Unilateral Climate Policy and Competitiveness: Economic Implications of Differential Emission Pricing

Unilateral climate policy raises concerns about international competitiveness and emission leakage that result in preferential regulatory treatment of domestic energy‐intensive and trade‐exposed (EITE) industries. Our applied analysis of unilateral EU abatement illustrates the potential pitfalls of climate policy design which narrowly focuses on competitiveness concerns about EITE industries. The sector‐specific gains of differential emission pricing in favour of these branches must be traded off with the additional burden imposed on other industries. From the perspective of the unilaterally abating region preferential EITE emission pricing can induce non‐negligible excess cost as policy concedes (too) low emission prices to EITE industries and thereby foregoes relatively cheap abatement options in these sectors. With respect to global cost‐effectiveness of unilateral climate policy, we find that differential emission pricing in favour of EITE industries can reduce emission leakage and thereby provide global cost savings compared with uniform pricing. However, the scope for cost savings is limited and may change into substantial cost increases if unilateral reduction targets are moderate and EITE industries get close to exemptions.