Emissions Trading with Non-signatories in a Climate Agreement: An Analysis of Coalition Stability

We investigate how different designs of carbon offset mechanisms like the Kyoto Protocol’s Clean Development Mechanism (CDM) affect the success of self-enforcing climate treaties. In a game-theoretic numerical model of coalition formation it is shown that effects of emission trading with non-signatories are negative if strategic behaviour and free-rider incentives are explicitly considered. Even imposing selling targets on credit supplying countries do not change this result. Larger stable coalitions are achieved when the treaty is designed such that its signatories do not use the gains from credit trading to lower their emission caps but stick to modest abatement targets to keep leakage effects at a minimum. Selling targets that introduce some “hot air” may exacerbate this effect on participation, albeit without a substantial effect on welfare.