Analysis of Carbon Leakage in an Extended Ricardo-Viner Model

Carbon leakage remains a topic of crucial importance as long as the international climate regime remains fragmented. In the first part of this paper, we adopt a typology of three distinct channels of carbon leakage and use it as a guide to review the existing literature. In the second part, we investigate the interplay of two forms of leakage, namely specialisation leakage (linked to termsof-trade adjustments) and supply side leakage (caused by changes in the relative price of fossil fuels). To do so, we resort to a two-country Ricardo-Viner (aka specific factors) model of international trade, extended by a global market for fossil fuels. We derive expressions for the marginal leakage rate both for domestic intersectoral and international leakage and confront the two channels of leakage. Finally, we suggest and assess various policy instruments, such as emissions trading, border tax adjustments, and sector-specific emission caps.