Carbon leakage undermines the effectiveness of unilateral carbon pricing. Taxes on import-embedded emissions, like the EU’s CBAM, prevent leakage but their product coverage is limited due to strong information asymmetries. We propose an alternative policy (LBAM) that sterilizes carbon leakage without requiring information on foreign carbon intensities. In a quantitative trade model, LBAM tariffs significantly improve over the EU’s CBAM in terms of global emissions and EU welfare. Importantly, LBAM avoids large welfare losses among EU trading partners that would result if CBAM were extended to all sectors. Combining LBAM tariffs with equivalent export subsidies reinforces these advantages.
We demonstrate that the estimation of gravity equations of trade flows suffers from an omitted variable bias when firms are granular and behave oligopolistically. We show how to correct for this bias in the estimation of both firm- and industry-level gravity. Using French and Chinese export data, we find that the oligopoly bias leads to a substantial underestimation of the effects of distance on trade flows. In a calibrated version of the model, the welfare gains from a trade liberalization are found to be almost twice as large under oligopoly as under monopolistic competition.
Trade and industrial policies, while primarily intended to support domestic industries, may unintentionally stimulate technological progress abroad. We document this mechanism in the case of rare earth elements (REEs) – critical inputs for manufacturing at the knowledge frontier, with low elasticity of substitution, inelastic supply, and high production and processing concentration. To assess the importance of REEs across industries, we construct an input-output table that includes disaggregated REE inputs. Using REE-related patents categorized by a large language model, sectoral TFP data, trade data, and physical and chemical substitution properties of REEs, we show that the introduction of REE export restrictions by China led to a global surge in innovation and exports in REE-intensive downstream sectors outside of China. To rationalize these findings and quantify the global impact of the adverse REE supply shock, we develop a quantitative general equilibrium model of trade and directed technological change. We also propose a structural method to estimate sectoral input substitution elasticities for REEs from patent data and find REEs to be complementary inputs. Under endogenous technologies and with complementary inputs, input supply restrictions on REEs induce a surge in REE-enhancing innovation and lead to an expansion of REE-intensive downstream sectors.