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

Countries around the world increase the downstream cost of low carbon technologies using anti-dumping duties and local content requirements, while simultaneously blaming inadequate efforts to address climate change on the economic cost of doing so. This paper presents a 2-country, 2-period strategic model of trade in a clean technology in the presence of differential country-level production costs and imperfect competition. If the difference in production cost is large enough and learning-by-doing allows the laggard country to catch up, then in the absence of production subsidies remaining in autarky during Stage 1 of the game can be welfare-improving for both countries. This result is strengthened when both countries use consumer subsidies. When countries choose their policy mixes, the Nash Equilibrium involves both trade and production subsidies on the part of the laggard country. The analysis suggests that an environmental trade agreement is most likely to be beneficial if production subsidies for clean technology are explicitly permitted.