Addressing the Leakage/Competitiveness Issue in Climate Change Policy Proposals

Of all the daunting obstacles faced by the effort to combat global climate change, the problem of leakage is perhaps the most recent to gain serious attention from policy makers. Assume that a core of rich countries is able to agree for the remainder of the century on a path of targets for emissions of greenhouse gases (GHGs), following the lead of the Kyoto Protocol, or to agree on other measures to cut back on emissions, and that the path is aggressive enough at face value to go some way toward achieving the GHG concentration goals that environmental scientists say are necessary. Will global emissions in fact be reduced? Even under the business-as-usual scenario—that is, the path along which technical experts forecast that countries' emissions would increase in the absence of a climate change agreement—most emissions growth was expected to come from China and other developing countries. If these nations are not included in a system of binding commitments, global emissions will continue their rapid growth. But the problem is worse than that. Leakage means that emissions in the nonparticipating countries would actually rise above where they would otherwise be, thus working to undo the environmental benefits of the rich countries' measures. Furthermore, not wanting to lose "competitiveness" and pay economic costs for minor environmental benefits, the rich countries could lose heart and the entire effort could unravel. It is important to find ways to address concerns about competitiveness and leakage, but without undue damage to the world trading system.

Developing Countries, Leakage, and Competitiveness

We need the developing countries inside the emissions control program, for several reasons.¹ As noted, these countries will be the source of the big increases in GHG emissions in coming years, according to the business-as-usual path. China, India, and other developing countries will represent up to two-thirds of global carbon dioxide emissions over the course of this century, vastly exceeding the expected contribution of countries belonging to the Organization for Economic Cooperation and Development of roughly one-quarter of global emissions. Without the participation of major developing countries, emissions abatement by industrial countries will not do much to mitigate global climate change.

If a quantitative international regime is implemented without the developing countries, their emissions are likely to rise even faster than the business-as-usual path, due to the problem of leakage. Leakage of emissions could come about through several channels. First, the output of energy-intensive industries could relocate from countries with emissions commitments to countries without. This could happen either if firms in these sectors relocate their plants to unregulated countries, or if firms in these sectors shrink in the regulated countries while their competitors in the unregulated countries expand. A particularly alarming danger is that a plant in a poor, unregulated country might use dirty technologies and thus emit more than a plant producing the same output would have in a high-standard, rich, regulated country, so that aggregate world emissions would actually go up rather than down!

Another channel of leakage runs via world energy prices. If participating countries succeed in cutting back their consumption of coal and oil, the high-carbon fossil fuels, demand will fall and the prices of these fuels will fall on world markets (other things equal). This is equally true if the initial policy is a carbon tax that raises the price to rich-country consumers as if it comes via other measures. Nonparticipating countries would naturally respond to declines in world oil and coal prices by increasing consumption.

Estimates vary regarding the damage in tons of increased GHG emissions from developing countries for every ton abated in an industrial country. But an authoritative survey concludes "Leakage rates in the range 5 to 20 per cent are common."²

Even more salient politically than leakage is the related issue of competitiveness: American industries that are particularly intensive in energy or other GHG-generating activities will be at a competitive disadvantage to firms in the same industries operating in nonregulated countries.³ Such sectors as aluminum, cement, glass...