Editing IPCC:AR6/WGIII/Chapter-12 (section)

=== 12.6.3 International Trade Spillover Effects and Competitiveness ===

<div id="h2-30-siblings" class="h2-siblings"></div>

International spillovers of mitigation policies are effects that carbon-abatement measures implemented in one country have on sectors in other countries. These effects include (i) carbon leakage in manufacture; (ii) the effects on energy trade flows and incomes related to fossil fuel exports from major exporters; (iii) technology and knowledge spillovers; and (iv) transfer of norms and preferences via various approaches to establish sustainability requirements on traded goods, such as EU-RED and environmental labelling systems to guide consumer choices ( ''robust evidence'' , ''medium agreement'' ) ''.'' This section focuses on cross-sectoral aspects of international spillovers related to the first two effects.

<div id="12.6.3.1" class="h3-container"></div>

<span id="cross-sectoral-aspects-of-carbon-leakage"></span>
==== 12.6.3.1 Cross-sectoral Aspects of Carbon Leakage ====

<div id="h3-19-siblings" class="h3-siblings"></div>

Carbon leakage occurs when mitigation measures implemented in one country or sector lead to a rise in emissions in other countries or sectors. Three types of spillovers are possible: (i) domestic cross-sectoral spillovers when mitigation policy in one sector leads to the re-allocation of labour and capital towards the other sectors of the same country; (ii) international spillovers within a single sector when mitigation policy leads to substitution of domestic production of carbon-intensive goods with their imports from abroad; and (iii) international cross-sectoral spillovers when mitigation policy in one sector in one country leads to the rise in emissions in other sectors in other countries. While the first two are described in [[IPCC:Wg3:Chapter:Chapter-13#13.6|Section 13.6]] , this section focuses on the third. Though some papers address this type of leakage, there is still a significant lack of knowledge on this topic.

One possible channel of cross-sectoral international carbon leakage is through global value chains. Mitigation policy in one country not only leads to shifts in competitiveness across industries producing final goods but also across those producing raw materials and intermediary goods all over the world.

This type of leakage is especially important because the countries that provide basic materials are usually emerging or developing economies, many of which have no or limited regulation of GHG emissions. For this reason, foreign direct investment in developing economies usually leads to an increase in emissions ( [[#Kivyiro--2014|Kivyiro and Arminen 2014]] ; [[#Shahbaz--2015|Shahbaz et al. 2015]] ; [[#Bakhsh--2017|Bakhsh et al. 2017]] ): in the case of basic materials the effect of expansion of economic activity on emissions exceeds the effect of technological spillovers, while for developed countries the effect is opposite ( [[#Shahbaz--2015|Shahbaz et al. 2015]] ; [[#Pazienza--2019|Pazienza 2019]] ). [[#Meng--2018|Meng et al. (2018)]] calculated that environmental cost for generating one unit of GDP through international trade was 1.4 times higher than that through domestic production in 1995. By 2009, this difference increased to 1.8 times. Carbon leakage due to the differences in environmental regulation was the main driver of this increase.

In order to address emissions leakage through global value chains, [[#Liu--2017|Liu and Fan (2017)]] propose the value-added-based emissions accounting principle, which makes it possible to account for GHG emissions within the context of the economic benefit principle. [[#Davis--2011|Davis et al. (2011)]] notice that the analysis of value chains gives an opportunity to find the point where regulation would be the most efficient and the least vulnerable to leakage. For instance, transaction costs of global climate policy and the risks of leakage may be reduced if emissions are regulated at the extraction stage as there are far fewer agents involved in this process than in burning of fossil fuels or consumption of energy-intensive goods. [[#Li--2020|Li et al. (2020)]] calls for coordinated efforts to reduce emissions embodied in trade flows in pairs of the economies with the highest leakage, such as China and the United States, China and Germany, China and Japan, Russia and Germany.

