An Economic Theory of Emission Cap Determination by an International Agreement

We attempt to clarify the problem of determination of national emission endowments under the Kyoto protocol. We argue that many issues, such as assigning culpability and compensation for the current global stock of carbon and the linking of emission endowments to per capita entitlements, are better handled through direct lump-sum transfers and not via distortions of the endowments of emission flows. Given these arguments, we model the distribution of endowments as equilibrium of a non-cooperative game. This framework allows us to make qualitative predictions about the impact of international differences on the pattern of emission caps. We also perform simple comparative statistic exercises that predict how the equilibrium caps vary with parametric changes. Moreover, we study how nations can manipulate the emission caps by strategic investment in technology and damage control.