Industrial policy and global public goods provision: rethinking the environmental trade agreement

Countries around the world use anti-dumping duties, local content requirements and other protectionist measures to promote their low carbon industries, thereby inflating downstream costs. At the same time, they ascribe insufficient climate action to the economic burden of mitigation efforts. This paper examines the trade-off between temporarily forgoing gains from trade by protecting an infant industry and increasing future gains through fiercer global competition later on. I introduce a strategic model featuring two countries, two time periods, and trade in a clean technology in a set up with differential production costs and imperfect competition. The findings suggest that when initial differences in production cost surpass a critical threshold, and learning-by-doing facilitates catch-up for the laggard, opting for autarky during Stage 1 can enhance overall welfare for both countries. This result is strengthened when both countries use consumer subsidies. Furthermore, when both consumer and producer subsidies are available, the Subgame Perfect Nash Equilibrium involves both trade and production subsidies on the part of the laggard country and the same welfare payoffs as perfect competition. The analysis suggests that an environmental trade agreement is most likely to be beneficial if production subsidies for clean technology are permitted.