Unfortunately, these proposals either face difficulties in collection and verification of data on emissions along value chains or require a high level of international cooperation, which is hardly achievable at the moment. [[#Neuhoff--2016|Neuhoff et al. (2016)]] and [[#Pollitt--2020|Pollitt et al. (2020)]] focus on the regulation of emissions embodied in global value chains through national policy instruments. They propose implementation of a charge on consumption of imported basic materials into the European emissions trading system. Such a charge, equivalent to around EUR80 tCO 2 –1 , could reduce the EU’s total CO 2 emissions by up to 10% by 2050 ( [[#Pollitt--2020|Pollitt et al. 2020]] ) without significant effects on competitiveness. This proposal is very close to the carbon border adjustment introduced in the EU and described in more detail in Sections 13.2 and 13.6.

Cross-sectoral effects of carbon leakage also occur through the multiplier effect, when the mitigation policy in any sector in country A leads to the increase of relative competitiveness and therefore production of the same sector in country B, which automatically leads to the expansion of economic activity in other sectors of country B. This expansion may in turn lead to the rise of production and emissions in country A as a result of feedback effects. These spillovers should be taken into consideration while designing climate policy, along with potential synergies that may appear due to joint efforts. However, the scale of these effects with regards to leakage should not be overestimated. Even for intrasectoral leakage, many ''ex ante'' modelling studies generally suggest limited carbon leakage rates (Chapter 13). Intersectoral leakage should be even less significant. Interregional spillover and feedback effects are well studied in China ( [[#Zhang--2017|Zhang 2017]] ; [[#Ning--2019|Ning et al. 2019]] ). Even within a single country, interregional spillover effects are much lower than intraregional effects, and feedback effects are even less intense. Cross-sectoral spillovers across national borders as a result of mitigation policy should be even smaller, although these are less well studied. In future, if the differences in carbon price between regions increase, leakage through cross-sectoral multipliers may play a more important role.

Another important cross-sectoral aspect of carbon leakage concerns the transport sector. If mitigation policy leads to the substitution of domestic carbon-intensive production with imports, one of the side effects of this substitution is the rise of emissions from transportation of imported goods. International transport is responsible for about a third of worldwide trade-related emissions, and over 75% of emissions for major manufacturing categories ( [[#Cristea--2013|Cristea et al. 2013]] ). Carbon leakage would potentially increase the emissions from transportation significantly as the trade of major consuming economies of the EU and US would shift towards distant trading partners in East and South Asia. [[#Meng--2018|Meng et al. (2018)]] consider more distant transportation as one of the major contributors to the rise in emissions embodied in international trade from 1995 to 2009.

Emissions leakage due to international trade, investment and value chains is a significant obstacle to more ambitious climate policies in many regions. However, it does not mean that disruption of trade would reduce global emissions. Zhang et al. (2020) show that deglobalisation and the drop in international trade may result in emissions reductions in the short term, but in the longer term it will make each country build more complete industrial systems to satisfy their final demand, although they have comparative disadvantages in some production stages. As a result, emissions would increase. According to Zhang et al. (2020), for China, the decrease of the degree of global value chain participation (which ranges from 0 to 1) by 0.1 would lead to an increase in gross carbon intensity of China’s exports of 11.7%. On distributional implications, [[#Parrado--2014|Parrado and De Cian (2014)]] report that trade-driven spillover effects transmitted through imports of materials and equipment result in significant inter-sectoral distributional effects, with some sectors witnessing substantial expansion in activity and emissions and others witnessing a decline in activities and emissions.

It should also be mentioned that international trade leads to important knowledge and technology spillovers (Sections 16.3 and 16.5) and is critically important for achieving other Sustainable Development Goals ( [[#12.6.1|Section 12.6.1]] ). Any policies imposing additional barriers to international trade should therefore be implemented with great caution and require comprehensive evaluation of various economic, social and environmental effects.

<div id="12.6.3.2" class="h3-container"></div>

<span id="the-spillover-effects-on-the-energy-sector"></span>
==== 12.6.3.2 The Spillover Effects on the Energy Sector ====

<div id="h3-20-siblings" class="h3-siblings"></div>

Cross-sectoral trade-related spillovers of mitigation policies include their effect on energy prices. Other things being equal, regulation of emissions of industrial producers decreases the demand for fossil fuels that would reduce prices and encourage the rise of fossil fuel consumption in regions with no or weaker climate policies ( ''robust evidence'' , ''med'' ''ium agreement'' ) ''.''

