Competitiveness Concerns With Incentive-Based Mechanisms

Competitiveness Concerns with Incentive-Based Mechanisms
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Introduction
The negative implications of climate change have become a reality with temperatures rising, drought, rising sea levels, and melting glaciers. The results of climate change are a major threat to humanity and the environment CITATION THT85 \l 1033 (Tietenberg, 1985). It is important to note that human-induced climate change remains the most perversive threat to societies, forcing countries to seek drastic measures to address the issue. Canada has been at the forefront of implementing its climate policy to reduce carbon leakage while at the same time protecting its trade-exposed industries from competition disadvantages. Trade-exposed industries denote those vulnerable to international competition and could be disadvantaged when subjected to carbon pricing and similar climate policies that are not applied uniformly across all nations. Carbon leakage implies that industries relocate to countries with weaker climate policies to reduce the costs associated with complying with measures aimed at reducing emissions, which eventually undermines the fight against climate change. Hence, as Canada implements its climate policy, it must make strategies to protect trade-exposed industries from competitive disadvantages and reduce carbon leakage. The best way to do this will be implementing a hybrid of measures, including a carbon border adjustment mechanism (CBAM), cap and trade, the free allocation of emissions permits, financial assistance to affected companies, and international cooperation.
Strategies to protect trade-exposed industries from competitive disadvantages
1 Implement a carbon border adjustment mechanism (CBAM)
If Canada implements its ambitious policies to reduce carbon emissions, some of its industries, i.e., steel, cement, etc., will be uncompetitive in the local market. The sectors may be transferred to unregulated foreign competitors. One of the most effective and easily implementable strategies to counter carbon leakage is using Carbon Border Adjustment Mechanism (CBAM), also commonly and synonymously referred to as Border Carbon Adjustments (BCAs). A BCA is a charge on embodied carbon in products imported into a jurisdiction with carbon pricing, potentially matched by rebates for embodied carbon in exports CITATION Par21 \l 1033 (Parry, et al., 2021). It is a policy tool designed to deter Emission Intensive Trade Exposed Industries (EITEIs) from relocating to countries with weaker emissions to avoid costs associated with decarbonization. A CBAM can help level the playing field for Canadian industries that face competition from countries with weaker climate policies CITATION Par21 \l 1033 (Parry, et al., 2021). This mechanism can apply a carbon price to imported goods to prevent carbon leakage and encourage other countries to adopt similar climate policies. Canada can impose carbon prices on all imported foods based on their embedded carbon emissions. This would affect the price of carbon-embedded products in the domestic market and make them competitive with locally produced goods. If CBAM is applied right, it can protect local industries from easily produced imported goods.
Border Carbon Adjustments (CBAs) help domestic EITEIs compete favorably with imported goods exported from countries with weaker or no carbon costs. When the goods reach Canada, they face the same carbon costs as domestically sourced goods, giving domestic goods a competitive edge against foreign-sourced products. This can help Canadian producers compete favorably with other countries with a lower cost of production because of heavy reliance on polluting energy sources such as coal.
Secondly, CBAM policies can help support climate ambition beyond Canada and push other countries to adopt more ambitious carbon emission goals CITATION Par21 \l 1033 (Parry, et al., 2021). By leveling the playing field for imported and domestic goods, BCAs can compel other countries to implement stronger domestic climate policies to avoid paying carbon costs in other countries and maintain market access.
When CBAMs are well-designed, they can reduce carbon leakage. When EITEIs cannot fully reflect the carbon costs in the prices of their goods due to exposure, such companies seek to relocate to jurisdictions with lower carbon costs. The same companies may continue serving the local market but still use carbon-intensive technologies for production to remain competitive. This not only affects the GDP of the country but also leads to capital outflow. The carbon price has not been reduced; it is emitted in different locations, undermining the environmental goals. BCAs help ensure that those EITEIs pay their carbon costs at the border when their goods return to the country. Thus, it becomes uneconomical and inconveniencing to relocate production to avoid stringent environmental policies in the country.
How to implement CBAMs
Import charges
McAusland and Najjar (2015) indicate that the implementation of carbon footprint taxes is an effective way to address the problem of carbon leakage. These are carbon costs imposed at the goods’ point of entry. They will be imposed on goods from countries that do not have carbon pricing, or they apply lower carbon costs relative to those borne by domestic manufacturers. The carbon costs can also be applied to a requirement that emission allowances be purchased for imported goods based on their carbon intensity. The purchases can either be direct or in the form of carbon offsets bought in the domestic market. Such import taxes can incentivize producers in other countries to minimize their carbon emissions. Even if producers consider relocating to countries with less strict climate policies, their products will be highly taxed at entry. Such a move will force producers in other countries to comply to climate policies, hence ensuring they do not have a competitive advantage over local industries in Canada.
