Do border measures affect carbon leakage?

In this paper we quantify the effects of the pledged commitments that have been made after the Copenhagen Climate Change Conference in December 2009 making use of the CGE-model WorldScan. We analyze the impacts of climate policy variants up to the year 2020, in particular on economic welfare and carbon leakage. We consider two main policy cases: ambitious and modest pledges. In the first case Annex I countries ambitiously adopt relatively low caps on GHG-emissions and allow free permit trade amongst each other. In this scenario China and India impose relative targets for CO2 emission-intensities of 45% and 25% below 2005 intensities. In the second case Annex I countries impose modest emission ceilings without permit trade and without the use of CDM. In this scenario China and India impose more modest relative targets too. Only in the EU permit trade occurs, separately within the Emissions Trading Scheme (ETS) and within the sectors outside ETS. In addition, we consider various variants for the case of modest pledges. The most important of these are: allowing Annex I countries to use CDM up to one third of the reduction effort and allowing industrialized countries to apply border measures (BM) for the ETS-sectors. In the BM case we assume that Annex I countries simultaneously adopt carbon import levies and carbon export refunds on all trade with non-Annex I. The level of these border measures is based upon the average prevailing direct and indirect carbon costs in domestic production of the ETSsectors. In all policy cases carbon leakage is considerable. Production leakage in absolute terms is rather modest though. Our simulations suggest that border measures are rather ineffective in reducing leakage. With additional simulations we show that the fossil fuel price channel is the most important cause of carbon leakage. Because border measures do not address this channel, they hardly affect carbon leakage.