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 ei¬?ciently when the major i¬ rms 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 inei¬?ciency. 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 ei¬?cient 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.