Industry export competitiveness and optimal quantitative strategies for international emissions trading

Transcription

1 Envronmental Economcs, Volume 5, Issue 4, 04 Tsung-Chen Lee (Tawan) Industry export compettveness and optmal quanttatve strateges for nternatonal emssons tradng Abstract Ths paper analyzes how quanttatve strateges for nternatonal emssons tradng (IET) could be used as an nstrument to reduce countres complance costs and enhance export compettveness. Usng the cost-effectve IET as a benchmark, the author shows that a green quanttatve strategy of encouragng domestc abatement s optmal for permt-buyng countres wth relatvely hgh demand for permts. In contrast, a brown quanttatve strategy that dscourages domestc abatement s optmal for permt-sellng countres and permt-buyng countres wth relatvely low demand. Fnally, the country frst settng quanttatve strategy on IET could enjoy the frst-mover advantage of reducng complance costs and enhancng export compettveness. Keywords: export compettveness, nternatonal emssons tradng, quanttatve strategy, cost-shftng strategy, strategc envronmental polcy. JEL Classfcaton: Q54, Q58. Introducton Internatonal emssons tradng (hereafter IET) proposed n the Kyoto Protocol adds a new dmenson to the practce of emssons tradng scheme (ETS), whch s an economc nstrument to reduce pollutants n a cost effectve manner. In the lterature, there are several studes showng the cost effectveness of ETS at natonal level (e.g., Chchlnsky and Heal, 995) and nternatonal level (e.g., Evans, 003; Crqu et al., 999; Kanuma et al., 999; Weyant, 999). The extended practce of ETS to the nternatonal level sgnfes that countres nteracton n the nternatonal market could arse from, n addton to the competton n the commodty export market, the permt tradng n the IET. Under the crcumstance, countres permt tradng behavor drectly affects the supply or demand condton and hence the equlbrum permt prce as well as complance costs, and ndrectly nfluences countres producton decson, export compettveness, and socal welfare. Even though volatng the cost effectveness of IET, self-nterested countres may have ncentve to trade permt strategcally because through whch they can transfer part of ther complance costs to others. Ths cost-shftng polcy, orgnatng from the dea of the lterature on strategc trade polcy (STP), s frst proposed by Lee et al. (03), who explore the extent to whch the concept of STP can be appled n IET. Concernng the mplcaton on export compettveness, the cost-shftng strateges n IET could be also thought of as a strategc envronmental polcy, Tsung-Chen Lee, 04. The lterature on STP usually focuses on government s trade polcy whch could affect frms nteractons n an nternatonal olgopolstc market. The central dea s the strategc proft-shftng polcy. Early contrbutors n ths feld nclude, among others, Brander and Spencer (98, 985), Spencer and Brander (983), Dxt (984), Brander (986), Eaton and Grossman (986), and etc. Acknowledgements: Ths work s supported by the Mnstry of Scence and Technology of Tawan (Project o.: SC H ). 4 whch s wdely dscussed n the lterature on trade and the envronment (e.g., Dean, 99; Conrad, 993; OECD, 993; Barrett, 994; Beghn et al., 994; Jaffe et al., 995; Thompson and Strohm, 996; Ulph, 996; Jayadevappa and Chhatre, 000). Gven the restrcton on the use of trade nstruments under free trade agreements such as World Trade Organzaton (WTO), strategc envronmental polcy appears as a feasble substtute to extract foregners rent. Up to now, none of the studes have yet attempted to analyze the compettve mplcatons of quanttatve strateges n IET as a strategc envronmental polcy. Ths ssue s mportant gven the common concern for compettveness n the desgn of clmate polcy and the megatrends n the wave of trade lberalzaton worldwde, hence stmulates our motvaton to explore how strategc tradng n IET could be used as a strategc envronmental nstrument to reduce countres complance costs and enhance export compettveness. Strategc tradng n IET s plausble n the real world for at least two