Does carbon leakage through international trade reduce the effectiveness of carbon pricing policies?

By Jonas Teusch, Filippo Maria D’Arcangelo, Tobias Kruse, and Mauro Pisu

Carbon leakage, whereby foreign emissions increase because of domestic climate policies, blunts the effects of domestic climate policies on global emissions. Traditionally, the empirical literature has not found much evidence of carbon leakage (e.g. Venmans et al, 2020). However, carbon prices were historically low and most existing evidence is limited to the EU’s emissions trading system where free allowances may have protected the international competitiveness of EU producers in emissions-intensive trade-exposed sectors.

In our recent paper (Teusch et al, 2024), we leverage satellite data from Climate TRACE to track emissions and carbon prices for cement and steel at the plant level across 140 countries. These two sectors alone account for more than 40% of industrial greenhouse gas emissions. We then use plant-level data to estimate the effect of carbon prices on emissions. Finally, we combine these data with international product-level trade data to quantify the effect of carbon prices on emissions embodied in the international trade of steel and cement products and obtain an estimate of carbon leakage in these sectors.

The recent rise in carbon prices was uneven across countries

Carbon prices have become more common over the past years and increased noticeably (OECD, 2023; World Bank, 2024). While most of the plants covered by this study are still not subject to carbon prices, carbon pricing systems now exist around the world (Figure 1). The average plant-level carbon price across all cement and steel plants in the dataset rose by a factor of seven (from USD 1.4 per tonne of CO₂e in January 2015 to USD 10.9 in December 2021). As carbon prices started from a low base, they remain low on average.

Figure 1.  Carbon pricing systems now exist around the world

Note: The map depicts the carbon pricing landscape in 2021. It shows all steel, cement and aluminium plants covered by the Climate TRACE dataset.
Source: Teusch et al, 2024.

The rise in carbon prices was uneven across countries, resulting in rising carbon price asymmetries. Carbon price asymmetries, computed as the average difference between the domestic carbon price and the carbon prices of trading partners (weighted by traded volumes), surged by more than 350% between 2015 and 2021, highlighting the heterogeneity of carbon price developments across countries and rising carbon leakage risk.

Carbon pricing can reduce emissions in steel and cement

Despite their reputation as “hard-to-abate” sectors, cement and steel plants respond to rising carbon prices by reducing emissions. Emissions from plants subject to carbon prices were stable between 2015 and 2022 whereas they rose for plants not covered by carbon prices (Figure 2). Empirical results based on panel regressions (controlling for confounding factors) suggest that, on average, cement and steel plants have reduced emissions by 1.3% in response to a USD 1 per tonne of CO₂ increase in carbon prices.

Figure 2: Emissions from plants facing no carbon prices increased whereas they remained stable for plants facing carbon prices

Note: The black solid line shows the 12-month moving average GHG emissions of plants (in steel and cement sectors) never regulated by carbon pricing rescaled to equal 100 in January 2015. The dashed grey line shows the average monthly GHG emissions of those plants. The green solid line shows the rescaled 12-month moving average GHG emissions of plants (in steel and cement sectors) regulated throughout the sample (i.e. that are always regulated by carbon pricing). The dashed green line shows the average monthly GHG emissions of those plants. The graph excludes plants that switch treatment status in the sample period.
Source: Teusch et al, 2024.

Carbon leakage through international trade offsets a moderate share of domestic emission reductions

On average carbon leakage through international trade offsets 13% of domestic emission reductions. Leakage, which we estimate using a gravity model of international trade, is driven by volume effects (increased imports); there is no evidence that countries import more from dirtier countries. One possible explanation for the relatively moderate leakage effect is that these sectors receive free allocation and other forms of government support (Garsous, Smith and Bourny, 2023), which reduces the carbon leakage risk. Another complementary explanation is that carbon price asymmetries across countries are not yet large enough to affect international trade flows in a more significant manner.

Carbon pricing may lead to additional spillovers

Carbon pricing asymmetries can lead to international spillovers in addition to carbon leakage through international trade. For example, carbon pricing can lead to downstream leakage, e.g. when carbon pricing on steel production impacts downstream manufacturing activities and locational choices. Carbon pricing can also induce positive spillover effects, for example via the diffusion of cleaner production techniques (including from regulated to unregulated facilities). Considering the importance of technology diffusion for reducing global emissions, innovation-related spillovers would merit further work.

Estimating and quantifying these spillovers is crucial to better understanding the impact of carbon prices asymmetries and mitigation policies on global emissions. Timely and granular sources of data covering emissions and output at product level are key elements to progress in this area and inform policies.

References

Garsous, G., D. Smith and D. Bourny (2023), “The climate implications of government support in aluminium smelting and steelmaking: An Empirical Analysis”, OECD Trade Policy Papers, No. 276, OECD Publishing, Paris, https://www.oecd.org/en/publications/the-climate-implications-of-government-support-in-aluminium-smelting-and-steelmaking_178ed034-en.html

OECD (2023), Effective Carbon Rates 2023: Pricing Greenhouse Gas Emissions through Taxes and Emissions Trading, OECD, https://www.oecd.org/en/publications/effective-carbon-rates-2023_b84d5b36-en.html

Teusch, J, F.M. D’Arcangelo, T. Kruse, M. Pisu (2024) “Carbon prices, emissions and international trade in sectors at risk of carbon leakage: Evidence from 140 countries”, OECD Economics Department Working Papers, https://www.oecd.org/en/publications/carbon-prices-emissions-and-international-trade-in-sectors-at-risk-of-carbon-leakage_116248f5-en.html

Venmans, F., J. Ellis and D. Nachtigall (2020), “Carbon pricing and competitiveness: are they at odds?”, Climate Policy, Vol. 20/9, pp. 1070-1091, https://doi.org/10.1080/14693062.2020.1805291

World Bank (2024), State and Trends of Carbon Pricing 2024, https://hdl.handle.net/10986/41544