The magnitude of carbon leakage and addressing it in the EU ETS

Abstract

This literary review discusses the phenomenon of carbon leakage in the European Union emissions trading system (EU ETS). I present the main principles of emissions trading applied in the EU ETS and how the current ETS policy is build. These lay the groundwork for assessing the magnitude of carbon leakage in the EU ETS and how it should be tackled. Assessing the magnitude of carbon leakage and ways to tackle it are the two key questions of this paper. As presented in this paper, carbon leakage might not be that big of a problem for the ETS as the European policy could insist. This suggests that the policy is partly created on political basis ignoring the environmental and economic principles beneath it.

I also present two solutions to carbon leakage presented in the literature. Out of the two alternatives, the use of border adjustment is supported by the economic literature. The downside of this environmentally and economically effective solution is its legal restrictions that lower its effectiveness. Despite these restrictions the proposed solution and the other alternative, output-based allocation, deliver better results than the current European policy to fight carbon leakage.