Concern that unilateral greenhouse gas emission reductions could foster carbon leakage and undermine the international competitiveness of domestic industry has led to growing calls for carbon-based border-tax adjustments (BTAs). This paper uses a global general equilibrium model to assess the economic effects of BTAs and comes to three main conclusions. First, BTAs can reduce carbon leakage if the coalition of countries taking action to reduce emissions is small, because in this case leakage (while typically small) mainly occurs through international trade competitiveness losses rather than through declines in world fossil fuel prices that trigger rising carbon intensities outside the region taking action. Second, the welfare impacts of BTAs are small, and typically slightly negative at the world level. Third, and perhaps more strikingly, BTAs do not necessarily curb the output losses incurred by the domestic energy intensive-industries (EIIs) they are intended to protect in the first place. This is in part because taken as a whole, EIIs in industrialised countries make important use of carbon-intensive intermediate inputs produced by EIIs in other geographical areas. Another, deeper explanation is that EIIs are ultimately more adversely affected by carbon pricing itself, and the associated contraction in market size, than by any international competitiveness losses. These findings are shown to be robust to key model parameters, country coverage and design features of BTAs.Did you get all that? No? Ok, then please allow me to translate that into slightly-less-nerdy prose: where a country has imposed draconian climate change-mitigation policies like cap-and-trade or a carbon tax, carbon tariffs won't protect that country's energy-intensive domestic industries (e.g., steel, aluminum, chemicals, and paper) against foreign competition that isn't burdened with a similar climate change-mitigation system. The reason: the domestic system will itself cost domestic industries far more than they would lose in business to the unburdened foreign competition. In short, carbon tariffs can't help save American manufacturers under a cap-and-trade system because the system itself, not foreign competition, will kill those companies.
Now it sure would've been nice to have this study completed before carbon tariffs were pronounced dead in America's 111th Congress, but, hey, better late than never. Indeed, as I said last week, the threat of carbon tariffs, stemming for example from the EPA's forthcoming greenhouse gas regulations, still roams the earth like a brain-thirsty zombie, so consider the OECD study to be yet another bullet in your sidearm should the nasty carbon tariffs corpse rise from the grave and start looking for fresh meat.
(I know, I know: I took the metaphor too far. I'll stop now.)