Carbon Leakage – Are Tariffs a Necessary Tool in Climate Policy?

Abstract

In absence of binding global agreements on climate policy some regions like the European Union have decided to take unilateral actions to reduce their greenhouse gas emissions. These unilateral actions have raised carbon leakage as an important policy issue to be addressed. Carbon leakage means that emission reductions in one region may be offset at least partially by emission increases in the rest of the world as fossil fuel prices fall and domestic companies lose their market shares.

This thesis will review the literature concerning the magnitude of the carbon leakage effects and measures to prevent it. The results of these studies are assessed in light of an optimal carbon tariff and tax model introduced by Hoel (1996). The work will provide an overview on estimates of the scale of carbon leakage rate, in addition to an assessment of carbon tariffs and current policy measures as tools to prevent leakage.

The findings suggest that carbon leakage is probably a remarkable threat only in certain energy-intensive sectors most exposed to foreign competition. Carbon tariffs or other border adjustments would therefore be limited in scope as a tool of climate policy. Their cost-effectiveness in global emission policy is doubtful, as they would mostly shift the cost burden from developed to developing world, rather than reducing emissions globally. This implies that tariffs would not be a necessary tool in unilateral climate policy. However, the same critique applies to the current measures in the EU as well. Also, the free permit allocation system currently in use is probably too lax, and thus produces effects contrary to the goals of emission policy while providing little protection for domestic industries.