Carbon prices have been suggested as a tool for mitigating climate change for decades now, but despite many countries adopting official carbon prices and implementing cap and trade programs, there is very little empirical evidence about how effective these programs are at actually mitigating global climate change.
The main reason this question is difficult to answer is due to leakage. Because climate change is a global problem, local reductions in carbon emissions could be offset by increased emissions elsewhere. We might expect this to happen in places where a carbon tax is implemented because it would be marginally less expensive to outsource high pollution industries to places with fewer restrictions.
Last week, a new article made progress on answering this question.
These researchers looked at the impact of the European Union’s Emissions Trading Scheme, a cap-and-trade plan implemented in 2005. While a cap-and-trade program and a more straightforward carbon tax are technically different, they achieve the same goal theoretically.
Both of these setups encourage industries to adapt their methods to reduce their carbon emissions, and provide a bonus incentive for industries that can adapt at lower costs. Both policy choices result in polluters having to pay some cost for their carbon emissions.
To understand whether or not carbon prices were truly lowering global carbon emissions, these researchers looked at three possible channels of leakage. First, they explored whether or not firms were outsourcing their carbon intensive parts of their production chain to places with fewer regulations. They concluded that this was not a major factor because if this were happening, firms would have reduced value added to the economy.
To understand value added, consider a car manufacturer. If the manufacturer imports all of the individual components of a car and then assembles it, their value added comes from the labor used to assemble the car. If this firm decided they needed to dodge regulations and switched to importing mostly assembled cars that they just had to put the finishing touches on, then we’d see that in the value added.
When these researchers looked at data from French manufacturers, they found that value added did not substantially decrease, nor did the carbon intensity of their imports increase. This suggests that instead these manufacturers were changing their practices to lower their emissions without relying on increased pollution from outside the regulation’s jurisdiction.
The second avenue for carbon leakage would be if consumers switched to purchasing goods from unregulated firms. If this were happening, there would be economic contraction among the regulated firms as they would have to face increased competition from unregulated firms. Again, among the French manufacturers there was no such trend.
The final channel for leakage would be if firms operating multiple facilities could shift their production in such a way that more production was happening in unregulated facilities. To account for this they performed their analysis at the firm level, so they would have directly observed any shifting of pollution that was not captured by the regulation. The researchers found no evidence of this.
It’s easy to see that carbon prices reduce local pollution, but it is encouraging to see new evidence to support the idea that this is actually making a global difference. Evidence like this should make local policymakers worried about the impact of leakage more confident that prices placed on carbon locally will lead to global results for slowing climate change.