The Interaction of Climate and Trade Policy

The 2015 United Nations Climate Change Conference in Paris was an important step towards a climate policy solution with global coverage. Rising interconnectedness of the global economy makes global climate policy ever more pressing. The share of merchandise trade in GDP, for instance, rose from 17.5% in 1960 to 50% in 2014. Economic policy enhances globalization by reducing trade barriers: after significant reductions of tariffs in past trade liberalization rounds, recent trade negotiations have focused on the reduction of non-tariff barriers ignoring climate/energy issues. Climate/energy and trade policy can affect each other in various ways. On the one hand, the reduction of trade barriers enlarges trade volumes and production, which is likely to increase CO2 emissions and carbon leakage, whereas increased specialization can in- or decrease emissions and leakage via structural change across sectors and productivity gains within sectors. On the other hand, carbon pricing and renewable energy support affect trade and specialization. The resulting productivity gains as well as the carbon leakage effects are unclear ex ante. These policy interactions have hardly been considered by scholars and policy makers so far. Hence, this article sheds light on relevant interactions. This article presents an applied general equilibrium model which combines the theoretical foundations of an Eaton-Kortum type model of international trade with the complexity of a global multi-region, multi-sector model Computable General Equilibrium (CGE) model of production and consumption. Unlike standard Armington type models, the Eaton-Kortum model features endogenous trade-induced productivity gains via Ricardian specialization and takes non-tariff trade costs into account. Model regions and sectors can be disaggregated, e.g. representing German federal states and technology-specific electricity generation. With these features the model goes beyond standard CGE models and provides new insights in the nexus between trade policy and climate as well as energy policy. Simulations suggest that the removal of tariffs creates smaller regional welfare gains than a comparable reduction of non-tariff barriers to trade but also a slightly smaller increase in global CO2 emissions. Trade policy-induced productivity gains and renewable energy subsidies significantly reduce carbon leakage from the EU to the rest of the world by making the EU more CO2 efficient. The results suggest negotiating trade and global climate treaties in an integrative way.