Authors: Carolyn Fischer and Stephen W. Salant

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. 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.