WIIW The Vienna Institute for International Economic Studies - Wiener Institut für Internationale Wirtschaftsvergleiche

Ahmad Lashkaripour

To what extent can trade policy help reduce global carbon emissions? We examine this question using a multi-country multi-industry general equilibrium trade model with transboundary carbon externalities. Our framework accommodates firm-delocation in response to policy, multi-lateral carbon leakage, and returns to scale in production and abatement. Our central result is a set of simple formulas for unilaterally optimal trade and carbon taxes in an open economy. The optimal policy consists of (i) a uniform carbon tax across all industries; (ii) industry-level production subsidies that restore marginal-cost-pricing independent of the industry’s carbon intensity; (iii) industry-level import taxes that penalize carbon-intensive imports but less so in high-returns-to-scale industries; and (vi) industry-level export subsidies that, in addition to improving the terms of trade, promote clean exports against carbon-intensive foreign competition. Mapping our formulas to data, we find that trade taxes can replicate only around 3% of the carbon reduction attainable under (first-best) cooperative global carbon taxes. This lack of effectiveness is partly driven by a tension between the carbon-reducing and terms-of-trade rationales for trade taxation under scale economies. Trade taxes, however, can be remarkably effective at enforcing international climate agreements even in the presence of scale economies and firm-delocation effects.