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«Christoph Böhringera and Victoria Alexeeva-Talebib a University of Oldenburg b Centre for European Economic Research, Mannheim Emails: ...»

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Unilateral climate policy and competitiveness:

Differential emission pricing from a sectoral, regional and global perspective

Christoph Böhringera and Victoria Alexeeva-Talebib

a

University of Oldenburg

b

Centre for European Economic Research, Mannheim

Emails: christoph.boehringer@uni-oldenburg.de, alexeeva-talebi@zew.de

Abstract. Unilateral emission reduction commitments raise concerns on international competitiveness

and emission leakage that result in preferential regulatory treatment of domestic energy-intensive and trade-exposed industries. Our analysis illustrates the potential pitfalls of climate policy design which narrowly focuses on competitiveness concerns about energy-intensive and trade-exposed branches. The sector-specific gains of preferential regulation in favour of these branches must be traded off against the additional burden imposed on other industries and economy-wide excess costs to meet the unilateral emission reduction target. From the perspective of global cost-effectiveness, however, preferential emission pricing for domestic energy-intensive and trade-exposed sectors can reduce leakage and thereby lower overall cost of cutting global emissions as compared to uniform emission pricing.

JEL Classification: D58, H21, H22, Q48 Keywords: unilateral climate policy design, leakage, competitiveness Non-technical summary Though the issue of competitiveness ranks high and has tangible implications for the design of unilateral emission regulation, the climate policy debate misses a rigorous clarification of competitiveness notions and a comprehensive quantitative analysis of policy proposals that respond to competitiveness concerns of specific industries. In this paper, we first discuss alternative indicators that can be used to quantify specific aspects of competitiveness at the level of sectors and countries. We subsequently elaborate on a computable general equilibrium model complemented with selected competitiveness indicators to facilitate the comprehensive impact assessment of EU leadership in climate policy from sectoral, global and regional perspective. While disentangling competitiveness and carbon leakage motives, we find that preferential emission pricing in favour of energy-intensive and trade-exposed (EITE) branches is powerful to reinforce industrial competitiveness in the EU, though less suitable to counteract leakage.

Depending on the degree of preferential treatment, our paper highlights the scope for enhancing global cost-effectiveness of unilateral actions with inter-sectoral carbon price differentials as compared to uniform emission pricing: With price differentials ranging up to factor five in favour of EITE branches, gains from reduced leakage andimproved terms of trade in non-abating regions are sufficient in magnitude to more than offset the increase in additional direct abatement costs in the EU due to foregone cheap abatement options in European EITE industries.

Das Wichtigste in Kürze Obwohl das Leitmotive der Wettbewerbsfähigkeit für die Ausrichtung unilateraler Emissionsminderungspolitiken von entscheidender Bedeutung ist, fehlen der klimapolitischen Debatte sowohl eine klare Definition dieses Begriffes als auch eine umfassende Analyse von Politikmaßnahmen, welche potentielle Wettbewerbsnachteile unilateralen Klimaschutzes in bestimmten Industrien abschwächen können. In diesem Beitrag diskutieren wir zunächst Indikatoren, die spezifische Aspekte der Wettbewerbsfähigkeit auf Ebene einzelner Sektoren und Länder quantifizieren können. Anschließend analysieren wir die ökonomischen Auswirkungen der globalen Führungsrolle der EU in der internationalen Klimapolitik aus sektoraler, regionaler und globaler Sicht. Dies erfolgt mittels eines numerischen allgemeinen Gleichgewichtsmodels, ergänzt um ausgewählte Indikatoren zur Messung der Wettbewerbsfähigkeit. In unserer Analyse entflechten wir dabei die Einzelmotive der Wettbewerbsfähigkeit und des Carbon Leakage. Unser Beitrag illustriert, dass eine Differenzierung der Emissionspreise zugunsten energieintensiver und exportorientierter Industrien zwar die industrielle Wettbewerbsfähigkeit in einem erheblichen Maß stützen kann. Weniger wirksam ist diese aber darin, den Emissionsanstieg außerhalb der EU als Folge unilateralen Klimaschutzes zu begrenzen. Die Kosteneffektivität unilateralen Klimaschutzes mit intersektoralen Emissionspreisdifferenzialen kann sogar im Vergleich zu uniformen Emissionspreisen ansteigen: Sofern der Grad der Preisdifferenzierung nicht den Faktor fünf übersteigt, können die potentiellen Vorteile aus der Reduktion der globalen Emissionen sowie aus der Verbesserung der realen Wechselkurse (aus der Sicht der nicht-EU Länder) die Nachteile mehr als aufwiegen, die infolge der Nichtnutzung von günstigen Vermeidungsoptionen in den geschützten europäischen Industrien entstehen.

1 Introduction At the sixteenth United Nations Climate Change Conference in Cancún, the world community committed itself to the objective of limiting the rise in global average temperature to no more than 2° Celsius above pre-industrial levels in order to hedge against dangerous anthropogenic interference with the climate system. According to scientific knowledge assessed by the Intergovernmental Panel on Climate Change (IPCC) in its Fourth Assessment Report (IPCC 2007), this implies that global greenhouse gas emissions must decline within the next two decades and be reduced by roughly a half vis-à-vis 1990 emission levels.