reasons. Frst, based on Artcle 7 of the Kyoto Protocol, IET shall be supplemental to domestc actons for the purpose of meetng quantfed emsson lmtaton and reducton commtments. However, ths supplementarty prncple does not provde a clear defnton regardng the ndvdual countres transacton levels. As a consequence, dfferng nterpretaton on what extent the IET should be used arses (Zhang, 00). One nterpretaton ndcates that the domestc actons should be the man means of meetng the countres abatement commtments, so that IET should be an addton to domestc actons. The other nterpretaton states that IET wll be supplemental to whatever domestc actons are taken, and one country could use IET to meet ts abatement commtments as much as t wshes. In other words, countres can freely choose the tradng amount n IET to maxmze ther nd-

2 Envronmental Economcs, Volume 5, Issue 4, 04 vdual nterests. Second, n the IET system, there s no supranatonal authorty wth the power to determne the transacton levels and/or to prevent ndvdual governments to set strategc tradng behavor. The strategc tradng behavor n IET s also vald under the framework of WTO, because no assocated measurng crteron s specfed. Specfcally, ths paper ams at examnng the lnk between export compettveness and the strategc tradng n IET wth bndng exogenous target level of carbon emssons. We develop a two-stage sequental game wth complete nformaton to analyze the optmal quanttatve strateges. Countres are assumed to be Cournot compettors n the nternatonal commodty market wth free trade (e.g., Brander and Spencer, 985) and prce-takers n the ETS. Parallel to the lterature on Porter hypothess (e.g., Greaker, 003), we defne a green (brown) strategy as the one such that margnal cost of own abatement exceeds (falls short of) the nternatonal permt prce. The optmal quanttatve strateges and mplcatons on export compettveness are then explored under a second-best scenaro gven that the regulaton on commodty trade s not allowed. We show that the second-best quanttatve strateges n IET depend on two effects, consstng of the drect effect on emssons tradng and the ndrect (spllover) effects on commodty export. Combnng these two effects, a green strategy of promotng domestc abatement best serves the nterest of a country s export ndustry when the ndustry has relatvely hgh demand for permts. In contrast, a brown strategy of dscouragng domestc abatement s optmal for permt-sellng countres and permt-buyng countres wth relatvely low demand. We also demonstrate that, n the case of unlateral regulaton, the country adoptng strategc tradng behavor wll be better-off. In sum, our result partally parallels what s found n the Porter hypothess, ndcatng that countres wth relatvely hgh demand of permts, such as the European Unon, would set strngent regulaton n an IET system and come out n favor of a greener domestc abatement polcy. The remander of ths paper s organzed as follows. Secton ntroduces the basc settngs of the model. The equlbra wthout and wth quanttatve strateges are derved n Sectons and 3, respectvely. The mplcatons on export compettveness are drawn n Secton 4. Fnally, the concludng remark s summarzed n the fnal Secton.. The basc settngs Assume a two-sector economy, wth a numerare sector and a homogeneous olgopoly sector. Consder a partal equlbrum model of the olgopoly sector. There are ( ) Annex- countres, ndexed by,. The output level of country s denoted as q > 0. All outputs n these countres are exported to a non Annex- regon wth the nverse demand p Q, where Q q s the aggregate output level. The producton generates carbon emssons, and the emssons are proportonal to output levels. Let θ > 0 be the output-based emsson factor (carbon emssons per unt of output) of country. Country s gross emsson level s thus θ q. Among the countres, there s an nternatonal agreement whch sets legally bndng restrctons on ndvdual countres carbon emssons, and allows these countres to comply wth ther respectve caps by own abatement or permts tradng n an IET market. The emsson cap assgned to country s w. Country could