In this essay I will be discussing the high
importance of acknowledging Carbon leakage when designing climate policies. Not
taking into consideration carbon leakage whilst designing climate policies
could undermine a carbon-pricing policy’s environmental objective by causing
emissions to increase in regions beyond the reach of the policy. Thus it is for
this reason that it is imperative whilst discussing climate policies that
carbon leakage is also taken into consideration. Gaining an understanding of
the potential risk of carbon leakage is important for policy makers when
deciding whether to introduce or reduce carbon pricing and may also change
their policy response. If we do not acknowledge carbon leakage when designing
climate policies, then climate polices may become less or ineffective overall.

Currently, climate policies such as the EU ETS are
attempting to take into account carbon leakage. Whilst current climate policies
such as Cap-and–Trade take into consideration carbon emissions within the
region, they do not always take into account the carbon leakage that may occur
as an unintended consequence of production. In the first section I will explain
what Carbon leakage is. I will then follow this by explaining why it is
imperative to take into account carbon leakage and the consequences that may
occur to the environment if it is not. 
In the second section I will evaluate how well current policies take
into account this problem and potential solutions.  

This section of the essay will outline why carbon
leakages occur and the detrimental effects it has on the environment, but also
the effect it could potentially have on employment and GDP when not discussed
whilst creating climate policies. Moreover, I will also discuss why not
acknowledging carbon leakage can have an adverse effect on the quality of
climate policies.

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The impacts of carbon leakage can be both
environmental and socio-economic. Carbon leakage is caused by “asymmetrical
climate policies” (Marcu A, 2013, pg. 5). What is meant by this is that
policies that have a price for carbon emissions in one region, while another region
has no, or a more relaxed, climate policy and price causes carbon leakage. This
is because if carbon emission policies of a country raise the
cost of local emission, then another country with a more relaxed carbon
emissions policy would have a comparative advantage. Carbon
Leakage increases firms cost by attempting to make firms internalise the negative
externalities they cause i.e. the pollution they produce. This leads increase in costs causing
firms to move to regions with more relaxed carbon emission policies with
cheaper costs. Rather than incentivising firm cleaner production and
innovation, the carbon-pricing could lead firms to move abroad as there are
cheaper forms of production (because climate and emission policies are not
currently universal policies). Due to this, it is clearly arguable that by not
acknowledging carbon leakage, carbon emission policies can lead to innovation
failure as firms will simply move to another country with a more relaxed
climate policy and pollute more in other regions. A possible solution for this
is that policies that aim to tackle carbon leakage need to be universal or face
the potential of carbon emission policies failing to be implemented correctly.

One system that is aiming to reduce carbon
leakage is the European Union
Emissions Trading System (EU ETS). This is achieved by setting carbon prices, such as
the ‘cap-and-trade’. The EU ETS has a ‘cap and trade’ system which aims to
reduce not only regional but also global carbon emissions (reference).  The EU ETS sets an aggregate emissions limit of particular greenhouse gases that can be emitted by the EU
participants who are involved and covered by the system. The cap is reduced
over time so that in total, emissions too will fall over time.  What is meant by this is that the EU ETS aims to cap the overall level of emissions allowed
to be produced by setting an aggregate emission limit. Within that limit,
participants in the system are able to buy and sell permits as they need it.
These permits are the trading ‘currency’ of the system. The gradual cap on the
total number of permits creates scarcity for these allowances in the market. This
scarcity for allowances means that the allowances will increase in price as
there is less supply of them. This high price for the scarce allowances incentivises
firms to produce less carbon emissions in order to reduce their need for the permits.
However, if the demand for a firm’s goods remains the same,
production may move abroad to a cheaper country with lower emission standards,
and global emissions will not be reduced – they may even potentially increase. The risk
of carbon leakage to some extent weakens the environmental outcomes; while at
the same time can lead to a decline in domestic production with a decrease in
employment. This could be a major socio-economic issue as if firms move and
decide to invest abroad to reduce their costs, the amount job opportunities
would decrease for citizens living in a region with high carbon emission costs.


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