A Framework for Integrating Climate Goals into Trade Agreements

Abstract

This paper develops a framework for embedding carbon pricing policies into existing international trade agreements, which have historically evolved without consideration for climate change. Using a model of international trade with input-output linkages that incorporate detailed fossil fuel energy supply chains, we show that (i) countries with larger gains from trade agreements contribute more to carbon emissions, suggesting that contingent trade reforms that link market access to carbon pricing could effectively reduce emissions; and (ii) commonly-used carbon taxes which target emissions on energy demand side create pecuniary terms-of-trade externalities for energy exporters. Building on (i), we integrate trade and climate policies by examining each country’s gains in moving from the breaking point of trade agreements to an equilibrium that includes both trade agreements and carbon pricing. Since the effectiveness of this approach is constrained by the externalities identified in (ii), we propose a Global Climate Fund that collects border-related portions of carbon tax revenues and allocates compensatory side payments. This mechanism significantly enhances the agreement’s effectiveness in reducing global emissions.