Carbon Leakage

Because of the difficulties in forming international climate agreements, most climate policies have been the result of unilateral action. There is widespread concern that unilateral policies are ineffective because emission reductions in abating countries are offset by increases in nonabating countries. The authors summarize the channels through which such carbon leakage can occur, review estimates of the magnitude of the problem, and list policies that have been suggested to mitigate carbon leakage. The most prominent cause of carbon leakage is the 'energy market channel': unilateral policies to reduce emissions from fossil fuels decrease the world market price of fossil fuels, encouraging their use in nonabating countries. Terms of trade effects, indicating a loss of competitiveness in energy-intensive sectors in abating countries, are less important. Numerical estimates of the carbon leakage rate - the fraction of emission reductions in abating countries that is undone by increases elsewhere - are mostly between 2% and 40%; however, outliers exist in both directions. Policies to mitigate carbon leakage, such as border tax adjustments, are likely ineffective.