The Impact of Unilateral Climate Policy with Endogenous Plant Location and Market Size Asymmetry

This paper analyses the impact of unilateral climate policy on firms' international location strategies in emission-intensive sectors, when countries differ in terms of market size. The cases of both partial and total relocation via foreign direct investment are separately considered. A simple international duopoly model highlights the differences between short-term and long-term effects. In the short-term no change in location is a likely outcome in very capital-intensive sectors and, when there is a strategy shift, this takes the form of partial rather than total relocation. In the long-run total relocation becomes a feasible outcome. However, when tighter mitigation measures are introduced by the larger country and unit transport cost is high, with a pronounced market asymmetry, the probability of firms not relocating abroad is high even in the long-term. The welfare implications of unilateral environmental measures are assessed considering global industrial pollution and accounting for shifts in location strategy.