Linking Numerical and Analytical Models of Carbon Leakage

Carbon leakage describes the economywide response in carbon emission levels caused by abatement in one part of the economy. Most quantitative studies of carbon leakage predict that 10-30% of unilateral abatement efforts will be offset by emission increases (a positive net leakage effect) elsewhere in the world economy. This is the subject of intense policy focus in international climate policy debates because countries contemplating new policies to reduce domestic emissions worry that their efforts will be rendered costly and ineffective. In a recent theoretical study, Fullerton, Karney and Baylis (2012) (henceforth FKB) identify a new potential source of carbon leakage effects which they refer to the Abatement Resource Effect (henceforth ARE). The intuition for this effect is that when stricter carbon regulation comes into effect in one part of the economy, it may draw basic factors of production away from other, carbon-intensive activities. The authors show that if this effect is strong enough, an economy may exhibit negative net leakage in response to the policy change. That is, emissions levels outside of the abating part of the economy may fall as these resources are drawn away and the scale of their operations shrink. FKB identify the key parameters responsible for producing the net leakage effect in their model. Intuitively, it depends on a substitution parameter that governs the ease with which the economy can to shift out of the use of carbon services and into other resources within the regulated sector or region (a technique effect) and on a substitution parameter which governs the ease with which the economy can shift out of