Greener Thy Neighbor? On the Welfare Effects of Protectionist Climate Policies

Abstract

The world is witnessing a surge in green industrial policies, with prominent examples such as the U.S. Inflation Reduction Act (IRA) incorporating significant protectionist elements. While economists have traditionally cautioned against protectionism due to its distortive effects, we argue that in the case of climate policies, these distortions can have strategic value by facilitating coordination between countries on climate action. We present a simple model that blends a standard abatement game with a beggar-thy-neighbor game, leading to multiple potential equilibria. Using techniques from the global games literature, we show that uncertainty surrounding the distortions caused by protectionist policies yields a unique equilibrium. We find that protectionist climate policies improve welfare when expected distortions are low, as they promote coordination on climate change mitigation at relatively modest costs. For high expected distortions, protectionist policies are welfare-neutral, as countries are unlikely to adopt them. For intermediate expected distortions, protectionist policies are most harmful, combining a high probability of coordination failure with substantial costs. Our findings suggest that regulators like the WTO could enhance global welfare by limiting, but not entirely banning, protectionist climate policies, especially in the absence of effective climate agreements.

Keywords: climate change mitigation, protectionism, beggar-thy-neighbor policies, global games, inflation reduction act, coordination games

JEL Classification: C72, D83, Q56