Carbon leakage: Theory, evidence and policy design (paper and webinar)
Carbon leakage is much discussed in carbon pricing policy. Stakeholders, especially emissions-intensive industries, have expressed concern about the implications of carbon pricing when they compete with firms located in jurisdictions without equivalent policies. This technical note, Carbon leakage: Theory, evidence and policy design, from the Partnership for Market Readiness (PMR), provides an overview of the issue of carbon leakage, discussing the theory, evidence and policy design. This issue is of interest to a range of PMR countries and is of great importance to successful design and implementation of carbon pricing policies. The technical note addresses three broad questions:
- How to evaluate the expected competitiveness and carbon leakage impacts (negative and positive) due to carbon pricing policies for different sectors and the entire economy?
- How to mitigate the risk of negative impacts and strengthen the positive impacts (through instrument design or complementary policies) in the short and long term, and for different levels of expected decarbonization?
- How to manage the process of dialogue between a government, business and civil society on the implications for competitiveness and risks of carbon leakage, and their mitigation?
It draws lessons from policymaking experience and academic evidence to provide guidance to countries on how to address issues of carbon leakage as they arise in their national contexts.
There is growing, global momentum for tackling carbon emissions and correcting “the largest market failure history has seen” (Lord Stern). Often this action involves the use of carbon prices—established either through carbon taxes or through cap and trade schemes—in recognition of their ability to achieve emissions reductions in a flexible and cost-efficient way. The introduction of carbon pricing forces firms and consumers to take account of the full economic costs associated with their production and consumption decisions. It therefore promotes a level playing field between polluting activities that impose climate change adaptation costs (and/or climate damages) on others and low- emissions activities that do not. In this sense, the absence of a carbon price can be thought of as a subsidy for “dirty” production. Reduction of these implicit subsidies and assigning cost of emissions to those who can control them is an intended goal of carbon prices. It leads to structural transformations and eventually more efficient allocation of resources in the economy. Stringent climate policies have also been found to stimulate clean technology innovations, in particular, among more advanced firms. Such technologies tend to have strong innovation multiplier (spillover) benefit throughout the economy, comparable to nano-technologies and robotics, unlike innovation in traditional fossil fuel-based technologies.
Download the report here: Carbon leakage: Theory, evidence and policy design.