Edited by Henk Folmer, H. Landis Gabel, Shelby Gerking and Adam Rose
Chapter 7: International trade and the environment: how to handle carbon leakage
Michael Hoel 1 INTRODUCTION It is frequently argued that international trade makes it more difﬁcult to reach an environmentally good outcome. One of the reasons often given is that international trade, and in particular internationally mobile capital, makes it difﬁcult for the government of each country to pursue a policy which gives the environment enough attention. Typically, the argument goes something like this: in open economies with mobile capital across countries, governments will compete by offering conditions favourable to business in order to attract investment. One form such competition may take is that governments set lower environmental standards, for example through lower emission taxes, than they would without international competition. In their attempt to underbid each other with low environmental taxes, all countries end up with emissions that are higher than what is Pareto optimal for the whole group of countries. The argument above has been studied in detail for the standard case by Oates and Schwab (1988) and others. An important conclusion is that in a competitive economy without any distortions (except for the environmental externality), and where emission taxes are used as the environmental policy instrument, there is no need for international coordination of the emission taxes. When the government of each country sets environmental taxes to maximize the utility levels of the country’s consumers, we get a Paretooptimal allocation of emissions and capital across countries. Several important environmental problems have a transboundary dimension, that is, the environment in one country will depend on emissions in...
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