Market-based emissions trading programs ("cap-and-trade") have moved to the front and center of industrial environmental regulation. When designing an emissions trading program, one of the most contentious issues a policymaker faces is the question of how to allocate emissions permits to stakeholders. How permits are allocated can have significant implications for both who bears the costs and how the required emissions reductions are achieved. Although the theoretical literature addressing the efficiency and distributional implications of permit allocation design has become quite sophisticated, empirical research is limited. The proposed work brings a detailed understanding of the electricity and cement industries, two major polluters, careful empirical analysis of firm-level decision making, and state-of-the-art econometric methods to bear on this first-order policy question. Intellectual Merit This project advances the literature at the interface of industrial organization and environmental regulation in several important ways. First, the researchers propose a novel source of exogenous variation to identify the effects of the permit allocation design decision on short-run firm behavior by exploiting panel data variation in allocation rules in the NOx Budget Program (NBP). This provides a unique opportunity to cleanly estimate the short-run response of firms to a full range of allocation mechanisms. The proposed research also investigates long-run dynamic effects of these regulations. Previous work in this area has largely focused on non-strategic simulation models of the industry using calibrated parameters. This project extends this literature through the use a fully-strategic equilibrium model of industry behavior based on econometrically-based parameters. Finally, the project makes an important contribution in its application of methodologies developed in the industrial organization literature on dynamic games to policy-revelent questions in the field of environmental economics. Broader Impacts Social Impact: Research findings would directly inform the design and implementation of future market-based environmental policies. The research provides evidence on the magnitude and direction of firms' responses to alternative emissions permit market designs. The proposed integration of empirics and applied theory will yield insights into how the permit allocation design decision can affect producer profits, consumer welfare, and the ability of the permit market to efficiently coordinate emissions abatement activities in real-world regulatory environments. Educational impact: Students working on this project will acquire hands on experience working with rich firm-level data sets, and build core competencies in applied econometrics and industrial organization. Both researchers will present research findings at academic and policy conferences and look forward to integrating research results into their graduate course curricula. Both MIT and UM have programs designed to integrate undergraduates into ongoing research. This project will nicely complement these undergraduate research programs.
