Greener Thy Neighbor? On the Welfare Effects of Protectionist Climate Policies

Abstract

The world is witnessing a surge in green industrial policies, with prominent examples such as the U.S. Inflation Reduction Act (IRA) incorporating significant protectionist elements. While traditionally viewed as distortive, we argue that in the case of climate policies, protectionism can have strategic value by facilitating coordination between countries on climate action. We present a simple model that blends a standard abatement game with a zero-sum beggar-thy-neighbor game, allowing for the possibility of multiple equilibria. Using techniques from the global games literature, we show that uncertainty surrounding the distortions caused by protectionist policies yields a unique equilibrium. We find that protectionist climate policies improve welfare when expected distortions are low, as they promote coordination on climate change mitigation at relatively modest costs. High expected distortions make these policies welfare-neutral, as countries are unlikely to adopt them. For intermediate expected distortions, protectionist policies are most harmful, combining a high probability of coordination failure with substantial costs. Our findings suggest that regulators like the WTO could boost global welfare by restricting but not entirely banning protectionist climate policies. We further find that efforts to reduce uncertainty about distortions might backfire, inadvertently encouraging coordination on costly protectionist measures.