This paper contributes to the recent literature on the Green Paradox (Hoel, 2011 and Harstad, 2012) that distinguishes between regulated and unregulated regions in a Hotelling framework. In our model, different grades of oil are characterized by different costs, emission factors, and underground reserves; furthermore, the clean backstop experiences cost-reducing technical change. As a result, even unregulated consumers may switch from fossil fuels to the backstop before exhausting them. Hence, cumulative emissions reductions can occur in this model, and we identify circumstances in which reducing emissions in the regulating coalition also induces reductions among unregulated consumers—”negative leakage.” Increasing an emissions tax, increasing the size of the regulated coalition and accelerating backstop cost reductions are policy substitutes for achieving a target emissions reduction.
Our model clarifies the significant benefits which technology-oriented policies can provide. First, accelerating cost reductions in the backstop induces consumers not just from the regulated region but also from the unregulated region to reduce emissions. Second, more rapid cost reductions in the backstop technology reduce the minimum coalition size required to influence cumulative emissions. Thus, rather than exacerbating climate damages, technology policies can serve to create greater scope for climate policy actions. The result stands in striking contrast to the earlier Green Paradox literature, which focused on the case of complete extraction and found that technology policies were destined to accelerate global warming.
After describing policy tradeoffs and thresholds theoretically, we calibrate a model of the five major sources of oil to estimate them empirically. Given the difficulties in securing international cooperation on global warming, promoting technical change in clean energy sources may be a more effective instrument for reducing carbon emissions in the absence of a unified global effort. Furthermore, we find that green technology policies have little effect on near-term rates of oil extraction. However, dramatic reductions in global emissions appear challenging in the absence of widespread participation in carbon regulation and rapid development of clean energy alternatives.
