FEEM working papers "Note di lavoro" series
2006 .094

Carbon Leakage Revisited: Unilateral Climate Policy with Directed Technical Change


Authors: Corrado Di Maria, Edwin van der Werf
Series: Climate Change and Sustainable Development
Editor: Carlo Carraro
Type: Journal
Keywords: Climate Policy,Carbon Leakage,Directed Technical Change,International Trade
JEL n.: F18,O33,Q54,Q55
JEL: Environmental and Resource Economics,
Pages: Vol. 39, No. 2, pp. 55-74
Date: 02/2008

Abstract

A common critique to the Kyoto Protocol is that the reduction in emissions of CO2 by countries who comply with it will be (partly) offset by the increase in emissions on the part of other countries (carbon leakage). This paper analyzes the effect of technical change on carbon leakage in a two-country model where only one of the countries enforces an exogenous cap on emissions. Climate policy induces changes in relative prices, which cause carbon leakage through a terms-of-trade effect. However, these changes in relative prices in addition affect the incentives to innovate in different sectors. We allow entrepreneurs to choose the sector for which they innovate (directed technical change). This leads to a counterbalancing induced-technology effect, which always reduces carbon leakage. We therefore conclude that the leakage rates reported in the literature so far may be too high, as these estimates neglect the effect of relative price changes on the incentives to innovate.

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