Monitoring Abatement in the Presence of an Import Quota on CERs

I analyze whether or not a monitoring problem regarding abroad abatement can justify the import quotas on abroad emission certificates applied by several emission trading schemes. For this purpose I extend the Becker (1968) Crime and Punishment model by heterogeneity in the observability of compliance. I do so by incorporating a firm’s cost minimizing choice of domestic and abroad CO2 abatement into a monitoring framework in which firms have to meet an exogenously set emission standard. I find that the government can implement the first best abatement allocation under incomplete information, however, under incomplete information this allocation is not socially optimal. Instead, the government should in the presence of a monitoring problem introduce an import quota for abroad abatement that shifts the allocation from abroad to domestic abatement