Abstract
This paper builds a two-country, two-sector (polluting, nonpolluting) trade model with directed technical change, examining whether unilateral environmental policies can ensure sustainable growth. The emission rate of the polluting sector depends on its relative use of a clean and a dirty input. A unilateral policy combining clean research subsidies and a trade tax can ensure sustainable growth, while unilateral carbon taxes alone increase innovation in the polluting sector abroad and generally cannot ensure sustainable growth. Relative to autarky and exogenous technical change respectively, trade and directed technical change accelerate environmental degradation either under laissez-faire or with unilateral carbon taxes, yet both help reduce environmental degradation under the appropriate unilateral policy. I characterize the optimal unilateral policy analytically and numerically using calibrated simulations. Knowledge spillovers have the potential to reduce the otherwise large welfare costs of restricting policy to onecountry.
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