Optimal Climate Policies in a Dynamic Multi-Country Equilibrium Model

By Elmar Hillebrand and Marten Hillebrand


This paper develops a dynamic general equilibrium model with an arbitrary number of different regions to study the economic consequences of climate change under alternative climate policies. Regions differ with respect to their state of economic development, factor endowments, and climate damages and trade on global markets for capital, output, and exhaustible resources. Our main result derives an optimal climate policy consisting of an emissions tax and a transfer policy. The optimal tax can be determined explicitly in our framework and is independent of any weights attached to the interests of different countries. Such weights only determine optimal transfers which distribute tax revenues across countries. We infer that the real political issue is not the tax policy required to reduce global warming but rather how the burden of climate change should be shared via transfer payments between different countries. We propose a simple transfer policy which induces a Pareto improvement relative to the Laissez faire solution.

Cool paper that expands in some ways on the work of Hassler, Krusell and Smith. It is particularly interesting that there is a Pareto improvement on Laissez faire. I wonder though whether a country could still deviate by having lower taxes and free-ride on the others. That may undo the Pareto equilibrium through some sort of tax competition.


4 Responses to Optimal Climate Policies in a Dynamic Multi-Country Equilibrium Model

  1. Thank you very much for the discussion! And yes, you are right: The Pareto improvement on Laissez faire does not eliminate the free-riding problem, and it might be that countries still have an incentive to deviate from the optimal tax policy. In this sense, the result requires some level of cooperation across countries. We are working on a non-cooperative extension of our results to see if/how we can choose transfer payments to support the equilibrium with optimal taxation in each country as a Nash equilibrium.

  2. Klaus Wälde says:

    When reading this paper, I was surprised by the modelling of environmental damage. Environmental damage is bad for the economy as it reduces total factor productivity. While this is certainly one important aspect of environmental changes, there are also direct utility effects of, say, global warming. Some like to put this dramatic by saying that “global warming is costly for the North and deadly for the South”. Expressed less emotionally, why would one not allow for an effect of environmental quality directly on the instantaneous utility function of individuals (capturing e.g. sunburns or skin cancer or psychic costs from loss of biodiversity etc)?

    A nice feature of the work by the two Hillebrands is their multi-country framework. This would allow to model “costs in the North and death in the South”. One would make the effects of environmental changes dependent on the current development level of a country. But I guess, one should first come up with some numbers on what it actually means that there are only costs in the North (good warning systems, we just reconstruct our houses?) vs more threatening effects in the South (fewer well-developed institutions, less well-developed health systems?). I see that this sounds more like future work than a precise comment for this specific paper.

  3. Klaus Wälde says:

    Quantitative findings would of course be nice. What do we learn about the 2-degree objective fixed by policy makers (the average world temperature should not increase by more than 2 degrees)? A quantitative version should be able to make predictions about whether this objective can still be attained. Is it already too late or is there still hope?

    In this context: The 2-degree-objective has been contested of course. Any number is always arbitrary to some extent (why not 2.1 or 1.9 degrees?). Is there any mechanism in the model that would justify a clear threshold level? Does the model predict that a rise about x degrees would lead to something qualitatively different than any rise in average temperature that remains below these x degrees? Are there tipping points in the model, points of no return? A quantitative version of the model would provide some rational for 2-degree-objectives and could come up with quantitative values for the x.

  4. Hi Klaus,

    thanks for your comments! Since you posted this (quite a while ago), we have substantially revised the paper which now incorporates many of your suggestions including quantitative results. We also discuss a modification where climate change has direct utility effects. The final version is now accepted for publication in JET and can be downloaded here:

    Thanks again, kind regards,

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