Unilateral CO2 Reductions and Carbon Leakage: The Consequences of International Trade in Oil and Basic Materials

A recursively dynamic general equilibrium model featuring six world regions with trade in energy and non-energy goods is used to simulate the period from 1990 through 2100 in 10-year intervals. The simulations explore the effect of unilateral action by the OECD to curb global CO2 emissions. Unilateral cuts create incentives for free-riding by non-participating regions, so that global emissions are reduced by less than the amount that the OECD cuts back its regional emissions. Carbon "leakage" occurs through two channels. First, basic materials production increases in unconstrained regions, resulting in increased carbon intensity of GDP. Second, reductions in OECD oil imports cause the world oil price to fall, leading to an increased energy intensity in the non-participant regions. In this paper, we use a general equilibrium model to assess the extent to which these two mechanisms reduce the effectiveness of OECD reductions in curbing global CO2 concentrations.