Robust Policies against Emission Leakage: The Case for Upstream Subsidies

Asymmetric regulation of a global pollutant between countries can alter the competitiveness of industries and lead to emissions leakage, which hampers countries’ welfare. In order to limit leakage, governments consider supporting domestic trade exposed firms by subsidizing their investments in abatement technology. The suppliers of such technologies tend to be less than perfectly competitive, particularly when both emissions regulations and advanced tech-nologies are new. In this context of twin market failures, we consider the relative effects and desirability of subsidies for abatement technology. We find a more robust recommendation for upstream subsidies than for downstream subsidies. Downstream subsidies tend to increase global abatement technology prices, reduce pollution abatement abroad and increase emission leakage. On the contrary, upstream subsidies reduce abatement technology prices, and hence also emissions leakage. Moreover, as opposed to downstream subsidies, they provide domestic abatement technology firms with a strategic advantage.