A California Effect for International Environmental Externalities?

An influential conventional wisdom holds that globalization could induce upward convergence in environmental regulations. Wealthy countries impose environmental regulations that prompt exporters in other countries to adopt sustainable production techniques, so the cost of environmental regulation in these countries decreases. However, previous research has only examined this California Effect for environmental regulations to address domestic externalities. I formally investigate the case of international externalities, such as global warming or ozone depletion. I find that a country can exercise leadership by enacting environmental regulations to strategically induce other countries to regulate in the future, but only if the incentive to free ride is not too strong. Surprisingly, under deep economic integration, environmental regulations are strategic complements with positive spillovers, so that international coordination is necessary to capitalize on the California Effect. In addition to showing that the California Effect is a powerful instrument of environmental statecraft, the results suggest new reasons why liberal trade and investment policies might improve environmental protection. They can also inform a strategy to promote efforts to mitigate global warming.