FEEM working papers "Note di lavoro" series
2014 .055

Unilateral Climate Policy and Foreign Direct Investment with Firm and Country Heterogeneity


Authors: Francesca Sanna-Randaccio,  Roberta Sestini, Ornella Tarola
Series: Climate Change and Sustainable Development
Editor: Carlo Carraro
Keywords: Foreign Direct Investment. Carbon leakage. Climate Policy, Emissions Technologies
JEL n.: F12, F23, Q58

Abstract

We contribute to the debate on the impact of unilateral climate policy with a two-country two-firm international oligopoly model accounting for endogenous plant location and heterogeneity in both country size and firm’s emissions technology. Our results suggest that, if the carbon price differential is moderate as compared to unit transport costs and the  relative size of the highly regulated country is big enough, a no relocation equilibrium may prevail also in the long run. A large market asymmetry coupled with a small technology gap emerges as the only configuration in which unilateral climate policy leads to a fall in world emissions irrespective of the optimal location choice. Thus for being effective and not leading to production relocation, unilateral climate policy should be moderate, implemented by a sufficiently large area and complemented by mechanisms for promoting the international transfer of clean technologies. Welfare implications are also discussed.

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Suggested citation: Sanna-Randaccio, F., R. Sestini, O. Tarola, (2014), 'Unilateral Climate Policy and Foreign Direct Investment with Firm and Country Heterogeneity', Nota di Lavoro 55.2014, Milan, Italy: Fondazione Eni Enrico Mattei.

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