Carbon Leakage 101

Carbon Leakage 101

Australia generates about 1.5% of global greenhouse gas emissions, and is one of the world’s largest polluters on a per capita basis. The contentious Australian Carbon Tax, introduced 1 July 2012, was aimed at reducing greenhouse gas emissions (GHG) in Australia by 5% below 2000 levels by 2020 and 80% below 2000 levels by 2050. Most recently, the carbon tax has been criticised for its fixed-price regime to the European Emissions Trading Scheme (ETS), where Australian businesses are now paying a carbon tax 550% higher than those in Europe.

There is an important consideration for countries (such as Australia) when determining the best mitigation approach, which doesn’t get as much airtime – and that is carbon leakage. This week, we will discuss the significant costs that can be associated with carbon leakage, highlighting the need for Governments to protect their emission-intensive, trade-exposed (EITE) industries.

To start us off, what is carbon leakage? Carbon leakage is a term that refers to the risk of shifting the production of CO2-intensive goods offshore to unregulated countries, when a mitigation strategy is put in place. In a globalised economy of capital mobility and internationalised production capacity, it has been argued that there is no point in one country taking action if others do not.

In 2008, the World Bank released a study which demonstrated that there is a trend for energy-intensive industries to relocate to developing countries. The risk is for the production of emission-intensive goods to concentrate in “pollution havens”. The pollution haven hypothesis has been described as the phenomenon where “as pollution control costs begin to matter for some industries in some countries, other countries should gain comparative advantage in those industries, if pollution control costs are lower there (for whatever reason).”

The sectors subject to loss of competitiveness under uneven carbon constraints and potentially to carbon leakage, are EITE industries. Approximately two-thirds of Australia’s international trade occurs between China and Asia-Pacific countries, where carbon prices are unlikely to be adopted in the foreseeable future. Moreover, the production processes in these countries are relatively less energy-efficient and more emissions-intensive. This difference in energy efficiency increases the potential for significant carbon leakage with more net emissions being generated as industries relocate. Meanwhile significant costs would be inflicted on Australia if it were to unilaterally adopt carbon pricing without protecting trade-exposed producers.

Thus, leakage has the potential to destroy the economic viability and competitiveness of trade-exposed sectors, negatively impact Australia’s economic growth and prevent the carbon tax from achieving any material global environmental benefits in terms of greenhouse gas reduction. Industries located in Australia would now face a high mitigation cost, and their products’ markets would be challenged or targeted by foreign based competitors. Thus, industries in Australia with products that are widely traded globally, such as primary aluminium, cement and iron and steel, are likely to be affected by carbon leakage.

Furthermore, if there is a movement of activity offshore, it is likely to displace workers and create high transitional costs. Firstly, transitional unemployment may occur, as workers are displaced from firm shutdowns or redundancies. In addition, structural unemployment could occur as a significant skills gap may form between the manufacturing sectors that will be disadvantaged by emissions trading and other less affected professional or service oriented sectors. It will take substantially more time for workers to be retrained and moved to other jobs.

Due to the energy intensive nature of the Australia economy there is a higher likelihood of carbon leakage occurring here than the EU for example. Thus there is a greater impact on the unemployment rate and thus slowing of GDP. Furthermore, carbon leakage is likely to affect trade liberalisation and thus investment. Simply, people will be less willing to invest if the domestic businesses are seeing lower profits. Similar to the effects of greater unemployment, reduced investment will likely lead to lower levels of economic growth.

As we can see, there are significant costs associated with carbon leakage, and these need to be carefully considered when determining the mitigation approach best suited to each country. For example, the Australian Government has (rightly) recognised carbon leakage as a significant risk, and has proposed providing assistance to EITE industries to reduce this risk. The government has recognised that “adopting such a target ahead of some other countries will mean that Australia’s traded industries face higher carbon costs than some of their international competitors, which may have a significant impact on the most [EITE] industries”. To read up on how the Australian government proposes working towards supporting EITE industries, click here.

In my next article, I will look at the possible mitigation options that should be built into mitigation strategies in order to best protect EITE industries from carbon leakage.

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The Australian. Australian carbon tax called “ridiculous” by business leaders. Philip Hudson. Retrieved April 18th 2013 from:

Department of Climate Change and Energy Efficiency, Assistance to emissions-intensive, trade-exposed industries. Retrieved April 18th 2013

Department of Climate Change and Energy Efficiency, What is Climate Change? Retrieved April 18th 2013 from

Copeland, B. & Taylor, M. (2004) “Trade, Tragedy, and the Commons,” NBER Working Papers 10836, National Bureau of Economic Research

Driesen, D. (2010) Economic Thought and U.S. Climate Change Policy. US; Westchester book Group. [p156, 58, 189]

Jiang, T. (2003) Economic Instruments of Pollution Control in an Imperfect World. UK; Edward Elgar Publishing Ltd.

Metz, B. & Davidson, O. & Bosch, P. & Dave, R. & Meyer, L. (Eds.)(2007) Climate Change 2007.  NY; Cambridge University Press. [p615-20]