International Trade Linkage in Climate Change Cooperation

International Environmental Agreements (IEAs) that address global environmental problems with cross-border externalities (i.e., climate change) suffer from severe free-riding problems resulting in limited national participation. Gains and losses in international trade are concerning when countries act strategically on climate change cooperation, suggesting the potential for linking trade policy to IEA formation to overcome free riding. We construct a three-country, three-good competing exporters trade model with global externalities to determine strong Nash equilibrium coalition structures – first without trade linkage and then with trade linkage. We show that, without trade linkage, the environmental policy of a large exporter can be used to internalize environmental externalities, deal with leakages, and manipulate the terms-of-trade. Partial cooperation is preferred over non-cooperation. We show that trade linkage can deter free riding incentives and generate global welfare gains when climate change damage is moderate; otherwise, trade linkage is ineffective or possibly counter-effective. We endogenize the trade linkage choice by extending the IEA formation game to three-stages; in the first stage, each country may agree or disagree to the introduction of trade linkage. Trade linkage cannot be introduced under unanimity voting, since the free rider is always weakly worse off with trade linkage, and thus against linkage