Global carbon price asymmetry

Keywords Carbon leakage; Carbon pricing; Imperfect competition; International trade; Second best Abstract This paper studies a social planner who chooses countries' carbon prices so as to maximize global welfare. Product markets are characterized by firm heterogeneity, market power, and international trade. Because of the market-power distortion, the planner's optimal policy is second-best. The main insight is that optimal carbon prices may be highly asymmetric: zero in some countries and above the social cost of carbon in countries with relatively dirty production. This result obtains even though a uniform global carbon price is always successful at reducing countries' emissions. Competition policy that mitigates market power may enable stronger climate action. Author Affiliation: Energy Policy Research Group, Judge Business School, University of Cambridge, United Kingdom Article History: Received 17 December 2020; (footnote)1 I am grateful to Joshua Linn (Editor) and two referees for their valuable feedback and to Lassi Ahlvik, Geoffroy Dolphin, Sam Fankhauser, Felix Grey, Chris Harris, Cameron Hepburn, Frank Jotzo and David Newbery for helpful comments on earlier versions of this paper and to Bowie Wong for excellent research assistance. All views expressed and any errors are mine. Byline: Robert A. Ritz [rar36@cam.ac.uk] (1)