Complementary Climate Policies for Supply and Demand

This National Bureau of Economic Research working paper by Geir B. Asheim and Bård Harstad challenges the traditional focus on demand-side climate regulations, such as emissions fees. The authors argue that while supply-side and demand-side instruments are perfect substitutes in an ideal first-best scenario, they function as complements in a realistic second-best setting characterized by free-riding incentives among nations. The study demonstrates that relying solely on demand-side policies inadvertently lowers fossil fuel market prices, thereby increasing the economic gains for countries that defect from international climate treaties. To create agreements that are robust, strong, and self-enforcing, policymakers must strategically balance both supply- and demand-side measures. These findings remain valid across models with homogeneous countries and are further strengthened when accounting for national heterogeneity. The research highlights the critical need for integrated policy frameworks to effectively mitigate climate change and ensure international cooperation stability.