cooperate increases dramatically. Cooperation on climate action is particularly attractive if it is implemented through cooperative wellhead carbon taxes and trade agreements with major importers of fossil fuels. The windfall tax revenues (now also from carbon embodied in exported oil and gas) boost households’ welfare above BAU (we discuss this scenario in more detail below).

_Figure 6: Percentage Changes in Discounted Adjusted Household Consumption over the Period 2021–50 against BAU_ <!-- Start of picture text -->
1.00<br>0.00<br>-1.00<br>-2.00<br>-3.00<br>-4.00<br>-5.00<br>LCT Pioneers FF dependent countries  World<br>Unilateral carbon taxes w/o trade measures Unilateral carbon taxes; border tax on carbon content<br>Unilateral carbon taxes; Nordhaus tax Cooperative carbon emissions taxes<br>Cooperative carbon wellhead taxes<br>Discounted consumption - % against BAU<br><!-- End of picture text -->

_Source:_ World Bank and Purdue University (ENVISAGE).

_Note:_ BAU = business as usual; FFDCs = fossil fuel–dependent countries; LCT = low-carbon transition. Figure is calculated in market prices, using a 6 percent discount rate. All scenarios presented here assume traditional diversification in the FFDCs.

Free-riding on the unilateral climate action by LCT Pioneers is the long-term economically optimum strategy, unless they face a credible threat of Nordhaus-type import taxes (figure 7). Economic output in the two unilateral policy scenarios–with no border adjustment and with border taxes based on carbon content of imports–is robustly higher than in any cooperative scenario and even in BAU. These results hold regardless of the diversification strategy chosen by FFDCs. As discussed above, the ambitious unilateral climate policies implemented by LCT pioneers to stabilize climate at 2°C strengthen the pre-existing competitive advantage of FFDCs’ industries in carbon-intensive products and lead to production and emissions leakage. Unilateral action increases the (after tax) costs of energy-intensive industries in LCT Pioneers and depresses global pre-tax fuel prices, reducing the opportunity cost of fossil fuels used by industry in FFDCs. Therefore, so long as consumers in LCT pioneer countries continue to purchase carbon-intensive goods and services, producers in FFDCs expand market share in the globally declining emissions-intensive products, at the expense of producers in LCT pioneer countries. Traditional border adjustment taxes on carbon content on imports may not be enough to prevent this leakage. It is worth stressing that with traditional border carbon adjustments carbon leakage would be “efficient” in economic terms (Kossoy et al 2015). These scenarios are unstable, however, because they represent the worst-case scenario for LCT pioneers, hence they are likely to try to avoid it, for example by threatening to apply Nordhaus taxes.

The combination of unilateral carbon taxes and Nordhaus border taxes applied by LCT Pioneers is an effective and credible nudge for FFDCs to cooperate on climate action. This combined external policy shock represents the worst-case scenario for welfare and growth in the FFDCs, worth avoiding through climate policy cooperation. Nordhaus import taxes reduce international competitiveness of all goods and services of FFDCs, including crude fuels and derivatives, depressing FFDCs terms of trade across the board and contracting economic growth more than domestic carbon taxes do in 14