Carbon leakage and the future of Old Industrial Regions after Copenhagen

Abstract

CO2 prices will continue to differ from one country to another for a long time, even if a global post-Kyoto agreement is achieved in the near future. The non-homogeneous nature of climate policies may decrease the competitiveness of some industries with the risk of relocation of activities due to carbon leakage. One of most exposed industries in Europe is iron and steel, as it is highly CO2-intensive and relatively open to international trade. Most studies estimate a leakage of up to 20% as a consequence of all the industrial production activities that are expected to be relocated, and a level of relocation ranging from 1.5% to 35% specifically for the iron and steel sector. This might seem a relatively small macroeconomic impact if measured at country or EU level. However, the picture may be quite different if the analysis is conducted at sub-national level. Therefore, one could argue that there is an important gap in the literature as the relevant studies are applied to a large geographical scale when the fact is that in Europe this industry is highly concentrated in certain specific regions, i.e. the so-called Old Industrial Regions (OIR). This paper seeks to analyse the impact that different levels of relocation of the iron and steel industry in the OIRs will have as a consequence of climate policy. This is done using an AGE (Applied General Equilibrium) model. The results show that although these effects may be diluted from a national perspective, the impact for incumbent regions may be very large, and may in fact significantly reduce their GDPs. Another important outcome emerges when the costs of CO2 reduction derived from industry relocation and from cost-effective policies are compared. Although relocation of industrial activity (i.e. forced output change) can reduce CO2, the cost is very high compared with other options (e.g. induced input substitution). These results can help national and regional policy makers understand the necessary linkages between their environmental and industrial policies.