Does China emission trading scheme reduce marginal abatement cost? A perspective of allowance allocation alternatives

Emission trading schemes (ETSs) are regarded as cost-effective environmental regulatory policies; however, because of the loose carbon allowances, it is up for debate whether China's carbon emission trading scheme (CETS) plays a cost-effective role in carbon emission reduction. This paper investigates how the marginal abatement cost (MAC) is changed by the China CETS from a perspective of alternative allowance allocation methods. The empirical strategy adopts the directional distance function and difference-in-difference (DID) analysis, coupled with the industry-by-province level data from 2008 to 2016. The roles of free-auction combined allowance allocation rules and free allocation in the MAC are explored. Furthermore, the heterogeneous effects of adopted free allocation in CETS, i.e., benchmarking (BENCH), emission-based grandfathering (EGRAND), and intensity-based grandfathering (IGRAND) on MAC of industries are investigated. The empirical findings disclose the following. First, China CETS results in an 8% decline in MAC for the regulated industrial sectors in pilot areas. Second, regulated industrial sectors allocated carbon allowances by free rule decrease their MAC by approximately 1%, while those allocated carbon allowances by free-auction combined rule increase their MAC by 11%. Meanwhile, of the free allocation alternatives, IGRAND causes a 24% increase in the MAC, while EGRAND and BENCH allocation methods lead to insignificant changes in the MAC for the regulated industrial sectors.