Free allocation of emission permits to reduce carbon leakage: an evolutionary approach

The risk of firms' delocalization due to carbon pricing and the possible measures to avoid it are the object of a long debate and much controversy in the academic and policy fora. To examine this issue, this chapter examines the possible relocating effects provoked by the implementation of an Emission Trading System (ETS) adopting an evolutionary framework which allows to capture the possible spread of imitative behaviors across ETS-regulated firms. We set up a "toy model" that can illustrate the relationship between the level of free allocations granted by the ETS regulator, the price floor level and the dynamics of the system. Using numerical simulations, we show that changes in some key policy parameters may have non-linear effects on the number of firms that decide to relocate and on the abatement efforts of firms that decide to remain. In particular, we find that there exists an optimal level of allowances that can be given for free which maximizes the abatement effort of regulated firms.