International Environmental Agreements with Trade Leakage and Financial Aid

International Environmental Agreements (IEAs) aim to address transboundary pollution through multilateral cooperation; however, free-rider incentives from emission reduction externalities hinder participation and compliance. Moreover, asymmetric abatement efforts among countries result in trade leakage, wherein non-participating countries expand their emissions by taking advantage of trade competitiveness, thereby weakening the agreement’s environmental benefits. To examine how trade leakage affects IEA stability under country asymmetries, this study analyzes three scenarios: no leakage, leakage without countermeasures, and leakage with trade restrictions. Additionally, this study integrates the emerging issue of international carbon finance by specifically examining financial transfers from developed to developing countries. Findings indicate that financial aid enhances the participation of developed countries in agreements but may reduce that of developing countries. Trade restrictions between signatories and outsiders reduce welfare losses but do not necessarily raise signatories’ overall welfare. Positive outcomes arise only when the benefits from emission reductions outweigh those from trading restricted goods.