Energy efficiency policy in a non-cooperative world

In this paper, we explore energy efficiency policies in the presence of a global environmental problem and international cost interdependency associated with R&D activities. We develop a simple model with two regions where the cost of an appliance in one region depends upon the level of energy efficiency in that region and the level of R&D activities by the appliance industry. In our model, the cooperative outcome can be decentralized by imposing a tax on energy. However, we show that when regions do not cooperate, they have an incentive to adopt additional instruments to increase energy efficiency. The reason is that the lack of cooperation leads to under-taxation of the environmental externality which in turn creates an incentive to try to reduce emissions produced abroad. We illustrate this phenomenon with the Californian vehicle greenhouse gas standards.