How to Fix the Inefficiency of Global Cap and Trade

Abstract

Global cap and trade equalizes the price of emissions and leads to efficient abatement across countries, but sets the abatement level inefficiently low. It is set too low, because the global cap is the sum of individual country targets set on the basis of self-interest. The efficiency of a single price does not overcome the inefficiency of the public-goods problem inherent in global cap and trade. Fortunately, other policies lead to more cooperative and, hence, more efficient outcomes. Replacing the national quantity targets of global cap and trade with a global price target improves outcomes. To improve outcomes further, the price target is combined with a Green Fund. As we demonstrate by example, the Green Fund can induce cooperation between rich countries that want a high global price and poor countries that are more concerned with Green-Fund payments.