Addressing the Competitiveness Impacts of Pollution Regulations
| Author | Joseph E. Aldy |
| Position | Economist on the faculty at the Harvard Kennedy School |
| Pages | 15-15 |
SEPTEMBER/OCTOBER 2021 | 15
Reprinted by permission from The Environmental Forum®, September/October 2021.
Copyright © 2021, Environmental Law Institute®, Washington, D.C. www.eli.org.
An Economic Perspective
THE EU recently proposed
what would eectively be
taris on imported goods —
such as cement and steel — based on
the carbon intensity of their produc-
tion. Likewise, the Biden administra-
tion is considering carbon taris as a
part of its trade policy. is interest
in taxing the pollution embodied in
imports reects a long-held concern
that environmental regulations harm
the competitiveness of emission-in-
tensive manufacturers.
e pollution haven hypothesis main-
tains that businesses will relocate their
production from heavily regulated
jurisdictions to less-regulated ones —
just as a rm may seek to relocate its
production to a country with low tax
rates or cheap labor. Under this think-
ing, the competitive-
ness pressures of cli-
mate change regula-
tions, cap-and-trade
programs, and taxes
could deliver adverse
economic impacts —
even environmental
impacts. Moving manufacturing ac-
tivity to less-regulated markets could
reduce economic output and employ-
ment in the more-regulated market.
And relocating manufacturing activity
to a less-regulated market could result
in emission leakage. Higher net im-
ports, lower domestic production and
employment, and the undermining of
environmental benets all contribute to
political support for eorts to combat
adverse competitiveness impacts.
With EU emission allowance prices
exceeding $50 per metric ton of carbon
dioxide in recent months — and the
prospect of higher allowance prices as
the union aims to deliver on ambitious
decarbonization goals — the dierence
in the stringency in domestic emission
mitigation policies among the EU and
its major trade partners has widened. If
the United States moves forward with
ambitious emission mitigation policies,
then U.S. rms may also bear greater
compliance costs than rms in most
(non-EU) trade partners. e greater
the dierence, the stronger the incen-
tive to relocate activity to less-regulated
markets.
In practice, however, a number of
factors may mitigate climate policy-in-
duced manufacturing relocation. High
transportation costs for certain manu-
factured goods may enhance the value
of producing near nal consumers. Ag-
glomeration economies — the value of
co-locating with related manufacturing
facilities, such as in an industrial park
— may reduce the appeal of moving
to another jurisdiction. e irreversible
nature of xed capital investment — it’s
costly and, in cases, infeasible to pack
up and move a factory — may also
deter movement to a
low-regulation mar-
ket.
As other countries
increase the ambi-
tion of their domestic
emission mitigation
programs — such as
what President Biden has proposed for
the United States and as envisioned
through periodic revision and updating
of countries’ mitigation pledges under
the Paris Agreement — then the dif-
ference in regulatory compliance costs
across countries and, thus, the incentive
to relocate will decline.
It’s also important to recognize that
eliminating competitiveness pressures
from foreign rms would not eliminate
emission abatement costs for a steel
mill or pulp and paper mill. Facilities in
these and other energy-intensive indus-
tries have relatively high carbon dioxide
emissions per unit of economic output,
and the reduction in prots and output
at these facilities could reect the fact
that they have meaningful regulatory
compliance costs. In my work on the
U.S. manufacturing sector with Billy
Pizer of Resources for the Future, we
nd that the competitiveness eect
(measured by the increase in net im-
ports) composed less than 20 percent
of the decrease in output of energy-
intensive industries when energy prices
increase — such as they often do under
climate change regulations and carbon
pricing.
Across an array of simulation model-
ing and statistical analyses, the compet-
itiveness impacts of carbon pricing ap-
pear relatively modest in terms of eco-
nomic and environmental outcomes.
Nonetheless, the prospect that explicit
and implicit carbon prices could in-
crease in coming years, and the poten-
tial for economic harm to politically
important manufacturing industries,
have motivated considerable eorts
to develop policies to mitigate adverse
competitiveness eects.
Some carbon tax programs, such as
in northern Europe, have eectively ex-
cluded trade-exposed, energy-intensive
manufacturing. Some cap-and-trade
programs, such as in California, give
allowances free of charge to rms in
energy-intensive manufacturing. A car-
bon border adjustment, however, could
both address the adverse economic and
environmental competitiveness im-
pacts under domestic climate policies
and spur more ambitious policy actions
by other countries.
Designing carbon taris such that
they exempt imports from countries
with comparable domestic policies
could create an incentive for major
trade partners of the EU and the Unit-
ed States to implement more ambitious
domestic programs.
Addressing the Competitiveness
Impacts of Pollution Regulations
Creating incentives
for trade partners to
implement ambitious
domestic programs
P H R
P C T
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T C Q S P
T P R H E
F K A I
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ISBN P
ELI ELI P
W A T WEST
Joseph E. Aldy is an e conomist
on the facult y at the Harv ard Ken-
nedy School . You can contact hi m at
Joseph_Aldy@hks.harvard.edu.
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