To succeed in reducing carbon dioxide emissions, a climate policy must establish credible long-term incentives for investments in new energy-sector capital and in research and development. We argue that credibility implies that international agreements should focus on enhancing coordination and collaboration between countries, rather than on coercion.
At the national level, credibility requires political and economic incentives that can be provided by long-term tradable emissions permits, but it needs more flexibility than can be provided by a conventional permit system. We argue that the best mechanism for providing credible long-term incentives is a hybrid system of long and short term emissions permits. Key aspects of the system would be coordinated across countries but the permits would be issued and traded solely within national borders.