Linking the European Union Emissions Trading System (EU ETS) to the Chinese national ETS promises considerable economic and political benefits. However, different policy choices regarding cap setting between the systems are likely to impede a potential linking. A striking distinction is that the EU ETS relies upon an absolute cap, while the Chinese national ETS appears to apply an "intensity-based cap" during the early stages. The current linking literature focuses on mapping legal barriers in general and has not yet focused on EU and China, let alone the intricacies of policy design. This paper seeks to fill this gap by concentrating on (static and dynamic) efficiency and environmental effectiveness implications of linking and cap design. From the analysis of the cap we derive policy implications for a hypothetical ETS linking between the EU and China.
Key words: carbon market, emissions trading, EU ETS, cap setting, linking
JEL classification: Q54