The trading system, under which industrial polluters can buy and sell emissions quotas, is supposed to be the cornerstone of EU efforts to cut greenhouse gas emissions under the Kyoto Protocol.

However, the credibility of the scheme, which is still in its infancy, has taken a beating recently because member states are allotting more permits to pollute than industrial plants need.

"Our analysis shows that allocations proposed at present are too lax, so they will not create adequate incentives either to cut back emissions or to fund investment that helps developing country emission reductions," said Cambridge University professor Michael Grubb.

After issuing more quotas than polluters could use in 2005, the European Commission found that most of the member states that have filed their allocation plans for the 2008-2012 period so far had once again handed too many emissions permits.

The commission has also already taken the first step towards legal action against Austria, Czech Republic, Denmark, Hungary, Italy, Portugal, Slovenia and Spain for ignoring an end June deadline to submit their national allocation plans.

The European Union's executive arm is due to rule on government's allocation plans later this month and could reject those that it considers to be too lax.

"The commission cannot allow the credibility of this crucial and innovative policy instrument to be undermined," EU Environment Commissioner Stavros Dimas said. "We will have to be tough in our assessment of the national plans".

World Wildlife Fund climate change expert Stephan Singer said: "It is vital that bad national allocation plans are rejected for the EU to maintain a high standing in the fight against climate change."

In the statement signed by the European economists as well as Dimas, they said that governments needed to respect the basic economic principle of scarcity of supply in order to for the system to work.

"Emission trading creates a price and therefore a cost to CO2 emissions. When smartly constructed, this policy instrument provides clear incentives for changes in business practices and technology investments," the statement said.

"However, fundamental to the functioning of ETS (emissions trading scheme) is for the market to deliver a meaningful price for carbon," it added.

"This requires scarcity in supply which must be presented by emissions caps set at a level that represents a significant departure from business as usual practices."

Climate change has recently climbed high on the international political agenda in the wake of a report from British economist Nicholas Stern warning of looming environmental catastrophe.

Even before that, the EU's trading system was under close scrutiny abroad. California Governor Arnold Schwarzenegger for one is interested in setting up with a handful of east coast states a similar market in the United States, which has refused to sign the Kyoto Protocol.

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