Environmental Policy and Directed Technical Change in a Global Economy: Is There a Case for Carbon Tariffs?

In an open economy, can unilateral environmental policies undertaken by a group of committed countries ensure sustainable growth? This paper addresses this question in a dynamic model with directed technical change. There are two countries and two tradeable goods. One of the two goods (the polluting good) is produced with a clean input and a dirty input, which causes a global externality. Innovation can be targeted at both sectors and, within the polluting sector, at clean or dirty technologies. For most of the analysis, innovation is local. I show that carbon taxes in a single country are generally unable to ensure sustainable growth, that is, to prevent environmental quality from falling below some critical threshold. A temporary combination of clean research subsidies and a tariff in a single country can ensure sustainable growth for suffi ciently large initial quality of the environment in some cases, clean research subsidies alone may not do so. I characterize the first best policy, the world optimal policy under the constraint that one country must be in laissez-faire, and the optimal policy from the point of view of a single country. Calibrated numerical simulations show that, relative to autarky, trade accelerates environmental degradation, but that when one country undertakes the appropriate policies, trade helps reducing environmental degradation. Finally, I add knowledge spillovers and show that carbon taxes in a single country are still generally unable to ensure sustainable growth. JEL Classification: F18, F42, F43, O32, O33, O41, Q54, Q55