A global carbon tax? Why firm mobility and heterogeneity matters

This paper investigates the multiple effects of a global carbon tax in an imperfectly competitive economy characterized by asymmetrically sized countries, mobile and heterogeneous firms, and international trade. In the short run, the global tax produces only Pigouvian effects, thereby reducing emissions, as argued in the literature. However, in the long run, when firms are mobile we uncover several less friendly impacts of the tax that crucially depend on the level of trade costs. In fact, agglomeration and relocation effects of dirty or clean firms may greatly reduce or magnify the effects of the tax. In addition, we show that a global tax instrument may actually eliminate the most environmentally-friendly spatial locations when trade costs are high. Given the urgent need for a global environmental policy that curbs emissions, our findings highlight the relevance of trade costs, which may heavily impact the effectiveness of such a policy.