Carbon Leakage: The Impact of Asymmetric Regulation on Carbon-Emitting Production

Production and Operations Management

38 Pages Posted: 29 Nov 2015 Last revised: 13 Mar 2020

See all articles by Ximin (Natalie) Huang

Ximin (Natalie) Huang

University of Minnesota

Tarkan Tan

Eindhoven University of Technology (TUE) - School of Industrial Engineering

L. Beril Toktay

Georgia Institute of Technology - Sustainability

Date Written: January 17, 2018

Abstract

Regions with carbon emission regulations bear the risk of "carbon leakage'' if local producers shift production capacity to an unregulated region. We investigate the problem for a producer subject to geographically asymmetric emission regulation with uncertain future emission price. The producer has two ex-ante options to lower its compliance cost: investing in clean production technology in the regulated region and building production capacity in the unregulated region. The producer determines its production quantities ex-post, after emission price uncertainty is resolved. We study two anti-leakage policies, Border Tax (BT) and Output-Based Allocation (OB), where the former adopts a "stick'' approach that penalizes offshore production and the latter adopts a "carrot'' approach that grants free emission allowances for production in the regulated region. First, we show that the emission price uncertainty can exert opposing effects in the absence of an anti-leakage policy: When the expected emission price is low (high), a higher uncertainty aggravates (mitigates) carbon leakage. Second, through a comprehensive comparison, we highlight that while both BT and OB are able to reduce carbon leakage, BT has a stronger effect in both the regulated and unregulated regions in multiple dimensions, especially when the carbon leakage risk is high. Third, we find that a higher emission price uncertainty weakens the effect of both BT and OB. We therefore suggest that emission price uncertainty should be accounted for when formulating anti-leakage policies. Finally, we extend our analysis to a competitive case and find that the superiority of BT relative to OB is enhanced.

Keywords: Carbon leakage, Anti-leakage policies, Technology choice, Production capacity choice

Suggested Citation

Huang, Ximin (Natalie) and Tan, Tarkan and Toktay, L. Beril, Carbon Leakage: The Impact of Asymmetric Regulation on Carbon-Emitting Production (January 17, 2018). Production and Operations Management , Available at SSRN: https://ssrn.com/abstract=2696173 or http://dx.doi.org/10.2139/ssrn.2696173

Ximin (Natalie) Huang (Contact Author)

University of Minnesota ( email )

19th Avenue South
Minneapolis, MN 55455
United States

Tarkan Tan

Eindhoven University of Technology (TUE) - School of Industrial Engineering ( email )

PO Box 513
Eindhoven, 5600 MB
Netherlands

L. Beril Toktay

Georgia Institute of Technology - Sustainability ( email )

800 West Peachtree St.
Atlanta, GA 30308
United States

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