The they cause i.e. the pollution they

The impacts of carbon leakage can be both
environmental and socio-economic. Carbon leakage is caused by “asymmetrical
climate policies” (Marcu A, 2013, pg. 5). What is meant by this is that
policies that have a price for carbon emissions in one region, while another
region has no, or a more relaxed, climate policy and price causes carbon
leakage. This is because if carbon emission policies of a country raise the
cost of local emission, then another country with a more relaxed carbon
emissions policy would have a comparative advantage. Carbon Leakage increases
firms cost by attempting to make firms internalise the negative externalities
they cause i.e. the pollution they produce. This leads to increases in costs
causing firms to move to regions with more relaxed carbon emission policies
with cheaper costs. Rather than incentivising firm cleaner production and
innovation, the carbon-pricing could lead firms to move abroad as there are
cheaper forms of production (because climate and emission policies are not
currently universal policies). Due to this, it is clearly arguable that by not
acknowledging carbon leakage, carbon emission policies can lead to innovation
failure as firms will simply move to another country with a more relaxed
climate policy and pollute more in other regions. A possible solution for this
is that policies that aim to tackle carbon leakage need to be universal or face
the potential of carbon emission policies failing to be implemented
correctly. 

One system that is aiming to reduce carbon leakage
is the European Union Emissions Trading System (EU ETS). This is achieved by
setting carbon prices, such as the ‘cap-and-trade’. The EU ETS has a ‘cap and
trade’ system which aims to reduce not only regional but also global carbon
emissions (reference).  The EU ETS sets
an aggregate emissions limit of particular greenhouse gases that can be emitted
by the EU participants who are involved and covered by the system. The cap is
reduced over time so that in total, emissions too will fall over time.  What is meant by this is that the EU ETS aims
to cap the overall level of emissions allowed to be produced by setting an
aggregate emission limit. Within that limit, participants in the system are
able to buy and sell permits as they need it. These permits are the trading
‘currency’ of the system. The gradual cap on the total number of permits
creates scarcity for these allowances in the market. This scarcity of
allowances means that the allowances will increase in price as there is less
supply of them. This high price for the scarce allowances incentivises firms to
produce fewer carbon emissions in order to reduce their need for the permits.
However, if the demand for a firm’s goods remains the same, production may move
abroad to a cheaper country with lower emission standards, and global emissions
will not be reduced – they may even potentially increase. The risk of carbon
leakage to some extent weakens the environmental outcomes; while at the same
time can lead to a decline in domestic production with a decrease in
employment. This could be a major socio-economic issue as if firms move and
decide to invest abroad to reduce their costs, the amount job opportunities
would decrease for citizens living in a region with high carbon emission costs.

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The climate is a global public good and thus needs
global collaboration in maintaining it. Due to this, initially the best
approach to tackling carbon emissions would appear to organising all countries to
pay equivalent carbon emission costs– similar to the EU ETS, but a global
version. However, evident from the climate negotiations in Copenhagen (2009),
it is clear as to how difficult it can be to get all 180 countries to agree to
equal and simultaneous action. It is increasingly clear that the climate issue
and regional and national climate policies cannot wait for global action if we aim
to solve the climate problem. Yet differential action generates concerns that
carbon intensive producers might move outside of regions imposing a carbon
cost, causing carbon emissions and economic activity to ‘leak’ outside of these
regions. However, the
EU ETS currently “operates in 31
countries (all 28 EU countries plus Iceland, Liechtenstein and Norway)” (Climate Action – European
Commission, 2018). Despite the EU ETS not having all
countries as participants to its scheme, it is clear that the EU ETS is
attempting to reduce carbon leakage as by increasing the number of countries
that participate in the scheme it is evident that it acknowledges that carbon
leakage is more than a regional or national issue – it is a global issue.

However, if all countries take
into consideration carbon leakage whilst designing climate policies, as more
countries implement climate policies such as carbon pricing, carbon leakages
may reduce and potentially may even disappear. If it carbon leakage does arise,
it can have the possibility of having detrimental environmental and socio-economic
consequences. Carbon leakage could undermine a carbon-pricing policy’s
environmental objective by causing emissions to increase in regions beyond the
reach of the policy. The opportunity cost between preventing carbon leakage and
the other uses of the fiscal resources can help balance political interests.
For instance, if public citizens understand that there is a relationship
between the help provided to firms to reduce the risk of carbon leakage and the
fiscal resources available for other uses, including to support households, it
may help decision makers make more balanced decisions. In addition to this,
actions being made to address carbon leakage usually involve the use of fiscal
resources that could be used for other purposes e.g. to compensate households
or other general uses of revenue. This trade-off often requires to some extent
a level of political judgment providing the incentive for different interests
to persuade decision makers.