Domestic carbon pricing policies may impose adverse competitiveness risks on energy-intensive firms and industries competing with foreign firms that may bear a lower or zero price on carbon. The risks of competitiveness effects include adverse economic outcomes—reduced production, lower employment, and higher net imports—and adverse environmental outcomes, with the shifting of emissions-intensive activities to unregulated foreign markets. Each can undermine political support for carbon pricing. Competitiveness policies, such as border tax adjustments, output-based tax credits, and related policies, also carry potential risks. They may result in less favorable distributional outcomes, undermine cost-effectiveness and economic efficiency, and raise risks in international trade and multilateral climate negotiations. This paper reviews the theoretical and empirical research on competitiveness risks, as well as the risks posed by competitiveness policies, and presents two alternative frameworks through which policymakers can weigh these various risks when evaluating policy options for addressing potential competitiveness effects as a part of a domestic carbon pricing regime.
- The risks of competitiveness effects include adverse economic outcomes—reduced production, lower employment, and higher net imports—and adverse environmental outcomes, with the shifting of emissions-intensive activities to unregulated foreign markets.
- Policies to mitigate competitiveness impacts may also carry important distributional, economic efficiency, and diplomatic risks.
- Existing empirical estimates of competitiveness impacts suggest that pricing carbon would impose small economic and environmental costs for most industries and the economy as a whole.
- Policymakers could employ a framework to compare the benefits and costs of various options for competitiveness policies and identify the alternative that maximizes net social benefits.
- Rigorous assessments of the benefits and costs of policies to address competitiveness risks could also inform a political economy framework focused on securing sufficient political support for a carbon pricing policy.