comply wth w through makng better use of technologes such as mprovement of energy effcency, carbon capture and storage, etc. Let e be the actual emsson level of country, where 0 e θq. Country s own abatement level equals ( θq e) and the assocated abatement costs α C ( q, e) ( θ q e) are strctly convex, where α > 0 s a technologcal parameter and ncreasng wth fallng abatement effcency. In the IET market, the non Annex- regon plays no role because t has no oblgaton of carbon reductons. As for the Annex- countres, there s no specfc restrcton on ther tradng n the nternatonal agreement, so they can strategcally choose the amount of permts tradng. Denote country s tradng amount as t, where t e w; t > 0 means the amount that country purchases from the IET market, and t < 0 sgnfes the amount that country sells to the IET market. Based on the above settng, country s socal welfare S equals the revenue of commodty sales mnus the cost of complyng wth emsson cap w, and the latter s composed of own abatement cost and permt tradng expendture or revenue. That s, α Sqe (, ) ( ) ( ),,,, pq θ q e re w + () The emsson caps n an nternatonal agreement (e.g., Kyoto Protocol) are assgned for free. In practce, the allocaton can be determned based on hstorc emssons (grandfatherng), outputs, abatement performance, etc. In ths paper, we assume that there s already an agreed allocaton, and how ths allocaton s determned s beyond the scope of ths paper. 5

3 Envronmental Economcs, Volume 5, Issue 4, 04 where r > 0 s the permt prce, and r( e w) > ( < )0 represents country s permt tradng expendture (revenue). In the followng sectons, we respectvely solve the equlbra wthout and wth quanttatve strateges n the IET market. The compettveness mplcatons are then drawn by comparng the two equlbra.. Equlbrum wthout quanttatve strateges In the absence of quanttatve strateges, each country chooses optmal output level q ˆ and emsson level e ˆ to maxmze ts socal welfare, as denoted n (). The assocated frst-order condtons for an nteror soluton are: p qˆ [ α ( θqˆ eˆ )] θ, () and α θqˆ eˆ r,,,. (3) ( ) Equaton () states that country wll adjust ts output level untl margnal revenue of commodty sales equals margnal cost of producton (.e., margnal abatement cost assocated wth producng one more unt of commodty). Equaton (3) ndcates thatcountry s optmal emsson level s determned at the condton under whch margnal abatement cost equals permt prce. Ths condton s generally referred to as the cost-effectve condton of IET because all tradng countres have the same margnal abatement cost and the sum of countres complance costs s mnmzed. The equlbrum aggregate output ˆQ and equlbrum output prce ˆp are derved usng equatons ()-(3) and the nverse demand functon p Q, and are shown as follows: ˆ Θr Q and + where Θ θ. + Θr pˆ, + (4) Country s output level s qˆ ˆ p θr by ()-(4). Substtutng qˆ ˆ p θr (4) nto (3) yelds country s demand for permts: Θ ˆ + r r e θ θr,,,. (5) + α Assume that the permt demand functon s downward slopng,.e., < 0. Thus the followng as- eˆ r sumpton s made. Θ Assumpton A: μ θ θ + > 0. + α Usng (5) and the market-clearng condton of IETe w, we derve the equlbrum permt prce as follows: ˆ θ r Γ w, + (6) where Γ μ > 0 gven Assumpton A. In order to have a postve equlbrum permt prce, we further make the followng assumpton. Assumpton A: θ w > 0. + At the equlbrum wthout quanttatve strateges, the IET market operates n the cost effectve way that mnmzes the sum of countres complance costs for a gven aggregate abatement target. Ths equlbrum wll be used as the benchmark case for nvestgatng the compettveness mplcatons of quanttatve strateges n the followng sectons. 