Coalition Formation and International Trade in Greenhouse Gas Emissions

The success of any international climate change agreement depends on abatement targets and the incentives for countries to participate. International emissions trading is frequently cited in the policy literature as a means to making headway on both issues. With trading, more stringent targets become less costly, and agreements could be profitable for the developing world by allowing them to capture the rents from the sales of carbon emission permits. The present paper formulates a general equilibrium model of self-enforcing carbon abatement agreements. In our setting, permit allocations are determined endogenously as equilibrium behavior within a candidate coalition. This allows us to ask how the negotiations of self-interested agreement members might affect coalition stability, the agreement’s abatement target, and the division of surplus among member states. We embed this strategic behavior in an empirically-based representation of the global economy in seven sectors and six regions and calibrated to a 1998 base year. This allows us to identify the dominant general equilibrium effects and make predictions about the prospects for cooperation over the next twenty years. We find that the most effective equilibrium coalitions yield abatement at approximately twice the level achieved in a world without cooperation. These coalitions are sub-global and involve high income/high abatement cost countries buying large volumes of emissions permits from their developing world partners. While the grand coalition is stable, it is typically suboptimal. Permit allocations required to solicit broad participation dilute the gains achieved through cooperation. Terms of trade effects in energy markets work in favor of adopting more stringent targets, yet equilibrium abatement levels are still modest when measured against a global first-best. Sensitivity analysis suggests that our results are driven less by the propensity for coalition members to negotiate inecient agreements than by the classic free-rider incentive. Our conclusions are stable over the time horizon and with respect to a variety of baseline growth assumptions. International agreements fall short of the global first best, however, and the prospects for an effective agreement are as good now as they are likely to be at any point over the next 20 years. A strategy of delayed negotiations could be both costly and ineffective.