Learning about environmental damage: implications for emissions trading

In this paper the impact of adjusting the supply of tradeable emission permits on incentives for cleaner technology adoption is examined. Two policy rules for adjusting the supply of permits are considered: open market operations; and a proportional adjustment rule under which the regulator expropriates permits from individual firms in proportion to their existing permit holdings. Adjustment via open market operations is neutral with respect to cleaner technology investment decisions but may be politically difficult to implement. The proportional adjustment rule is also neutral with respect to investment decisions and at the same rime allows more flexibility from a political perspective.