Dynamic efficiency of enviromental policy: the case of intertemporal emissions trading

In this paper we analyze the effects of dynamic environmental policies on firms' optimal investment behavior within finite time horizons. We show that when finns are allowed to intertemporally trade their emissions, they invest in abatement in earlier periods, advancing compliance with future environmental standards. Therefore, policies such us emissions banking" enhances the dynamic efficiency of the marketable permits and derives substantial cost-savings by itself. We show the dynamics of banking policy and emissions trading when the firm faces a two step emission standard with strict requirements at the end of the programo The firm's optimaI trajectory under apure banking program is compared to command-and-control (CAC), Pigouvian taxes and emissions borrowing, aH for a finite time horizon. Banking introduces time flexibility, inducing the firm to over-comply with environmental standards in earlier periods, thus buying a delay in adjustment to future tighter policies. Finally, we analyze the dynamics of a pure emission trading program, where permits are available in a perfect competitive market, but do not last forever. Our results justify the current low trading in the U.S. Acid Rain Program (ARP) alld link firm's cost savings to the success of the banking policy.