Theoretic and empirical issues related to border carbon adjustments

Abstract

Faced with the failure in coordinating a global policy to limit carbon emissions, one of the key issues in climate policy is carbon leakage, where emissions reductions in regulated regions stimulate emissions in unregulated regions. Many studies discuss border carbon adjustments to mitigate leakage and propose a rate of adjustments based on the carbon price (a Pigouvian rate). But, the question arises, is such a prescription optimal? This thesis analyzes optimal border carbon adjustments, specifically showing that the conventional Pigouvian rates are suboptimal. In Chapter 2, a general-equilibrium simulation model shows that the optimal trade policy is to set a net import tariff less than the Pigouvian rate. In Chapter 3, an analytical model demonstrates that the optimal import tariff consists of both the marginal social damage of the externality and the ability of the home country to influence foreign prices and thus foreign production. Furthermore, the model proves that the optimal rate is less than the Pigouvian rate because of the foreign consumer response. Chapter 4 shows that the findings in the previous chapters hold in an empirical context. Specifically, a general-equilibrium simulation model calibrated to the GTAP 7.1 global dataset demonstrates that the optimal border adjustments are smaller than the Pigouvian rates by 20% to 50% depending on export policy. This thesis contributes to the ongoing discussion of border carbon adjustments by showing the suboptimality of Pigouvian rates in both the theoretical and empirical contexts. Admittedly, using Pigouvian rates to set border adjustments provides a simple rule. The tradeoff between the efficiency improvement that I explore, and the cost increase related to implementing and maintaining the optimal rates (compared to the Pigouvian rates) should be considered.