Carbon Emission Leakages: A General Equilibrium View

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Abstract
In December 1997, a number of countries - referred to as the Annex 1 countries - signed the Kyoto Protocol under which they agreed to ceilings on their emissions of greenhouse gases (GHGs). Such unilateral action by a group of countries has often been criticized on the grounds that it could be undermined by the existence of so-called "carbon leakages". Carbon leakage refers to the possible rise of GHG emissions in countries that do not participate in a carbon abatement coalition. This paper provides a discussion of the key mechanisms and factors underlying the size of carbon leakages. To this aim, we use a two-region, two-final goods simplified CGE framework, incorporating three types of fossil fuels (coal, oil and low-carbon energy), international trade and capital mobility. This framework was designed to make extensive, multidimensional sensitivity analysis tractable. Indeed, a wide range of alternative assumptions and parameterisations would have been difficult or even impossible to simulate and interpret with a large general equilibrium (GE) model. Amongst different determinants of carbon leakages, the results suggest that the supply elasticity of coal plays a critical role. The degree of product differentiation of manufactured goods and the international capital mobility appear as relatively less influential. The shape of the production function also matters, a fact that has attracted little attention so far. Our analysis also suggests that the level of leakage rates is low within the range of parameters provided in the literature and corresponding to the ones embodied, for example, in the OECD GREEN model.

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