The Perils of Carbon Leakage

Aaron Foyer
The Perils of Carbon Leakage infographic

What is carbon leakage?

Carbon leakage is a term used to describe a situation where efforts to reduce carbon emissions in one region or country result in an increase in emissions in another region or country. This phenomenon can occur as a consequence of policies and actions taken to combat climate change. Here’s an explanation of how carbon leakage is caused by policy:

  • Emission Reduction Policies: Carbon leakage often arises when a country or region implements policies aimed at reducing carbon emissions within its borders. These policies can take various forms, such as carbon pricing mechanisms (carbon taxes or cap-and-trade systems), renewable energy incentives, energy efficiency regulations, and emissions reduction targets.
  • Increased Costs for Businesses: One of the main ways emission reduction policies can cause carbon leakage is by increasing the costs of production for businesses within the regulated area. For example, if a government imposes a carbon tax on industrial emissions or mandates the use of expensive low-carbon technologies, it can lead to higher operational costs for businesses.
  • Competitive Disadvantage: When businesses face higher operating costs due to emission reduction policies, they may become less competitive in the global market. Products manufactured in regions with lower environmental regulations and costs may become more attractive to consumers because they are cheaper.
  • Relocation of Industries: To maintain competitiveness and avoid the additional costs associated with emission reduction policies, some companies may decide to relocate their operations to regions or countries with less stringent environmental regulations. This relocation can lead to an increase in emissions in the new location, which partially or entirely offsets the emissions reductions achieved in the original area.
  • Product Import and Export: In cases of carbon leakage, the production of emissions-intensive goods may shift to regions with laxer regulations. However, these products can still be consumed in regions with stricter emission reduction policies. This results in emissions associated with the production and transportation of goods being effectively “imported” into the regulated area.
  • Loss of Green Jobs: In some instances, emission reduction policies can lead to job losses in industries that are heavily impacted by these policies, such as fossil fuel extraction or energy-intensive manufacturing. These job losses can be a politically sensitive issue and may result in calls to weaken or repeal emission reduction measures.



IMF Working Paper: Revisiting Carbon Leakage, International Monetary Fund