The Role of Emissions Trading and Permit Allocation in International Climate Agreements with Asymmetric Countries

This paper presents a model of international environmental agreements in which cooperation between asymmetric countries can arise through pure self-interest. It demonstrates how emissions trading creates economic surplus by exploiting asymmetries. This surplus can be distributed via the appropriate allocation of reduction commitments, which ensures that membership in the agreement is compatible with countries' incentives to join. While this mechanism improves upon the business-as-usual outcome, it does not solve the underlying collective action problem wherein abatement falls short of the social optimum. We also show that countries' incentives to participate in a global climate agreement crucially depend on the permit allocation schemes, and that allocation schemes that ensure full participation in the global climate agreement might be at odds with fundamental equity considerations.