Emissions trading and competitiveness: lessons from Germany

Germany's National Allocation Plans (NAP I and NAP II) for implementing the EU Emissions Trading Scheme (EU ETS) are critically analysed. Emissions trading has created a new scarcity, and grandfathering constitutes a subsidy that is used to reach additional policy goals related to energy and distribution policy. With respect to energy policy, the objective was to protect the German coal industry; but in terms of distribution policy the hidden agenda was to allocate as many emissions allowances as possible to the industries involved. The whole discussion is based on the false premise that a generous, or at least 'needs-based', allocation of costless emissions allowances increases an industry's competitiveness. As a consequence, NAP I is overburdened with several complex special rules and exemptions which distort the incentive effect of emissions trading, thus making climate change mitigation in Germany more costly than necessary. The attempted continuation of this policy, in particular with regard to new installations and an over-generous cap, has led to the European Commission's rejection of these rules in the German NAP II in November 2006. Despite significant improvements since then, some important shortfalls remain. Unfortunately, the economic literature available on this topic refers to highly stylized models of allocation rules and neglects the concrete details of the German NAP II. This article tries to close this gap in the literature by analysing the most distorting rules as well as the most important and arguments of the misguided debate on competitiveness.