3. Optmal quanttatve strateges n IET Ths secton develops a non-cooperatve game to analyze ndvdual countres optmal quanttatve strateges n IET. Strategc tradng behavor n IET ntroduces shadow tarff (or subsdy) on emssons tradng whch would alter countres demand for permts and market equlbrum. Countres recognze the ensung mpacts of strategc tradng and take them nto consderaton n determnng ther optmal tradng amounts. Accordngly, each country faces a two-stage optmzaton problem wth an objectve of maxmzng socal welfare. In the frst stage, countres smultaneously choose ther respectve optmal quanttatve strateges for IET, and, n the second stage, gven the strategc tradng amounts and the assocated shadow tarff (or subsdy), they select ther respectve optmal outputs and emssons. Then the equlbrum output prce and permt prce are respectvely determned based on the nverse demand functon for output and marketclearng condton of the IET. To solve the subgame perfect equlbrum (hereafter SPE) of the game, we work backwards, startng from the second stage. In ths stage, gven the quan- The sequence of the game reflects the plausble stuaton n whch quanttatve strateges are made at the government levels, and the decsons for outputs and emssons are made at the frm levels. 6

4 Envronmental Economcs, Volume 5, Issue 4, 04 ttatve strategy t, country chooses optmal output q and emsson e to maxmze ts socal welfare α max S ( q, e ) [ ( ) ( )], ( q, e) pq θ q e r e w + (7) s.t. t e w,,,. (8) The Lagrange functon for the above problem s α L ( q, e, λ) pq ( θq e ) + r( e w ) + (9) λ t ( e w), [ ] where λ s the Lagrange multpler, whch measures the effect of a small change n quanttatve strategy t on country s socal welfare, and s referred to as the shadow tarff (or subsdy) of t. The assocated frst-order condtons for an nteror soluton are: p q [ α ( θ q e )] θ, (0) and ( ) α θq e r+ λ,,,. () Based on (), the shadow tarff (or subsdy) of quanttatve strategy t can be expressed as λ α( θq e ) r, whch s the dfference between domestc margnal abatement cost and permt prce. In the case of λ > 0, domestc abatement cost s greater than permt prce, mplyng a shadow tarff mposed on the permt purchase or a shadow subsdy dstrbuted to the permt sale. As a consequence, domestc abatement level ncreases. In contrast, λ < 0 means a shadow subsdy s dstrbuted to the permt purchase or a shadow tarff s mposed on permt sale, consequently decreasng domestc abatement amount. Based on the above and the lterature on Porter hypothess (e.g., Greaker, 003), the followng defnton s provded. Defnton D. A green (brown) tradng strategy s defned as the quanttatve strategy for IET such that domestc margnal abatement cost exceeds (falls short of) the nternatonal permt prce, and s a strategy of encouragng (dscouragng) domestc abatement. The equlbrum aggregate output Q and permt prce p are gven by Θr θλ Q and p + + Θr + θλ + () Country s optmal output level s q p θ( r+ λ),,, by (0)-(). Substtutng ths equaton of q and () nto () yelds country s demand for permts: + Θr + θλ j j j r + λ e θ θ( r+ λ), + α (3) whch s also downward slopng gven assumpton e A,.e., μ < 0. The assocated equlbrum r permt prce s: r rˆ kλ, (4) where k Γμ, k, and 0 < k <. So far we have obtaned the relatonshps lnkng varables p, q, e and r to the shadow tarff (or subsdy) λ. Substtutng (4) and e t + w nto (3), we can derve the optmal λ, whch s a functon of tradng amounts (t, t ),.e., λ λ λ ( t, t ). Assume that < 0 (.e., a hgher t means a larger purchase or a lower sale of allowances, and sgnfes a browner strategy). Usng ths assumpton and equatons (0)-(4), we derve the followng results: e > 0, (5) r q > 0, > 0, and q j j < 0, (6),,. (7) Proofs of (5)-(7) are n Appendx. Equatons (5) and (6) state that f country adopts a browner strategy (hgher t ), ts optmal emsson level and excess demand for permts wll ncrease. Thus the equlbrum permt prce ncreases, too. Equaton (7) means that the country choosng a browner strategy can ncrease ts output level, and, other thngs beng equal, the aggregate output of ts rvals decreases. 7

