Assessment of carbon leakage through the industry channel: The EU perspective

Lack of consensus on an international agreement for reducing Greenhouse Gas Emissions (GHG) emissions eventually leads to asymmetric climate policies which not only increase the cost of reducing emissions but also decrease the effectiveness of the climate policy, through carbon leakage. We calculate the carbon leakage rate when EU undertakes a unilateral climate policy and we assess the importance of the competitiveness channel on carbon leakage. Our analysis is global and mirrors energy and climate policies and commitments that are currently announced at country level. The effectiveness of possible measures to mitigate carbon leakage is also evaluated and the results emphasize on the importance of the size of the group of countries participating in the GHG mitigation effort. The analysis is based on the results obtained using the GEM-E3 model, a global multi-sector and multi-country computable general equilibrium model. It is found that total carbon leakage is around 28%, over the 2015-2050 period, when the EU acts alone with moderate Armington trade substitution elasticity values; leakage rates are found to increase when assuming higher trade elasticities. The size and composition, in terms of GHG and energy intensities, of the group of regions undertaking emission reductions matter for carbon leakage. The paper finds that the leakage is significantly reduced when China joins the mitigation effort. If the USA joins the EU effort, the leakage rate drops only to 25% and if alternatively China joins the EU the leakage rate drops to 3% over the 2015-2050 period. This is attributed to both the market size of China and to the energy intensity features of its production. Chemicals and metals are industries prone to higher leakage rates.