Consumption-Based Approaches in International Climate Policy: An Analytical Evaluation of the Implications for Cost-Effectiveness, Carbon Leakage, and the International Income Distribution

As an agreement on an international climate treaty appears out of sight in the short run, many countries rely on unilateral greenhouse gas abatement strategies. The reach of such unilateral policies can be extended beyond the borders of the abating country by a switch to a consumption-based policy orientation. Such a policy does not target the emissions discharged on the territory of the country that abates, but the emissions embodied in the goods it consumes. If industrialized countries adopt this approach, they can bring the large and increasing amount of emissions embodied in imports from emerging economies into the scope of the policy. The policy switch could be implemented by means of border carbon adjustments; according to theoretic arguments such adjustments can improve the efficiency of unilateral policies. This paper develops a 2-region, 5-good analytical partial-equilibrium model to study the effects of a switch of the policy base. We especially focus on changes in production technology triggered by the policy. We find that a policy targeting consumption – when using a leakage definition appropriate for consumption-based approaches – does not cause leakage through the non-energy market leakage channel. In addition, the question whether a consumption-based policy is environmentally more effective is decided through policy transmission in non-energy markets, but not in energy markets. Still, despite the many arguments in favour of consumption-based approaches, we find that none of these arguments per se suffices to make a consumption-based policy the environmentally more effective or the more cost-effective option. Whether it is indeed more effective depends on (i) demand and production parameters and (ii) the precise design of the border tax (or any other appropriate policy instrument). In particular, the availability of “green” technology in emerging economies influences the results. Additionally, a switch of the policy base may also cause a substantial redistribution of the costs of the policy between abating and non-abating countries.