In an ideal world, permits would be traded internationally, and such a system might be of benefit to developing economies: if the cost of reducing pollution is relatively low in developing economies because they have few controls in place, then developed economies, for whom the cost of GHG reduction is high could induce firms in the developing world to undertake cost reductions. Such a trade would be mutually beneficial. For example, if a developed-economy firm must expend $30 to reduce GHGs by one tonne, and this can be achieved at a cost of $10 in the developing economy, then the firm in the developed world could pay up to $20 to the firm in the developing world to reduce GHGs by one tonne. Both would obviously gain from such an arrangement. This gain arises because of the common property nature of the gases – it matters not where they originate.
This process is evidently just an extension of the domestic cap-and-trade system described above under ‘incentive mechanism I’ to the international market. The advantage of internationalizing the system is that the differences in the cost of reducing emissions may be very large internationally, and the scope for gains correspondingly larger.
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