Analyzing the carbon pricing-leakage nexus through structural gravity estimation

Abstract

Carbon emissions drive climate change, and failure to reduce these emissions could lead to disastrous consequences. Countries impose carbon pricing as an instrument to reduce carbon emissions. However, carbon leakage is a counteractive mechanism where countries with higher carbon emission prices may see their sectors outsource production to countries with lower prices or lose competitiveness and market share to foreign companies with lower production costs. This study confirms that fuel excise taxes are the leading channel of carbon leakage. Structural gravity estimates show that carbon pricing based on carbon taxes and emission trading schemes (ETS) does not cause carbon leakage, but fuel excise taxes and ETS exemptions have a significant impact. This finding is supported when looking at carbon prices in different sectors. Thus, policymakers should consider adjusting fuel excise taxes accordingly.