Climate Change, Strict Pareto Improvements in Welfare and Multilateral Income Transfers

This paper explores the role of multilateral transfers in achieving strict Pareto improvements in welfare, focusing on identifying conditions under which their use is warranted when carbon prices differ internationally and there are impediments to international trade. Using a general equilibrium model of international trade with global emission externalities, it is shown that strict Pareto improvements in welfare may arise from multilateral income transfers when either trade or carbon taxes are constrained away from their Pareto optimal levels. The purpose of transfers is then to account for the impact on emissions of the trade distortions and inappropriate carbon pricing. Such transfers exist if and only if a generalized normality condition is violated. A numerical example illustrates the transfer mechanism.