A Study on Policy Interactions between Cap-And-Trade and Renewable Portfolio Standards in the South Korean Power Sector

The global community is paying more and more attention to climate change. Greenhouse gases that cause climate change are a representative environmental bad in economics. As with goods, the efficient allocation of a bad is achieved through optimization behavior of market agents. Microeconomic theory predicts that consumers maximizing their utility as producers maximize profits can lead to the optimization of social welfare. However, this is conditional on the premise that no market failures exist due to, for instance, externalities. In case of market failure, the government can intervene in the market through policy instruments such as regulation to improve social well-being. The South Korean government has been making efforts to address climate change through various policies. While tackling environmental externalities, regulations could impose heavy burdens on the industrial sector, which is the major source of greenhouse gas emissions. Hurting business can have a negative impact on the economy, discouraging more aggressive greenhouse gas abatement from industry. This implies that the cost-effectiveness of any climate policy should be thoroughly investigated. Policies to address individual externalities affect each other. This suggests that it is difficult to maximize social welfare if an individual policy takes only into account the social marginal costs of one environmental good or bad. Therefore, it is necessary to estimate the exact social marginal costs and benefits through qualitative and/or quantitative analyses of policy interactions. As one of these efforts, this study performs a policy interaction analysis that has not yet been performed in the process of establishing environmental and energy policies. Specifically, the interaction between the cap-and-trade and RPS (Renewable Portfolio Standards) policies, both representative measures for coping with climate change that are applied to the power wholesale sector in South Korea. The wholesale power sector is suitable for studying the interaction of environmental and energy policies in that it is not only a field in which a large amount of greenhouse gases and other local pollutants are emitted, but also one greatly influenced by government policies. Although this study does not directly estimate social marginal costs or benefits, the results of the paper provide critical evidence that can be used in internalizing environmental externalities.