International trade and climate change cooperation

Abstract

International trade and the environment have close interactions. The gains and losses in trade are a concern for each country when it is strategically choosing actions on climate change cooperation. However, such interactions have been relatively neglected in the literature. This thesis aims to study how an international environmental agreement (IEA) on climate change is formed in a globalized economy and how trade and trade policy affect the formation of such an IEA. To study the role of trade in climate change cooperation, this thesis builds a “three-country, three-good” general equilibrium model in an open economy and defines an endogenous IEA formation game accordingly. It is found that the environmental policy of a large exporter is used to internalize environmental externalities, and more importantly, to deal with leakage problem and to manipulate terms-of-trade gains. Thus, countries that form a partial coalition can enjoy a larger market power and exploit more surplus in international trade. This model also predicts that there exists a small coalition paradox that prevents large welfare gains and emission reduction from full cooperation. To investigate the possibility of trade linkage in IEA formation, a three-stage trade linkage game is defined in a partial equilibrium competing exporters trade model. Each country is empowered to agree or disagree to the introduction of trade linkage to the IEA in the first stage. It is found that trade linkage can deter free riding incentives and generate global welfare gains when climate change damage is moderate. Second, the presumption that trade linkage always induces participation in IEA is misleading. It can be ineffective when climate change damage is large or even counter-productive when climate change damage is small. Third, trade linkage cannot be introduced in the first place if the voting rule requires consensus approval, since the free rider is always weakly worse off with trade linkage, and thus against linkage. Trade linkage is only possible if a majority voting rule is applied.