Policies for reducing but not outsourcing industrial carbon emissions

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Senior Fellow, Resources for the Future
Marie Skłodowska–Curie Fellow of the European Commission
16 November 2018

From 27-28 November 2018, the GGKP's Sixth Annual Conference will be held in conjunction with the OECD's 2018 Green Growth and Sustainable Development Forum (GGSD) on the theme of "Inclusive solutions for the green transition: Competitiveness, jobs/skills and social dimensions" in Paris, France.   

Carolyn Fischer, Professor of Environmental Economics at the Vrije Universiteit—Amsterdam and the Canada 150 Research Chair in Climate Economics, Innovation and Policy at the University of Ottawa, will give a scene-setting presentation at the conference on 28 November in Session 2: 'Green growth and Competitiveness: firms who win, firms who lose'.

Economists agree that significant, comprehensive carbon pricing schemes are the best way to ensure consistent financial incentives for reducing emissions across all sectors. Why, then, do we see so few countries employing them to green their industries?

A first challenge is limited coverage, wherein many firms are exempt from carbon pricing, either because they do not meet criteria to be subject to regulation or are in a jurisdiction that does not have carbon pricing. A consequence of differential treatment can be carbon leakage, which occurs when businesses transfer production to other countries with laxer emission constraints to avoid costs related to national carbon pricing schemes or climate policies.

Fear of leakage can contribute to a second challenge: many industrial sectors that are covered by carbon pricing systems face only weak prices, which are too anaemic to lead to significant reductions in sectoral emissions. For example, while prices have risen sharply after recent EU reforms, to around EUR 16 (USD 18), EU emission trading scheme (ETS) allowances were trading at around EUR 5-10 (USD 6-12) per metric ton of carbon dioxide emissions for much of 2013-2017.

Fortunately, policy options are available to address both of these challenges.

President Emmanuel Macron of France has recently endorsed implementing an EU ETS price floor, something I along with an international group of scholars have made a case for. Specifically, an auction reserve price would increase market confidence and certainty, showing a clear commitment to the carbon market by regulators, and help ensure that pricing remains better aligned with the costs of carbon. It would also help avoid erosion in the ETS price as competing policies to promote renewable energy and energy efficiency become more ambitious, allowing their effects to be truly additional. Such a firm commitment to the carbon market is particularly important given that not only economic forces but also political decisions can rapidly upend carbon markets, as recently seen in Canada, where the new Progressive Conservative government in Ontario ended the emissions trading program implemented by the previous government soon after taking power, pulling the province out of the joint trading system it had forged with California and Quebec.

Meanwhile, impacts on competitiveness can be addressed in better ways than exempting sectors that are particularly susceptible to carbon leakage or keeping carbon prices low. For instance, the free allocation of emission allowances can be used to maintain a level playing field for Energy-Intensive, Trade Exposed (EITE) industries, which are most at risk of carbon leakage. In the EU ETS, a system of product benchmarks is used to determine free allocation for firms in EITE sectors; although largely fixed within a trading phase, the allocation is updated if the firm undertakes significant capacity changes or experiences large decreases in activity level, and this condition provides an inducement to maintain production levels. Other systems, as in California and New Zealand, explicitly use output-based rebating (OBR), in which case the free allocation of permits to firms within the affected sectors is based on their actual annual output.

OBR effectively provides a subsidy to production that offsets much of the cost of emissions embodied in the product. Firms are not exempt from the carbon price—that remains a strong driver to green the industry—but the cost of remaining emissions does not burden product prices. This allocation mechanism should allow carbon pricing to be more ambitious without threatening competitiveness. In fact, raising carbon prices raises the value of the free allocation to these sectors. A challenge in the EU ETS is ensuring that the right sectors are targeted and treated adequately; currently sectors that are less exposed to leakage are included in the list of sectors that are allocated additional emission allowances, and with the declining cap on free allocations EITE industries are likely to be insufficiently compensated.

Another option is border carbon adjustment (BCA), which is often featured in proposals for carbon taxation in the United States. BCA would levy a carbon tax or permit requirement on imported goods comparable to that faced by domestically produced goods. This would reduce carbon leakage by offsetting the inherent advantage that producers in countries with weaker regulations would possess. More importantly, BCA would ensure that consumers face appropriate carbon price signals across the range of products they purchase. While explicit trade measures may be controversial, a similar effect could be achieved by using the existing systems of OBR for addressing competitiveness and then including a carbon consumption charge on high-carbon commodities, regardless of their origin. Finally, sectoral agreements, which are agreements between nations that would only govern emissions in select sectors of the economy, can also be considered as a means to converge on cleaner production techniques across borders. 

Of course, industries seeking to decarbonize face other challenges beyond the issue of carbon pricing. For example, technological barriers may limit the ability of certain sectors to green their operations, financial constraints may hinder investment in lower-emission technologies, and society as a whole must address transitional costs of shifting towards new and cleaner products as well as processes.

There are a range of other policy options to address these issues and accelerate the transition to a lower-carbon economy. These could focus on, for example, training and reskilling workers to work in greener industries; public awareness campaigns to shift consumer demand away from high-emission products; sustainable public procurement; resource efficient or circular approaches to building and construction.

To date, the evidence indicates that fears of competitiveness losses due to the EU ETS have been unfounded. The effects of ETS schemes on profits and employment have been found to be largely insignificant or even positive. Of course, one may not expect dislocations to arise from low carbon prices over short timeframes, but these results may also indicate that the countervailing policy of free allowance allocation has been sufficient.

Despite these challenges, carbon pricing remains one of the most effective approaches to reduce carbon emissions. Effective policies can must be designed to address issues related to leakage and competitiveness for sustainable growth for both countries and businesses.


The opinions expressed herein are solely those of the authors and do not necessarily reflect the official views of the GGKP or its Partners.