Climate policy: Bucket or drainer?

Abstract

Worldwide, industry is responsible for about 40% of greenhouse gas (GHG) emissions, making it an important target for climate policy. Energy-intensive industries may be particularly vulnerable to higher energy costs caused by climate policy. If companies cannot offset rising energy costs and would face increased competition from countries without climate policy, they may decide to relocate their industrial production to the countries without climate policy. The resulting net effect of climate policy on GHG emissions in foreign countries is typically referred to as “carbon leakage”. Carbon leakage may lead to higher global GHG emissions due to the use of less advanced technology in less developed countries. Based on a literature review of climate policy, earlier environmental policy and analyses of historical trends, this paper assesses the carbon leakage effects of climate policy for energy-intensive industries. Reviews of past trends in production location of energy-intensive industries show an increased global production share of Non-Annex 1 countries. However, from empirical analyses we conclude that the trend is primarily driven by regional demand growth. In contrast, climate policy models show a strong carbon leakage. Even though future climate policy may have a more profound impact than environmental policies in the past, the modelling results are doubtful. Leakage generally seems to be overestimated in current models, especially as potential positive spillovers are often not included in the models. The ambiguity of the empirical analyses and the modelling results warrants further research in the importance of production factors for relocation.