5 Envronmental Economcs, Volume 5, Issue 4, 04 ext, turn to the frst stage of the game. Gven ( q, e ), p, and r, country chooses t to maxmze ts socal welfare. Gven the assumpton of λ < 0, the optmal condton for shadow tarff (subsdy) can be expressed as follows: λ Φ( e w ) +Ω q,,,, (8) r / t where Φ 0 > and e / qj / j Ω < 0 accordng to (5)-(7). e / ( ) The optmal shadow tarff (subsdy) n (8) s a second-best strategy, and t s composed of two parts, consstng of a drect effect on emssons trad- Φ e w and an ndrect effect on commod- ng ( ) ty exports Ω q. Gven Φ > 0, the drect effect on emsson tradng Φ e w s postve (negatve) f and only f e ( ) > ( < ) w. Therefore, when consderng only the drect effect, a green strategy s optmal for permtbuyng countres whle a brown strategy s optmal for permt-sellng countres. The explanaton s provded as follows. In a perfectly compettve IET market wthout quanttatve strateges, margnal abatement cost equals permt prce by (3). Consderng the ensung mpacts on permt prce, ndvdual countres would have ncentve to adopt quanttatve strateges such that the allowance prce alters toward ther respectve desred drecton. By dong so, they could transfer part of ther respectve complance cost to others,.e., referred to as the cost-shftng polces. Settng a green strategy s optmal for permt-buyng countres because t decreases the excess demand for permts and hence the equlbrum permt prces. In contrast, t s optmal for permtsellng countres to select a brown polcy to decrease ther domestc abatement and excess supply of permts, and ths wll lead to a hgher permt prce. The above result s consstent wth Lee et al. (03), who suggest that dscouragng permt trade (wth a tax on permt tradng) s optmal for prce-takng countres as far as cost-shftng s concerned. On the other hand, the ndrect effect on commodty exports Ω q measures the spllover mpact of the quanttatve strategy t on commodty export. Ths effect s always negatve, mplyng that a brown strategy s optmal f only the ndrect effect s consdered. Ths result s consstent wth the common percepton n the lterature on trade and the envronment whch suggests that strct envronmental regulaton mght shft the margnal cost upward and hence lowers profts and compettveness. The above results are summarzed as follows. Proposton. The optmal permt-tradng strategy hnges on two effects, consstng of the drect prce effect on permt tradng and ndrect (spllover) effects on commodty export. If only the drect prce effects are consdered, the permt-sellng countres should choose a brown strategy whle the permtbuyng countres should select a green strategy. In contrast, when consderng only the ndrect effect on commodty export, all countres should choose brown strategy. Based on the above, the drect and ndrect effects are both negatve for permt-sellng countres, hence λ < 0 (or equvalently, a brown polcy) s optmal for these countres. In contrast, the optmal polces for permt-buyng countres depend on the relatve magntude of the postve drect effect to the negatve ndrect effect. If the postve drect (negatve ndrect) effect domnates, a green (brown) strategy s optmal. In order to draw more ntutve nsghts regardng the optmal polcy of a permt-buyng country, equaton (8) s rewrtten as follows: λ > > 0 f and only f I I, < < for country wth ( e w) ( e w) > 0, (9) where I > 0 s the permt-buyng ntensty (.e., the rato of permt purchase to the gross θq Ω emsson), and I > 0. Based on (9), the θφ followng defnton s provded. Defnton D. A permt-buyng country has relatvely hgh (low) demand for permts f and only f I > ( < ) I. Gven defntons D-D and equaton (9), permtbuyng countres wth relatvely hgh demand for permts should adopt a green strategy, whle those wth relatvely low demand for permts should choose a brown strategy. The above results are summarzed as follows. 8

6 Envronmental Economcs, Volume 5, Issue 4, 04 Proposton. A brown strategy s optmal for permtsellng countres and permt-buyng countres wth relatvely low demand for emsson permts. In contrast, a green strategy s optmal for permt-buyng countres wth relatvely hgh demand for emsson permts. 