Emission Credit Trading and Regional Inequalities

This paper examines how regional inequalities are affected by emission controls via credit trading and availability of absorption sources. We assume that homogeneous goods are costly traded without emission controls and that the rural areas have an advantage in terms of the availability of absorption sources. We especially focus on the long-term effects of firm relocation. Our two key findings are as follows. First, in the case where an emission control scheme is implemented without allowing for offsetting emissions with carbon absorption sources (carbon sinks), strengthening the emission controls drives firms to relocate from rural areas to urban areas, in the case that wage levels remain unchanged in both areas. As a result, regional inequalities in terms of both the number of firms and relative public welfare are enlarged by emission controls. Our second finding shows that in the case in which the emission control scheme allows for emissions-absorption offsetting, strengthening emission controls has mixed effects on the relative welfare of rural areas. Numerical simulations show that when the costs associated with transporting differentiated goods are relatively low, the introduction of emission controls with an offsetting system results in greater inequality across regions compared with introducing emission controls without such offsetting.