International Environmental Agreements and Trading Blocks — Can Issue Linkage Enhance Cooperation?

Abstract

This paper examines the effect of designing international agreements that jointly determine environmental and trade policies on the participation level and aggregate welfare. This paper builds on the non-cooperative game approach of the International Environmental Agreements (IEAs) literature extending the basic model by introducing firms that trade in a global market. Countries choose the level of a tax on emissions and a tariff on imports: signatories enjoy tariff-free trade among themselves, impose a tariff to nonsignatories and a common emissions tax; nonsignatories levy a tariff on imports and a tax on domestic emissions. Resorting to numerical simulations, the paper shows increased participation to the joint agreement of around 70% of the total number of countries. These coalitions are not only much larger than the two-country coalition derived in the case without trade, but they also achieve substantial welfare improvements of around 60% of the welfare improvement the grand coalition provides over the coalition of two. The paper presents a series of numerical simulations to confirm the robustness of these results to changes in the parameters values.