4. Implcatons on export compettveness Ths secton s concerned wth the compettveness mplcatons of quanttatve strateges for IET. The emphass s on whether and how the quanttatve strateges affect the countres socal welfare. Frst, compare the equlbra n the prevous two sectons. Based on equatons (3) and (), countres quanttatve strateges would volate the cost-effectveness of ETS. Equaton (4) ndcates that the aggregate mpact of quanttatve strateges on the equlbrum permt prce s ambguous because countres mght adopt green or brown strateges. Accordngly, ndvdual countres optmal permt tradng amounts and domestc abatement levels could be hgher or lower at the equlbrum wth quanttatve strateges, as compared to the benchmark case (.e., the costeffectve equlbrum). Thus ndvdual countres may or may not beneft from strategc tradng n the case of multlateral quanttatve strateges. Ths result and mplcaton are summarzed as follows. Proposton 3. Countres quanttatve strateges would volate the cost-effectveness of IET. Countres may or may not gan from adoptng quanttatve strateges n the case of multlateral quanttatve strateges. In the lterature and n practce, strategc costshftng tradng behavor n IET s wdely neglected. Therefore, our next focus s on a plausble crcumstance of unlateral quanttatve strategy (.e., a crcumstance where only one country has the far-seeng ntellgence to act strategcally n the IET, whle others behave based on the cost-effectve condton n equaton (3), as suggested by the general lterature). Wthout loss of generalty, assume that country sets quanttatve strategy whle other countres do not. The assocated equlbrum s provded as follows. Corollary. The equlbrum of unlateral quanttatve strategy s gven by: % λ Φ e % w + Ω q % ; ( ) Q% Θr% θ % λ + Θr% +θ % λ and p% ; + + ( r λ ) q% p% θ % + % and q% p% θr% for, ; r% + % λ r% α e% θ p% θ( r% + % λ) and e% θ[ p% θr% ] α for, ; and r% rˆ k % λ. Compared to the equlbrum wthout quanttatve strateges n Secton, country s socal welfare s hgher at the equlbrum of unlateral quanttatve ~ strategy,.e., S ˆ > S, and the proof s n Appendx. In other words, the country takes the frst step to set the unlateral quanttatve strategy can enjoy the frst-mover advantage of makng the prce toward ts desred drecton and shftng ts complance costs to others. As a result, the country s producton cost s lower and ts exports become more compettve. Ths result s summarzed as follows. Proposton 4. The country wth far-seeng ntellgence of actng strategcally n IET would enjoy the frst-mover advantage of enhancng export compettveness. Concluson Ths paper nvestgates the optmal quanttatve strateges on the IET market and the assocated compettveness mplcatons. We show that the optmal permt tradng strategy depends on two effects, consstng of the drect effect on emssons tradng and the ndrect (spllover) effects on commodty export. The drect effect captures the mpact of strategc tradng on permt prce. Allowancebuyng countres can select a green strategy to reduce the excess demand and lower the permt prce, whle allowance-sellng countres can choose a brown strategy to reduce the excess supply and enhance the permt prce. On the other hand, when consderng only the ndrect effect on commodty export, all countres should choose a brown strategy. Combnng the drect and ndrect effects, we show that a brown strategy s optmal for permt-sellng countres and permt-buyng countres wth relatvely low demand for permts, whle those wth relatvely hgh demand should adopt a green strategy. Fnally, the country takng the lead n settng quanttatve strategy n IET wll enjoy the frst-mover advantage of reducng complance costs and enhancng compettveness. Ths paper presumes a perfectly compettve ETS, whch can be relaxed n the future. In other words, one can assume that some countres have market power, and explore how market structures affect the results. On the other hand, an emprcal estmaton of the mpacts of quanttatve strateges on the export compettveness deserves future research attenton. In partcular, relable estmates on countres abatement costs and comprehensve smulatons could make such an analyss applcable to practcal polcy desgn. 9

