The Impact of Unilateral Climate Policy with Endogenous Plant Location and Market Size Asymmetry

Abstract

AbstractThis paper analyses the impact of unilateral climate policy on firms' international location strategies in emission‐intensive sectors, when countries differ in terms of market size. The cases of both partial and total relocation via foreign direct investment are separately considered. A simple international duopoly model highlights the differences between short‐term and long‐term effects. In the short‐term no change in location is a likely outcome in very capital‐intensive sectors and, when there is a strategy shift, this takes the form of partial rather than total relocation. In the long‐run total relocation becomes a feasible outcome. However, when tighter mitigation measures are introduced by the larger country and unit transport cost is high, with a pronounced market asymmetry, the probability of firms not relocating abroad is high even in the long‐term. The welfare implications of unilateral environmental measures are assessed considering global industrial pollution and accounting for shifts in location strategy.