Output-based allocation of emissions permits for mitigating the leakage and competitiveness issues for the Japanese economy

The adoption of domestic emissions trading schemes (ETS) can impose a heavy burden on energy-intensive industries. Particularly, energy-intensive industries competing with foreign competitors could lose their international edge. Although the abatement of CO₂ emissions in industrialized countries entails the reduction of their energy-intensive production, a corresponding increase in the production of energy-intensive goods in countries without CO₂ regulations may lead to carbon "leakage." This paper examines the effects of various allocation methods of emissions permits in the Japanese ETS on the economy and CO₂ emissions using a multiregional and multisector computable general equilibrium model. Specifically, we apply the Fischer and Fox (Land Econ 83(4):575-599, 2007) model to the Japanese economy to address carbon leakage and competitiveness issues. We compare auction schemes, grandfathering schemes, and output-based allocation (OBA) schemes. We further extend the model by examining a combination of auctions and OBA. Though the auction scheme is found to be the best in terms of macroeconomic impacts, the leakage rate is high and the harm to energy-intensive sectors can be significant. OBA causes less leakage and damage to energy-intensive sectors, but the macroeconomic impact is undesirable. Considering all three effects-leakage, competitiveness, and macroeconomics-we find that combinations of auctions and OBA are desirable.