Buy coal? Deposit markets prevent carbon leakage
If a coalition of countries implements climate policies, nonparticipants tend to consume more, pollute more, and invest too little in renewable energy sources. In response, the coalition's equilibrium policy distorts trade and is not time-consistent. This paper derives conditions for when trading fossil fuel deposits increase efficiency. In isolation, a bilateral transaction may occur too often or too seldom compared to the optimum. However, when the market clears, the above-mentioned problems vanish, the first-best is implemented, and the coalition finds it optimal to rely entirely on supply-side policies, which are simple to implement in practice.
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