To date however prospects for a Post-Kyoto agreement covering all major emitting countries are bleak.

Even in the case of a broader follow-up agreement to the Kyoto Protocol, it is much likely that emission reduction targets will be quite unevenly spread across the signatory regions with OECD countries taking a lead role reflecting their historical responsibility and a higher ability to pay.

One-sided commitments to ambitious emission reduction targets raise competitiveness and emission leakage concerns in all the major economies implementing or proposing unilateral responses to the threat of climate change. At the fore of climate policy discussions, competitiveness and leakage concerns refer in particular to the performance of energy-intensive and trade-exposed (EITE) industries. Obviously, unilateral emission pricing of domestic industries where emission-intensive inputs represent a significant share of direct and indirect costs will put these sectors at a disadvantage compared to competing firms in countries abroad which lack comparable regulation. The loss in competitiveness is to some extent associated with the potential for emission leakage, i.e. the change of emissions in non-abating regions as a reaction to the reduction of emissions in abating regions (e.g. Hoel 1991 or Felder and Rutherford 1993).

Leakage can arise when energy-intensive and trade-exposed industries in emission-constrained regions lose competitiveness, thereby increasing emission-intensive production in unconstrained regions. A second important leakage channel works through international energy markets: Emission constraints in larger open economies depress the demand for fossil fuels, thereby depressing world energy prices which in turn lead to an increase in the level of energy demand in other regions. Competitiveness and leakage concerns have motivated claims for special treatment of energy-intensive and trade-exposed sectors ranging from reduced emission prices or output-based emission allocation to border carbon adjustments (see Böhringer et al.

2010a).

A prime example of the competitiveness and leakage issues at stake in unilateral climate policy is provided by the European Union (EU) which considers itself as a leading force in the battle against anthropogenic climate change. During the Spring Summit in March 2007, the European Council has agreed upon an ambitious climate policy with unilateral greenhouse gas emissions reductions in 2020 by at least 20% compared to 1990 levels (EC 2010). At the same time, the EU is strongly committed to the objective of increasing competitiveness, economic growth and enhancing job creation alongside the so-called Lisbon Strategy (EU 2006).1 The simultaneous pursuit of environmental and competitiveness objectives has led to the preferential treatment of EITE industries in EU climate policy. The aggregate EU emission reduction is divided between energy-intensive sectors – of which EITE industries are a subset – covered through an EU-wide emission trading system (the so-called EU ETS) and the remaining parts of the EU economy (without trade linkages). As a consequence of competitiveness and leakage concerns, the emission reduction requirements for ETS sectors have been chosen relatively lax compared to the reduction targets for non-ETS segments of the EU economy (Convery and Redmond 2007) which effectively boils down to preferential emission pricing of EITE industries.

While the issue of competitiveness ranks high and has tangible implications for the design of unilateral emission regulation, the climate policy debate misses a rigorous clarification of competitiveness notions and a comprehensive quantitative analysis of policy proposals that respond to competitiveness concerns of specific industries. In the assessment of unilateral EU climate policy, the bulk of “competitiveness research” is skewed towards a partial equilibrium perspective focusing on EITE industries which are directly affected by the EU ETS (e.g. Ponssard and Walker 2008, Meunier and Ponssard 2010, Monjon and Quirion 2010). The sector-specific partial equilibrium framework does neither allow for a comparison of competitiveness implications across different industries nor a simultaneous assessment of economy-wide performance in terms of an overarching welfare metric. General equilibrium analysis of EU climate policies based on multi-sector, multi-region computable general equilibrium (CGE) models put the emphasis on the excess cost of emission abatement induced by emission market segmentation and overlapping regulatory measures (see Böhringer et al. 2009 for a summary assessment of the EU climate and energy package) rather than competitiveness and leakage aspects.

Our paper provides an impact assessment of EU leadership in climate policy to illustrate the potential pitfalls of climate policy design that narrowly focuses on competitiveness concerns about EITE branches.

Based on quantitative simulations with a large scale computable-general equilibrium model of global trade and energy we show that sector-specific gains of preferential regulation in favour of EITE branches must be traded off against the additional burden imposed on other industries to meet an economy-wide emission reduction target. Beyond burden shifting between industries, our results highlight the scope for substantial excess cost in emission reduction at the regional level as policy grants lower carbon prices to EITE industries and thereby foregoes relatively cheap abatement options in these sectors. From the perspective of global cost-effectiveness, however, preferential emission pricing for domestic energy-intensive and tradeexposed sectors can reduce leakage and thereby lower overall cost of cutting global emissions as compared to uniform emission pricing.

The remainder of this paper is organised as follows: Section 2 discusses alternative indicators that can be used to quantify specific aspects of competitiveness at the level of sectors and countries. Section 3 lays out Focusing on the “pressing challenge for competitiveness”, the European Commission has initiated a permanent monitoring of competitiveness developments in the EU on the basis of selected competitiveness indicators in order to a computable general equilibrium model complemented with selected competitiveness indicators to facilitate the comprehensive impact assessment of unilateral climate policies. Section 4 presents a quantitative impact assessment of EU leadership in climate policy. Section 5 summarises and concludes.

2 Competitiveness indicators



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