Is International Cooperation Necessary for Climate Policy?

Most game theory models of international environmental policy have the benefits to a country being a function of a country's emissions whereas the costs are a function of global emissions. Obviously, the result is that the emissions of a country impose a negative externality on the rest of the world, and hence that international cooperation through an International Environmental Agreement (IEA) is necessary to solve the problem of climate policy. Here, international trade is added to the simple general equilibrium model of Azacis and Collie (2025). Since an increase in emissions will increase the output of a country, it will also increase exports thereby worsening the country's terms of trade but improving the terms of trade for the rest of the world. Hence, there will be a positive terms of trade externality in addition to the negative environmental externality with the overall externality turning out to be endogenous depending upon the quantity of emissions from the rest of the world. It is shown that the Nash equilibrium (NE) with environmental policies (tradeable permits or emissions taxes) is Pareto efficient when preferences are identical and there is no home consumption bias. In this case there are no potential gains from international cooperation through an IEA. When preferences are symmetric but with a home consumption bias, the NE with environmental policies will not be Pareto efficient and there will be potential gains from international cooperation through an IEA.