Carbon Abatement, Coalition Formation, and International Trade in Greenhouse Gas Emissions

The success of any international climate change agreement depends on the strategic incentives of countries to participate. We use a calibrated non-cooperative game to consider how the terms on which countries are allowed to trade in emissions permits affect equilibrium cost and emissions predictions. Wealthy, high abatement demand countries will participate only in agreements which promise significant reductions in global emissions, the while developing countries entering such agreements must be allowed to sell sufficient emissions rights to make an their participation worthwhile. We find that stringent caps on the level of emissions rights that any individual country may allocate itself, combined with relatively weak restrictions on the volume of trade in which countries may engage are an effective way of aligning regional incentives. This result runs contrary to received wisdom from the non-strategic literature on emissions trading.