth losses, we determine welfare maximizing initial allocations of permits that address participation constraints and equity concerns.
Our findings demonstrate that carefully designed permit allocations can sustain stable international cooperation while preserving climate ambitions.  The welfare maximizing permit allocations exhibit a distinct temporal pattern directing permits earlier in time to vulnerable, low-income regions (notably Africa) and later to wealthier regions.

Keywords: equity, international environmental agreements, integrated assessment models, permit trading, initial permit allocations