Carbon pricing, border adjustment and climate clubs: Options for international cooperation

In a dynamic, three-region environmental multi-sector general equilibrium model, we find that carbon pricing generates a long-lasting downturn as production costs rise. Dirty production is shifted towards countries with laxer climate policies, known as carbon leakage. A border adjustment tax mitigates but does not prevent carbon leakage. Its impact on emissions is limited, and it mainly “protects” dirty domestic production sectors with tradeable goods (in relative terms). Benefits from lower emissions damage materialize only in the medium to long run. From the perspective of a region that introduces carbon pricing, the downturn is smaller and long-run benefits are larger if more regions participate. However, for non-participating regions, there is no incremental incentive to participate as they forego trade spillovers and face higher production costs along the transition. Because of the costly transition, average world welfare may fall as a result of global carbon pricing unless “the rich” assist “the poor”. •Introducing carbon pricing generates a lasting economic downturn.•Which is eventually followed by an upswing when emissions-damage is reduced.•Border adjustment taxation reduces but does not prevent carbon leakage.•Especially low-income regions have no incremental incentive to join a climate club.•Supplementary, at least temporary transfers and price discrimination may be neces-sary to make them do.