Patterns of Path Dependence? The History and Future of Market-Based Climate Policy in Europe

At the end of the 1990s, the EU was still sceptic towards emissions trading, but in 2003 they have adopted a Directive that enables such trading in the EU from 2005 onwards. Those who write about this remarkable attitude change usually present a list of (more or less relevant) ad hoc explanations without providing an overall theoretical framework. In this paper, we have tried to develop such a framework on the basis of the path dependence approach. Sunk costs, switching costs and learning effects, among others, explain why decision-makers often change policy incrementally and build upon the path of existing regulation, ineffective and inefficient as it may be. This is exactly what initially happened in Europe. Various policymakers favoured traditional instruments, like standards or voluntary agreements. Moreover, those Member States that already had extant policy to build upon were tempted to make it more flexible by adding credit trading to it, a sub-optimal type of emissions trading. Permit trading, however, is more efficient and effective according to economic theory. An institutional lock-in was bound to take place. The attitudes of EU policy-makers changed, nevertheless, as a result of internal pressures and external 'shocks', which have contributed to a process of cultural change (and not just the other way around). The European Commission exerted internal pressure by adopting a pioneering role and while information on permit trading improved and resistance against 'pollution rights' crumbled, an external 'shock' occurred in the form of the withdrawal of the US from the Kyoto Protocol, which gave other countries favourable to unrestricted private trading credible threat power. Although the permit trading Directive has been adopted, a full-scale institutional break-out is not guaranteed. Some firms and policy-makers still try to steer the national allocation of emission rights in the inefficient direction of credit trading, by linking the height of ceilings for individual companies, within the ceiling for an industry as a whole, to the size of their production. Moreover, credit trading can still be used for installations not covered by the Directive. The path dependence approach, however, emphasizes that starting with (elements of) credit trading comes at a risk: it can result in an institutional lock-in and reinforce a path from which it may be difficult to escape after 2012. Governments should at least acknowledge this risk