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.


One Response 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.

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