Carbon leakage revisited. Unilateral climate policy under directed technical change

This paper analyzes the consequences of unilateral climate policy in the presence of directed technical change. We develop a dynamic two-country model in which two otherwise identical countries differ in their environmental policy: one of the countries enforces a (binding) cap on emissions while the other does not. Focusing on carbon leakage, we show how, compared with a 'traditional' endogenous growth model, directed technical change will always lead to lower emissions in the unconstrained country. When clean and dirty goods are good substitutes, it may even be induced to reduce its emissions below the optimum level when both countries are unconstrained, so leakage is negative.