Carbon leakage:: Interactions of primary and final goods markets

We look at a simple model of international trade in primary goods (energy) and final goods. Tighter environmental policies in one country induce increased emissions in the rest of the world since they reduce the price of energy and raise the prices of energy-intensive final goods. The model is calibrated and it is seen that the effect via the final-goods market is relatively unimportant compared to the effect via the energy market. Optimal environmental policies require the introduction of trade interventions such as tariffs, import and export subsidies. Finally, non-competitive markets for final goods are addressed and it is shown that most of the results are not substantially altered.