Carbon leakage under incomplete environmental regulation: An industry-level approach

Carbon leakage is a major concern for policymakers involved with environmental initiatives such as the European Union's emissions trading scheme and similar cap-and-trade proposals in the United States, Australia, and elsewhere. This paper provides a framework for understanding the drives underlying carbon leakage at the level of an individual sector in which only a subset of firms is covered by such regulation. It provides simple formulae to estimate leakage rates using information on industry characteristics that is typically available to the analyst. Illustrative estimates for the steel industry in the EU ETS suggest carbon leakage of 25-30% or (much) higher - unless environmental-efficiency improvements by regulated firms are substantial.