Working Paper: Rent-Seeking over Tradable Emission Permits: Theory and Evidence
The allocation of costless permits during the establishment of an emission permit trading program creates incentives for rent-seeking. I hypothesize that firms with strong political connections have an advantage in rent-seeking, which I model as a low rent-seeking cost in a contest for permits. Low rent-seeking costs are predicted to yield a higher permit allocation for a firm in equilibrium. This prediction is tested by exploiting an unusual feature of the U.K.’s allocation procedure in Phase 1 of the European Union’s Emissions Trading Scheme for carbon dioxide emissions. I observe both a firm’s actual permit allocation as well as an earlier, provisional allocation that was rooted in technocratic projections of future emissions but was never implemented. Firms had the opportunity to appeal their provisional allocation. I find that a firm’s financial connections to members of the House of Commons strongly predict its post-appeal allocation. Even after controlling for the provisional allocation, along with industry and financial characteristics, a connection to an additional member is associated with a significant increase in a firm’s actual permit allocation. Although no data exist on the amount firms spent on rent-seeking, theoretical predictions on rent-dissipation provide a basis for estimating these expenditures. The welfare loss from rent-seeking is estimated to be at least 137 million euros, which represents a significant cost over and above the abatement costs firms incurred to reduce their emissions.