Cournot, Pigou, and Ricardo Walk in a Bar – Unilateral Environmental Policy and Leakage With Market Power and Firm Heterogeneity.

40 Pages Posted: 12 Feb 2021 Last revised: 21 Dec 2021

See all articles by Claudio Baccianti

Claudio Baccianti

Tilburg University - Tilburg University School of Economics and Management

Oliver Schenker

Frankfurt School of Finance & Management

Date Written: December 20, 2021

Abstract

Policymakers aiming for the unilateral regulation of transboundary pollutants, such as greenhouse gases, fear as a consequence rising emissions in non-regulating countries. This so-called pollution haven or carbon leakage effect is of particular concern in emission-intensive and trade-exposed sectors such as steel, aluminium or chemical production. While these industries are often characterised by market concentration, most models that study the effectiveness of unilateral environmental policies operate under perfect or monopolistic competition, ruling out the adjustment of markups and cost pass-through rates. We study the determinants of emission leakage using a two-country general equilibrium model with heterogeneous firms and Cournot competition. We show that firms from the non-regulating country respond to the implementation of Pigouvian emission taxes on their competitors abroad and the subsequent gain in comparative advantage by increasing markups rather than output. We find that this effect, jointly with the exit of the least productive and most emission-intensive firms, can provoke a reduction of emissions in the non-regulating country and thus increase the effectiveness of the unilateral emission tax. Border emission taxes dampen the market power gains of non-regulated firms and thus reduce the effectiveness of a unilateral emission tax.

Keywords: International Trade, Unilateral Climate Policy, Border Carbon Adjustment, Oligopolistic Competition, Heterogeneous Firms

JEL Classification: C68, F12, F18, Q56, Q58

Suggested Citation

Baccianti, Claudio and Schenker, Oliver, Cournot, Pigou, and Ricardo Walk in a Bar – Unilateral Environmental Policy and Leakage With Market Power and Firm Heterogeneity. (December 20, 2021). Available at SSRN: https://ssrn.com/abstract=3784505 or http://dx.doi.org/10.2139/ssrn.3784505

Claudio Baccianti

Tilburg University - Tilburg University School of Economics and Management ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Oliver Schenker (Contact Author)

Frankfurt School of Finance & Management ( email )

Adickesallee 32-34
Frankfurt am Main, 60322
Germany

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