25While the extent and nature of environmental legislation varies from country to country, free trade in emission allowances can undermine stricter regulations. This effect is similar but more pronounced than the carbon leakage described in Section 2. If two countries both limit their emissions with a cap-and-trade system, and if the equilibrium price of emission allowances is different in the absence of permit trading in the two countries (so that the EPF does not hold), emissions trading increases efficiency if emission caps remain fixed. However, trade can encourage one or both countries to weaken their regulations in order to increase their supply of permits and thus increase their profits through commercial permits. It took 16 years for the World Heritage Convention and the CITIES Conventions, first ratified in the 1970s, to be ratified by more than 100 countries. However, the Kyoto Protocol was first ratified in 1998 and took only five years to reach the same point, and the Paris Agreement (2016) received 121 ratifications in the first year. 14One way to introduce trade policy as a lever for international climate policy is to revise the WTO. This revision would probably be rejected by most developing countries. A more practical way to introduce trade leverage is to include it in an environmental agreement, rather than as part of a WTO reform. Trade sanctions are legal under applicable WTO law, provided that they are imposed on a signatory to the Environment Agreement and are in conformity with that Agreement. The agreement should allow signatories to impose a border tax adjustment on other signatories to compensate for a cost disadvantage that goes beyond a minimum level and is caused by stricter climate policies.

For example, tax offsetting at the border only protects against carbon leakage for sectors that face the highest costs of complying with climate policy. Given the obligation to include countervailing subsidies in the calculation of a tax adjustment at the border and the discipline imposed by the WTO dispute settlement procedure, the overall impact of the tax adjustment at the border would likely be small. However, the policy effect could still be significant, making it harder to argue that leaks undermine national greenhouse gas emission reductions and harm domestic industry. According to our proposal, fiscal equalisation at the borders can only be used against the signatories of an agreement. It would most likely be used when trading partners have very different climate-related obligations, such as in trade between developed and developing countries. This makes it particularly important for developing countries to participate in an environmental agreement by taking advantage of the positive incentives mentioned above. Even if developing countries are not obliged to reduce their emissions in the short term, fiscal border adjustment limits their ability to benefit from emission reductions in developed countries. This undermines an important argument that the United States has used to stay out of Kyoto. 29 In accordance with those assumptions, the authorisation to trade in authorisations for the reason set out in Section 3 increases efficiency. Since we assume that the EPF does not hold and we ignore other general equilibrium considerations (such as endogenous commodity prices), we use a partial equilibrium parameter here. Trade permits allow for some degree of cheaper reduction when countries have different marginal mitigation costs. This fact could give the impression that the exchange of permits promotes a higher degree of reduction.

In this sense, trade appears to be «environmentally friendly.» We look at the International Environmental Agreement (IEA) with side effects. 71 What is new here is that trading can also reduce participation in equilibrium. Verifying this claim is complicated, but the basic idea is simple (Karp 2009). .