Trade policy is often cast as a solution to the free-riding problem in international climate agreements. This paper uncovers the extent to which trade policy can deliver on this promise.
We introduce global supply chains of carbon and climate externality into a multi-country, multi-industry general equilibrium model of trade. By deriving analytical formulas for optimal carbon and border taxes, we quantify the reduction in emissions under two prominent proposals that combine carbon pricing with border taxes. First, we show that carbon border taxes can reduce global emission by only a modest amount. By comparison, Nordhaus’s (2015) climate club proposal can result in an inclusive club of all nations that promotes free trade and cuts global emissions by two-thirds of the emission reduction attainable under the globally first best. This successful outcome hinges on the EU, US, and China committing to the climate club as core members, using their collective trade penalties to enforce cooperation by reluctant governments.
Dr. Farrokhi is Assistant Professor of Economics at Purdue University and visiting Princeton University as a Kenen Fellow at the IES and Department of Economics.
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