Are We Putting the Carbon-Price Cart Ahead of the Global-Agreement Horse?

Abstract

The political feasibility of carbon pricing is intrinsically linked to the international institutional context in which policy decisions are made.     When countries act independently, the efficiency gains from choosing carbon pricing over alternative policy instruments are small due to the limited scope of the instrument selection decision and low optimal abatement. But with a binding international agreement, the efficiency gains increase markedly, both because the scope of  instrument selection expands, and because optimal abatement increases. With symmetric countries, gains grow with the square of the number of participants. With heterogeneity, gains vary, increasing by roughly two orders of magnitude for the United States under a global agreement. This enhanced efficiency under cooperation helps explain the success of the European Union Emission Trading System (EU ETS), where 17 of 30 participants see gains from carbon pricing increase by over three orders of magnitude with the agreement.

Keywords: carbon pricing, climate policy, instrument selection, political constraints

JEL Classification: Q48, Q52, Q54, Q44