WTO agreements discipline the use of subsidies, particularly for upstream manufacturing or exports. Unlike tariff rules, the Subsidies Code lacks exceptions for transboundary externalities like human health or resource conservation, including those related to combatting global climate change. Yet support policies for green goods (like renewable energy) are much more popular internationally than imposing a cost on bads (like carbon taxes). These support policies may encourage downstream consumption (renewable energy deployment) or upstream development and manufacturing of those technologies. The strategic trade literature has devoted little attention to the range of market failures related to green goods. We consider the market for a new environmental good (e.g., an alternative renewable energy technology) that when consumed downstream may provide external benefits (like reduced emissions). The technology is traded internationally, but provided by a limited set of upstream suppliers that may operate in imperfect markets, such as with market power or external scale economies.

We examine the national incentives and global rationales for offering production and consumption subsidies in producer countries, allowing that some of the downstream market may lie in non-regulating third-party countries. While producer countries can benefit from restraints on upstream subsidies, global welfare is higher without them, and market failures imply that optimal subsidies are even higher. We supplement the analysis with numerical simulations of the case of renewable energy, exploring optimal subsidies for the major renewable energy producing and consuming regions.

Keywords: international trade, subsidies, imperfect competition, externalities, emissions leakage

JEL numbers: F13, F18, H21, Q5
One sentence: Trade-distorting subsidies may be under- (not over-) provided by strategic countries when market failures are present.


This seminar has been jointly organized by FEEM and IEFE, Bocconi University.