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In the context of emission markets, failure to include early action (EA) as a criterion when sharing out the reduction effort may be unfair. This paper presents (1) a method based on index decomposition that seeks to quantify EA and (2) a method for determining effort sharing considering EA. It is shown that, in the case of European industry (EU-15) and for the period 1995–2005, EA accounted for a reduction of 21% in energy-related CO2 emissions. Considering two alternative schemes for sharing out the reduction effort in European industry, equal shares (all industries in all countries reduce their emissions by the same percentage) and taking EA into account, we find that Spain, Austria, Italy, the United Kingdom and Sweden would be better off under an equal shares scheme as opposed to one that takes EA into account. The efforts of the remaining countries would be greater than if EA was taken into account. An equal shares scheme would also greatly benefit the textile, non-metallic mineral, paper and “other” industries, and would be particularly detrimental to the chemical, non-ferrous and other metal, and engineering industries.

One of the initiatives proposed by the European Union (EU) to encourage the reduction of greenhouse gas emissions and the resulting climate change is the creation of an Emission Trading Scheme (ETS) (Directive 2003/87/CE, hereafter called “Directive”). This consists of allocating a limited number of emission allowances to participating firms that can be traded between them subject to the restriction that none of them are permitted to exceed their CO2 emission allowance. These types of schemes seek to ensure that environmental targets set to limit emission levels are met in a cost-effective way, i.e. by minimizing the abatement costs arising from the need to reduce emissions (Montgomery, 1972; Tietenberg, 1980; Baumol and Oates, 1988). The Directive provides a structure within which an ETS can be set up between certain sectors of industry across the EU. The initial allocation, which is always one of the most controversial points in these programs, is left in the hands of Member States. This is a matter of crucial importance as it has a great effect on the distribution of income derived from ETS. When there is a market but allowances are allocated free of charge,1 allocation is merely a representation of the effort required of each agent. When deciding the initial allocation it is therefore important to recognize prior efforts made by the different agents to reduce emissions,2 i.e. early action (EA). This is so because from the perspective of a fair distribution, equal effort should be required of all agents, given that asymmetries in this context might be translated into redistributions of income. Past efforts must therefore be taken into account when reduction efforts are shared among agents and allowances are allocated. Despite the importance of considering EA, very few studies have attempted to solve the problem omission of EA when sharing out efforts to reduce emissions. The main aim of this paper is to develop a new methodological framework that allows the consideration of EA-related criteria when sharing out efforts to reduce CO2 emissions. We begin by analyzing the distributive aspects of the effort sharing mechanism proposed in the Directive. Section 3 presents a methodological framework based on decomposition analysis, aimed at including EA among the criteria for sharing out efforts to reduce emissions. Following this, in Section 4, we apply the method to the case of European industry. The paper closes with a discussion section (Section 5) and some conclusions and final considerations (Section 6).

This paper analyzes some of the distribution problems relating to effort sharing for the reduction of emissions in the EU ETS (Directive 2003/87/EC). From the viewpoint of a fair distribution, all agents should be required to make an equal level of effort, because any asymmetry in this sense translates into a redistribu- tion of income. This implies that there is a need to recognize past efforts realized by agents prior to the establishment of the market, something that is known as ‘‘early action’’ or EA. The Directive does not include EA among the criteria for sharing the burden among the various sectors of the economy, thus generating potential problems of unfair distribution. In order to avoid the problem of unfair distribution, we developed a method based on index decomposition analysis which enables EA to be quantified and included among the criteria for sharing out the burden of reducing emissions. Using this method, it is calculated that EA, i.e. improvements in technology and changes in the energy mix, accounted for a reduction of 21% in energy-related CO 2 emissions from European industry between 1995 and 2005. Overall, emissions from European industry over that period decreased by 7%. So, if no action had been taken to reduce the emission levels, in 2005 this figure would have been 14% higher than in 1995. We also analyze the distributive effects of applying two alternative effort sharing methods in European industry: equal shares (with all industries in all countries required to reduce their emissions by the same percentage) and a sharing that takes EA into account. Spain, Austria, Italy, the United Kingdom, Sweden and Denmark would be better off under an equal shares scheme, as their efforts would be lower (by as much as 16% in the case of Spain and 15% in the case of Austria). The efforts of the remaining countries would have to be greater than if EA was taken into account, so they would be worse off. An equal shares schemewould also greatly benefit the textile, ‘‘other’’, non-metallic minerals and paper industries and would be particularly detri- mental to the chemical and non-ferrous metal and other metal industries, as well as engineering. In short, failure to include EA as an effort sharing criterion may have significant consequences in terms of income distribution. It would therefore be advisable for future reviews of the EU ETS to incorporate EA in its effort sharing criteria. Finally, it is important to point out that the problem discussed here of distributive effects of a failure to recognize EA originates largely from the limited scope of the market (only CO 2 and only certain industries) and the fact that allowances are shared free of charge. In this regard, it should be pointed out that the EC is now seeking to extend the market to other gases and sectors, and that it is also gradually introducing auctions as a method of distribution.