7 Envronmental Economcs, Volume 5, Issue 4, 04 References. Barrett, S. (994). Strategc Envronmental Polcy and Internatonal Trade, Journal of Publc Economcs, 54, pp Brander, J. (986). Ratonales for Strategc Trade and Industral Polcy, In: Krugman P. (eds.) Strategc Trade Polcy and the ew Internatonal Economcs, MIT Press, Cambrdge, pp Brander, J. and B. Spencer (98). Tax and the Extracton of Foregn Monopoly Rent under Potental Entry, Canadan Journal of Economcs, 4, pp Brander, J. and B. Spencer (985). Export Subsdes and Internatonal Market Share Rvalry, Journal of Internatonal Economcs, 8, pp Beghn, J., D. Roland-Holst and D. van der Mensbrugghe (994). A Survey of the Trade and Envronment exus: Global Dmensons, OECD Economc Studes, 3, pp Chchlnsky, G. and Heal, G. (995). Markets for Tradable CO Emsson Quotas: Prncples and Practce, OECD Workng Papers. Pars: Organzaton for Economc Co-operaton and Development. 7. Conrad, K. (993), Taxes and Subsdes for Polluton-Intensve Industres, Journal of Envronmental Economcs and Management, 5, pp Crqu,P., S. Mma and L. Vguer (999), Margnal Abatement Costs of CO Emsson Reductons, Geographcal Flexblty and Concrete Celngs: An Assessment Usng the POLES Model, Energy Polcy, 7, pp Dean, J.M. (99). Trade and the Envronment: A Survey of the Lterature, Workng Papers Polcy Research: Background Paper for the World Development Report. Washngton, D.C.: Word Bank. 0. Dxt, A. (984). Internatonal Trade Polcy for Olgopolstc Industres, The Economc Journal, 94 (supplement), pp Eaton, J. and G. Grossman (986). Optmal Trade and Industral Polcy under Olgopoly, Quarterly Journal of Economcs, 0 (), pp Evans, M. (003). Emssons Tradng n Transton Economes: The Lnk between Internatonal and Domestc Polcy, Energy Polcy, 3, pp Greaker, M. (003). Strategc Envronmental Polcy; Eco-Dumpng or a Green Strategy? Journal of Envronmental Economcs and Management, 45, pp Jaffe, B.A., S.R. Peterson, P.R. Portney and R.. Stavns (995). Envronmental Regulaton and the Compettveness of US Manufacturng: What Does the Evdence Tell Us? Journal of Economc Lterature, 33 (), pp Jayadevappa, R. and S. Chhatre (000). Internatonal Trade and Envronmental Qualty: A Survey, Ecologcal Economcs, 3, pp Kanuma, M., Y. Matsuoka and T. Morta (999). Analyss of Post-Kyoto Scenaros: The Asan-Pacfc Integrated Model, The Energy Journal, Specal Issue on the Cost of the Kyoto Protocol: A Mult-Model Evaluaton, pp Lee, T.C., H.C. Chen and S.M. Lu (03). Optmal Strategc Regulatons n Internatonal Emssons Tradng Under Imperfect Competton, Envronmental Economcs and Polcy Studes, 5, pp OECD (993). Envronmental Polces and Industral Compettveness. Pars: Organzaton for Economc Cooperaton and Development. 9. Spencer, B. and J. Brander (983). Internatonal R&D Rvalry and Industral Strategy, Revew of Economc Studes, 50, pp Thompson, P. and L.A. Strohm (996). Trade and Envronmental Qualty: A Revew of the Evdence, Journal of Envronment and Development, 5 (4), pp Ulph, A. (996). Envronmental Polcy and Internatonal Trade When Governments and Producers Act Strategcally, Journal of Envronmental Economcs and Management, 30, pp Weyant, J. (Ed.) (999). The Cost of the Kyoto Protocol: A Mult-Model Evaluaton, The Energy Journal, specal ssue. 3. Zhang, Z.X. (00). An Assessment of the EU Proposal for Celngs on the Use of Kyoto Flexblty Mechansms, Ecologcal Economcs, 37, pp Appendx Proof of Equaton (5): Θ θ j θj e θ j j θ θ + μk θ θ + μk μ ( k ) θ < 0 λ + α + α + Usng Chan rule, we have e e λ > 0. λ Proof of Equaton (6): r r λ λ k > 0. λ 30 gven μ > 0 and + k > 0.

8 Envronmental Economcs, Volume 5, Issue 4, 04 Proof of Equaton (7): By (0) and (), we have q p θ ( r + λ ). Dfferentatng ths equaton wth respect to λ yelds θ j q θ j ( Θ k + θ ) + θ ( k ) ( k ) + ( k ) 0, < gven 0< k λ <. Usng Chan rule, we have q q λ > 0. λ Q Θk θ Because equaton () ndcates that, we have λ + qj θ j j Q q j θ ( k ) + ( k ) > 0. λ λ λ + + qj qj Usng Chan rule, we have j j λ < 0. λ Appendx Proof of Proposton 4: Denote A q% ˆq, B p% pˆ, F r% rˆ, and K e % eˆ. Then we have ( F + λ ) α S% Sˆ Aqˆ + Bq% F( e% w ). (a) % λ Ω q% e% w. Substtutng ths equaton nto (a) and rearrangng yelds Φ From Corollary, ( ) ( ) S Sˆ W % λ, % (a) Θ k θ ( ) W + θ k + k k < 0. where ( ) + α Φ Therefore, from (a) we have S % ˆ S > 0, or, equvalently, S% > S ˆ. 3