[[#Arroyo-Currás--2015|Arroyo-Currás et al. (2015)]] studied the energy channel of carbon leakage with the REMIND IAM of the global economy. They came to the conclusion that the leakage rate through the energy channel is less than 16% of the emissions reductions of regions who introduce climate policies first. This result did not differ much for different sizes and compositions of the early mover coalition.

[[#Bauer--2015|Bauer et al. (2015)]] built a multi-model scenario ensemble for the analysis of energy-related spillovers of mitigation policies and revealed huge uncertainty: energy-related carbon leakage rates varied from negative values to 50%, primarily depending on the trends in inter-fuel substitution.

Another kind of spillover in the energy sector concerns the ‘green paradox’: announcement of future climate policies causes an increase in production and trade in fossil fuels in the short term ( [[#Jensen--2015|Jensen et al. 2015]] ; [[#Kotlikoff--2016|Kotlikoff et al. 2016]] ). The delayed carbon tax should therefore be higher than an immediately implemented carbon tax in order to achieve the same temperature target ( [[#van%20der%20Ploeg--2016|van der Ploeg 2016]] ). Studies also make a distinction between a ‘weak’ and ‘strong’ green paradox ( [[#Gerlagh--2011|Gerlagh 2011]] ). The former refers to a short-term rise in emissions in response to climate policy, while the latter refers to rising cumulative damage.

The green paradox may work in different ways for different kinds of fossil fuels. For instance, [[#Coulomb--2018|Coulomb and Henriet (2018)]] show that climate policies in the transport and power-generation sectors increase the discounted profits of the owners of conventional oil and gas, compared to the no-regulation baseline, but will decrease these profits for coal and unconventional oil and gas producers.

Many studies also distinguish different policy measures by the scale of green paradox they provide. The immediate carbon tax is the first-best instrument from the perspective of global welfare. Delayed carbon tax leads to some green paradox but less than in the case of support for renewables ( [[#Michielsen--2014|Michielsen 2014]] ; [[#van%20der%20Ploeg--2019|van der Ploeg and Rezai 2019]] ). With respect to the latter, support for renewable electricity has a lower green paradox than support for biofuels ( [[#Michielsen--2014|Michielsen 2014]] ; [[#Gronwald--2017|Gronwald et al. 2017]] ). The existence of the green paradox is an additional argument in favour of more decisive climate policy now: any postponements will lead to additional consumption of fossil fuels and consequently the need for more ambitious and costly efforts in future.

The effect of fossil fuel production expansion as a result of anticipated climate policy may be compensated by the effect of divestment. Delayed climate policy creates incentives for investors to divest from fossil fuels. [[#Bauer--2018|Bauer et al. (2018)]] show that this divestment effect is stronger and thus announcing of climate policies leads to the reduction of energy-related emissions.

The implication of the effects of mitigation policies through the energy-related spillovers channel is of particular significance to oil-exporting countries ( ''medium evidence'' , ''medium agreement'' ). Emissions-reduction measures lead to decreasing demand for fossil fuels and consequently to the decrease in exports from major oil- and gas-exporting countries. The case of Russia is one of the most illustrative. [[#Makarov--2020|Makarov et al. (2020)]] show that the fulfilment by Paris Agreement Parties of their NDCs would lead to 25% reduction of Russia’s energy exports by 2030 with significant reduction of its economic growth rates. At the same time, the domestic consumption of fossil fuels is anticipated to increase in response to the drop in external demand that would provoke carbon leakage ( [[#Orlov--2017|Orlov and Aaheim 2017]] ). Such spillovers demonstrate the need for dialogue between exporters and importers of fossil fuels while implementing the mitigation policies.

<div id="12.6.4" class="h2-container"></div>

<span id="implications-of-finance-for-cross-sectoral-mitigation-synergies-and-trade-offs"></span>