Does the CO2 emission trading directive threaten the competitiveness of European industry? Quantification and comparison to exchange rates fluctuations

The European Union commitment to implement the Kyoto Protocol has been recently criticised by some Member States and high level officials who claim that such a policy would threaten the competitiveness of European industry vis-à-vis countries without a commitment. This concern has been voiced in particular against the European directive 2003/87/EC, which will create a CO2 allowance market covering carbon-intensive industry and energy supply from 2005 on. We assess this claim through a quantitative analysis for twelve industry sectors for 2001, based on the OECD STAN and BTD databases, as well as on the IEA CO2 emissions database. Excluding intra-EU trade, it first appears that, with only one exception, carbon-intensive sectors (iron and steel, minerals, paper, power generation, fuel refining, chemicals) are less exposed to extra-EU competition than non-carbon intensive ones (transport material, machinery, textile, wood, food and drinks). Only the non-ferrous metals sector is both more carbon-intensive and more exposed than industry average. We then compute the loss in sales for three sets of import and export price elasticities, estimated at the sector level, and compare it to the impact of a 10% rise in UE currencies visà- vis all other currencies. It appears that if allowances are grandfathered, and assuming a high allowance price (20 euros per ton of CO2), the competitiveness impact of the directive is, at worst, 20% of the impact of the 10% rise in exchange rates. Furthermore, if allowances are auctioned and the income recycled through a cut in social security contributions, sales of non-carbon intensive sectors increase. For two out of our three sets of import and export price elasticities, the overall impact is positive, i.e., the loss in carbon-intensive sectors is more than compensated by the increase in other sectors.