To achieve a pre-determined target of emission abatement, one can adopt a planning approach, i.e., to carefully distribute and enforce non-tradable permits onto emitters, or use a market approach, i.e., to allow them to trade the permits with each other. We compare the welfare implications of the two approaches under incomplete information about the abatement cost, and with local externalities of such abatement, which may incur, for example, via changes in emissions of other substances. We show that market can address incomplete information but not heterogeneous local externalities; the opposite is true for planning. Therefore, the policy choice depends on the relative significance of the informational and externality problems. Applying the theoretical results to China’s abatement of carbon emissions, we show that while a national carbon market can achieve a slightly better welfare outcome than a carefully designed national abatement plan, it will be substantially outperformed by a hybrid scheme, in which planning is applied to regions with the least incomplete information, while the rest are sorted into a limited number of subnational carbon markets by their local externalities of abatement.

Guojun HE is an economist working on environmental, development, and governance issues. Currently, he is an associate professor in Economics and Management & Strategy at the University of Hong Kong (HKU). He serves as the director of HKU's ESG Research Institute and the associate director of HKU's Institute of China Economy. He holds a concurrent appointment at the Energy Policy Institute of the University of Chicago (EPIC) and leads research activities of its China center (EPIC-China). He is a co-editor of Journal of Environmental Economics and Management and China Economic Review. His work has been published in leading economics journals (like QJE, AER, AER: Insights, AEJ: Applied) and science journals (like PNAS, Nature: Sustainability, Nature Human Bahaviour, and The BMJ). He obtained his Ph.D. in economics from UC Berkeley in 2013.