The Trade-Off between Intra- and Intergenerational Equity in Climate Policy: Can Carbon Leakage Be Justified?

Abstract

This paper focuses on two equity aspects of climate policy, intra- and intergenerational equity, and analyzes the implications of equity preferences on climate policy, and on the production and consumption patterns in rich and poor countries. We develop a dynamic two-region model, in which each region suffers from local pollution and global warming, but also has an inequality aversion over current consumption allocations. Inequality aversion over consumption lifts the consumption path of the poor region, while it lowers the consumption path of the rich region, which must take a greater share of the climate burden. Therefore, a high abatement in the rich region is met by more pollution in the poor region, thus justifying carbon leakages. Moreover, the poor region may even be allowed to increase emissions relative to business as usual under the optimal climate policy. These effects are reinforced when introducing transfers between the regions. However, loans to poor countries to reduce inequality may result in a debt crisis, and debt remittance may be part of the optimal climate policy.