DP15989 Revisiting Cap-and-Trade in Presence of Publicly Owned Polluters: The Case of Italy 2006-2018
We use the example of the Italian electricity spot market to empirically document that carbon
pricing schemes may not work efficiently when the major firms in the market are government-
controlled. We show that government-controlled companies do not internalize emission prices
implied by the European Union emissions trading system in their bids, which reduces pass-
through of emission costs and introduces inefficiency. A vast majority of electricity generators in
the world are government owned and this is especially true for fossil fuel burning ones. We argue
that, as a result, contrary to conventional wisdom among economists, carbon pricing is unlikely
to be an efficient way to regulate and mitigate emissions in the electricity sector. A command-
and-control approach, involving emission standards, might be more suitable, especially since
reliable estimates of the production functions of electric generators are readily available. Our
results cast doubts on the welfare implications of the massive ETS program that China will be
implementing starting in 2021.
