Carbon leakage and the risk of relocation in Finland: How to mitigate the risk?

Abstract

Fighting climate change is one of the biggest problems the humankind is currently facing. It is generally agreed that the fight against climate change requires joint efforts across nations and every country’s contribution. Climate change, global warming, CO2 emissions on atmosphere – these are all global externalities that affect our lives on Earth. Their scale is so massive that it requires a globally joint effort to try and solve these issues. However, our weapons to fight these problems are rarely – if ever – global but local, which makes it hard to design optimal policies against them. The problem when fighting these global issues with local regulation is that at least in theory the ones being regulated can relocate elsewhere, to less strictly regulated places, thus making the regulative policy ineffective. In climate regulation this issue of companies and their emissions relocating is referred to as carbon leakage. The threat of carbon leakage has led the regulators to compensate climate regulation with different kinds of policies, such as refunds and rebates. This means that simultaneously as companies are regulated for, for example, producing CO2 emissions, they are also granted compensation for that same regulation. This counterintuitive behavior is justified for example by the fact that it might be politically easier to provide “something for everybody”, even if actions just repealed one another. This is done even though it is very hard to know how much compensation the ones involved would actually need or if the used compensation actually manages to decrease the risk of carbon leakage. This thesis aims to disclose how these climate-related matters are regulated, how they are compensated, how effectively they are compensated and could there be a more efficient way to use that money. Focus is in Finland and Finnish companies and the benefits paid for energy taxation. The theoretical framework comes from a research made by Martin et al., (2014). They studied the vulnerability to carbon leakage in six European countries when it comes to EU emissions trading scheme and what an effect the free allowances of it have. This thesis applies those same results to Finnish industries receiving compensation for their energy taxation and reviews if the allocation among industries is efficient when applied to the Martin et al. (2014) empirical framework. The outcome is that the money used for compensating energy taxation in Finland could be allocated more efficiently – meaning that with a different allocation we could decrease the companies’ vulnerability to that regulation more than what we do now. The compensation seems to be allocated to the industries that are traditionally important to our economy, for example wood and paper industry, even though there would be more vulnerable industries where the used money would result in more effect. In conclusion, the compensation is not used as efficiently as possible.