Political influence on international climate agreements with border carbon adjustment
by Achim Hagen (Humboldt-Universität zu Berlin) and Mark Schopf (FernUniversität in Hagen)

Strict climate policies can have negative competitiveness effects for domestic industries if foreign companies are subject to less stringent regulations. To protect domestic industries, Border Carbon Adjustments (BCA) are on the agenda: By adjusting the effective carbon tax at the border, full BCA create a level playing field for trade-exposed companies. They reduce carbon leakage and can change the incentives for countries to sign international climate agreements. The strategic impact of BCA can be very strong if trade-exposed polluting industries exert strong influence on policy decisions through lobbying activities.

In a recently published paper, we study the influence of industrial lobbying on national climate policies and the formation of an international climate agreement if BCA are in place to protect domestic industries. We use a simple model with perfectly competitive international trade and countries that regulate carbon emissions from production with carbon taxes. Countries can sign an international climate agreement to collectively increase their climate policy ambitions, or they can remain outsiders and free ride on the coalition's ambitious climate protection efforts.

We find that the strategic effects of lobbying by trade-exposed polluting companies depend on the distribution of carbon tax revenues and show a novel mechanism that can stabilize large climate coalitions. If the carbon tax revenues are transferred to the households, industrial lobbying aims to reduce the tax burden, distorts carbon taxes downwards and does not affect free-rider incentives. This leads to higher emissions and lower welfare. By contrast, if tax revenues are given back to the firms, industrial lobbying aims to raise the international commodity price. This reduces the tax difference and the welfare difference between the countries, which reduces the free-rider incentives. As a result, larger coalitions can be stable and lead to lower global emissions and higher welfare.

With this study, we do not want to trivialize the negative welfare effects of lobby influence through market distortions in general. However, since there is clear evidence for lobbying on national environmental policies and international climate agreements, we suggest that its influence should be taken into account and directed in the desired direction when shaping climate policy.

The full article is published open access in the Journal of Environmental Economics and Management:

Hagen, A. & Schopf, M. (2024). Political influence on international climate agreements with border carbon adjustment.Journal of Environmental Economics and Management, 125, 102979.

This text is jointly published by BCCP News and BSE Insights.

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