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 it is not time consistent. By adding a market for the right to exploit fossil fuel deposits, I show that these problems vanish and the …rst best is implemented. When the market for deposits clears, the coalition relies entirely on supply-side policies, which is simple to implement in practice. The result illustrates that e¢ ciency can be obtained without Coasian negotiations ex post, if key inputs are tradable ex ante. Key words: Coase, climate change, carbon leakage, supply v demand side policies, trade policies, the green paradox, and environmental agreements JEL: Q54, Q58, H23, F55 * I have bene…tted from the comments of Rolf Golombek, Michael Hoel, Garrett Johnson, Benny Moldovanu, Rob Porter, and Jean Tirole. The author’s email is: [email protected]