The environment and directed technical change in a North–South model

A key question in the economics of climate change is the importance of global policy coordination in reducing carbon emissions. In this paper, we study this question using a two-country (North–South) extension of Acemoglu et al. (2012) which introduces directed technical change into a general equilibrium model of climate change. We find that, first, the optimal policy necessarily requires global policy coordination, with the implementation of research subsidies and carbon taxes in both North and South. Second, under certain circumstances, appropriately chosen environmental regulations in the North alone can prevent the worst environmental disasters. In particular, such disasters can be prevented by a combination of carbon taxes and clean research subsidies under the restrictive conditions that (a) the two inputs are substitutable in both countries; (b) there is no international trade between the North and the South; and (c) the South imitates technologies invented in the North. Third, international trade between the North and the South typically makes it more difficult to prevent environmental disasters through unilateral policies in the North, because environmental regulation in the North may induce full specialization by the South in dirty input production, as imitation of clean technologies by the South then ceases to be profitable. Hence, given current circumstances, global policy coordination is highly desirable.