Abstract :
If all countries participate in a climate agreement, policies affecting the supply of fossil fuels have identical economic consequences as policies affecting the demand of fossil fuels. This is no longer true when there is limited participation in an international agreement. In the paper, it is assumed that a group of countries commit themselves to cooperating, while the remaining countries act independently and in pure self-interest. The paper compares supply and demand policies in this context and demonstrates that policies which affect only demand or only supply of carbon generally are inferior to policies affecting both demand and supply of carbon. The optimal mix of supply and demand policies is derived in the paper, with particular emphasis on carbon taxes. An important result is that if the marginal environmental costs of total emissions are sufficiently high (in the cooperating countries), then both production and consumption of carbon should be taxed at a positive rate. If on the other hand the marginal environmental costs of total emissions are sufficiently low, it may be optimal to subsidize production or consumption. In this case, production should be subsidized if the cooperating countries are net importers of carbon, while consumption should be subsidized if the cooperating countries are net exporters of carbon. Another important conclusion of the paper is that the cooperating countries should try to induce the non-cooperating countries, through appropriate transfers, to tax consumption and production of carbon at the same rate as in the cooperating countries.
