Domestic Effects of Environmental Policies with Transboundary Pollution

We model environmental interaction among countries as a policy game where governments in each country use quotas or taxes as strategy variables. The environmental policy has a triple role to play: targeting domestic emissions, providing strategic advantages for domestic firms and targeting imported pollution. Using a multi-sector economic model, we show that, besides the well-known inefficiencies arising at the international level, the environmental policy may lead to purely domestic inefficiencies.