Effects of Carbon Pricing in Germany and Spain: An Assessment with EMuSe

Abstract

Using the dynamic, three-region environmental multi-sector general equilibrium model EMuSe, we find that pricing carbon in Germany or Spain only leads to a permanent negative effect on output in these economies. The induced emissions reduction is not large enough to overcompensate for the increase in marginal production costs. If the rest of Europe joins the carbon pricing scheme, long-run output effects are positive. However, in this case, transition costs are even larger due to close trade relations within Europe. We find evidence for carbon leakage, which can be reduced slightly by a border adjustment mechanism. Still, it is no game changer as it mainly protects dirty domestic sectors. While Germany benefits from border adjustment, Spain actually loses throughout the transition. In the long run, the Spanish energy sector benefits most because of its relatively low emission intensity. Finally, Europe has a strong incentive to get the rest of the world on board as then the downturn is shorter and long-run benefits are larger.