To this point of the book we have ignored explicitly international aspects of environmental problems and policy. While the partial equilibrium models used in Chapters 3 through 6 do not rule out international trade, they abstract from issues that are specific to international pollution, policy contexts, and trade. An example of the first of these is transboundary pollution, whereby air and water emissions originating in one country are transported via wind, river, or marine systems to affect residents of other countries. This creates an environment in which the country suffering pollution damages does not have the legal authority to regulate emissions at their source. For this reason, unilateral national environmental policy usually fails to internalize the full consequences of domestic emissions, meaning that international cooperation is necessary to achieve an efficient outcome. One of the most prominent examples of transboundary pollution is climate change resulting from carbon dioxide and other greenhouse gas emissions. In sections 12.1 and 12.2 of this chapter we examine the transboundary pollution problem using a simple two-country, one commodity model without proper trade. We will see that it is relatively easy to describe efficient outcomes and policy initiatives for global pollutants. However, absent a single globally empowered regulator, countries’ voluntary participation in these policy initiatives may require international transfers in order to assure that individual welfare under the cooperative outcome is higher for all countries than under the non-cooperative outcome.

A second topic that we cover in this chapter is the interaction between environmental policy and international trade. Unilateral environmental policy in one country can have consequences for pollution in another country, in that more stringent domestic environmental policy may trigger the migration of production and mobile inputs to countries with laxer policies. This is known as emission leakage, and it has become a major focus of research and policy debate in the twenty-first century, particularly as regards the potential for “pollution havens” to develop. In sections 12.3 and 12.4, we study the problem of environmental policy when there is free international trade. We distinguish between small and large open economies, and study the differences between unilateral and cooperative environmental policy, within the two contexts. We will see that an environmental regulator needs to consider several adjustment margins when setting her policy.