What carbon leakage means ?

1. International Trade and Investment Leakage Associated with Climate Change MitigationJean-Marc Burniaux(GTAP and OECD)

2. What carbon leakage means ? How to measure it ? Why is it important ? • Economic costs of participating countries. • Environmental effectiveness. • Size of coalition.

3. Carbon leakages in Kyoto : an analytical overview • there is a large disagreement among models about the • size of carbon leakages generated in implementing the Kyoto Protocol. • - high side estimates : 20-40 % (MERGE, Light et al., Worldscan). • - low side estimates : below 10 % (GREEN, G-Cubed). • Little empirical evidence to validate these results. • Uncertainty is large about the values of the key parameters. So sensitivity analysis is needed!

4. 1) the trade channel. Key parameters • loss of competitiveness of energy-intensive industries in Annex 1 countries. • trade substitution elasticities (Armington) 2) the energy channel. • fall of the carbon price in non-Annex 1 countries • supply elasticities of carbon. • Trade substitution elasticities of carbon. 3) The investment channel • reallocation of foreign direct investment across countries • degree of international capital mobility. • investment behaviour and expectations. Channels for leakages.

5. The approach : based on several models; static and dynamic. • Typically a GE issue. • Experience with the OECD GREEN model. • A static prototype for extensive sensitivity analysis. • A new dynamic GTAP model with a full specification of investment behavior. GDYN-E

6. Result 1(1) The degree of substitution on non-energy markets (Armington elasticities) and does not matter a lot for the rate of leakages. (except for very low values of the trade sustitution elasticities) • Burniaux et Oliveira Martins, Economic Department Working Paper, No242, • OECD, 2000

7. Result 2 The value of the supply elasticity of coal is, by far, the key factor.

8. Result 4 The elasticity of coal supply is more influential than the degree of substitution on the coal market

9. Result 5 • The degree of technological flexibility matters ! (negative leakages).

10. Result 6 In a static framework, capital mobility has little impact, whatever the degree of technological adjustment ….. … but this is no longer true in a dynamic framework !!!!

11. But how does this outcome transpose in a dynamic setting ? • Dynamic GDYN-E : • Dynamic GTAP (Ianchovichina and McDougall, 2001) • International capital mobility with full account of assets ownership and location; • Explicit investment behavior … • … based on adaptive expectations. • + the production structure of GTAP-E (Truong, 1999). • … and extended to deal with CO2 policies (Burniaux, 2001)

12. Does capital mobility in a dynamic framework change the outcome about leakages ? No ! ...Oops ! ?

13. Leakage decomposition over time in GDYN-E ….. over the longer run, investment reallocation becomes a major factor.

14. Ror Act. Actual investment schedule Targ. (1) (2) (3) Expected investment schedule Exp. K Kstock Leakage dynamics : the investment reaction.

15. Actual = Expected schedules Ror Act=Exp=Targ Targ Actual Kstock Leakage dynamics : the case of a non-Annex 1 country. Investment increases because the rate of return is attractive compared with A1 countries and investors revise their expectation about the normal rate of growth upward.

16. Actual = Expected schedules Ror Act=Exp=Targ Act = Targ Actual Kstock Leakage dynamics : the case of an Annex 1 country. Investment decreases because investors revise their expectation about the normal rate of growth downward.

17. Leakage dynamics : the importance of the expected investment behavior. Little impact !

18. Leakage dynamics : the role of trade elasticities. Same outcome as in static …. But higher trade substitution implies higher investment outflows from A1

19. Leakage dynamics : the role of the coal supply elasticity. Need a fairly low value of coal supply elasticity (<1) to get high leakage rates !

20. Leakage dynamics : the role of technology substitution. Investment reallocation may generate high leakages in case of low substitution possibilities.

21. Assessment • For “reasonable” parameter values : the leakage rate is likely to be small … • … and investment reallocation does not matter. • But alternative values of some key parameters may generate quite substantial amount of leakage … • … and under certain circumstances, investment reallocation induces high leakages. • Over the longer term, investment reallocation becomes a critical component of leakages.

22. 8% without US > 5% with US 2.7% with A1 trading < 5% without A1 trading The policy design influences the amount of leakages : • the size of the acting coalition : the larger the coalition, the smaller the leakages. • “hot air” reduces leakages. • the use of the flexibility mechanisms reduces leakages.

23. Implications for further researchs • Further empirical evidence about the value of key parameters is badly needed : • Value of coal supply elasticity. • Behavior of oil producers. • Transitional rigidities in technological adjustment (putty-clay) may increase the leakages over the medium term.