Export rebates
This can be applied to the local manufacturers with foreign market access to enable their goods to be competitive in those markets. If export rebates are not applied, Canadian-produced goods could not compete favorably against goods produced in jurisdictions with weaker carbon emission policies or lower carbon costs. To help local manufacturers, Canadian authorities can offer rebates to domestic companies to offset their carbon costs. The rebates can come in the form of tax breaks, among other incentives.
A well-designed BCA could help address competitiveness and “carbon leakage” concerns in the interim for countries moving ahead unilaterally with ambitious carbon pricing CITATION Par21 \l 1033 (Parry, et al., 2021). However, it is important to note that while CBAMs may be effective tools for reducing carbon leakage, they may create unintended effects on the market. Trading partners may perceive them as prohibitive measures to reduce or curtail their market influence. This could potentially lead to retaliatory measures that could harm trade relations. Secondly, they need a significant administrative effort to implement the boundaries. While BCAs can be more efficient than other presently used instruments to address competitiveness and leakage concerns, BCAs are more complex to administer and could face legal challenges CITATION Par21 \l 1033 (Parry, et al., 2021). It would require a complex system to ensure compliance. Therefore, it is important to carefully design CBAMs to not only address leakage concerns and competitiveness, and Well-designed BCAs are a more natural instrument for maintaining the integrity of carbon pricing schemes and ultimately can be more effective than other instruments at addressing competitiveness and leakage CITATION Par21 \l 1033 (Parry, et al., 2021).
2 Cap and Trade
A carbon credit trading system can help prevent carbon leakage and increase the competitiveness of Canadian industries by providing a financial incentive for companies to reduce their greenhouse gas emissions. When emissions are capped, they become a scarce and valuable resource CITATION Car07 \l 1033 (Fischer & Alan K. Fox, 2007). The financial incentive comes from trading carbon credits and converting them to money. For example, a company can invest in more clean energy sources, i.e., solar or wind power, to reduce its carbon footprint and sell its carbon credit allowances to other companies which have exhausted their carbon credits. Unlike a carbon tax, the overall cap ensures that emissions are reduced in a controlled and targeted manner. The carbon tax does not guarantee that emissions will be kept within a limit. Under a carbon tax, it remains possible that emissions will significantly surpass objectives aimed at reducing emissions CITATION Gou13 \l 1033 (Goulder & Schein, 2013). Thus, using cap and trade, a country can dictate the limit of the volume of emissions, which is consistent with climate legislation. At the same time, trading carbon credits provides flexibility for companies to achieve emissions reductions in the most cost-effective way possible.
By using a carbon credit trading system, Canadian industries can achieve emission reductions more cost-effectively. For example, a company that cannot reduce its emissions beyond a certain level can purchase carbon credits from another company that has exceeded its emissions reduction targets. This incentivizes companies to reduce their emissions as much as possible while allowing them to achieve their emission reduction targets more flexibly and cost-effectively CITATION Gou13 \l 1033 (Goulder & Schein, 2013). The use of a carbon credit trading system can also increase the competitiveness of Canadian industries by promoting the adoption of low-carbon technologies and practices. Companies that invest in low-carbon technologies, such as renewable energy or energy-efficient equipment, can generate additional carbon credits, which they can sell on the carbon credit market. This creates a financial incentive for companies to invest in cleaner technologies, making them more competitive globally.
In addition, a carbon credit trading system can reduce the risk of carbon leakage by encouraging companies to reduce their emissions within Canada rather than relocating to countries with weaker environmental regulations. By using carbon credits to offset their emissions, companies can reduce their emissions within Canada and maintain their competitiveness in the global market.
One advantage of the cap-and-trade carbon trading system is that it allows companies to be flexible and choose the terms that best serve their interests while reducing their carbon footprint CITATION Gou13 \l 1033 (Goulder & Schein, 2013). Even the companies that buy carbon credits in the market opt to do so because it is better than relocating their industries elsewhere. Additionally, while the carbon credit system may inflate the prices of goods, they also allow the companies to be innovative in the best way to serve the market without relocating. Secondly, the system has a financial incentive to innovate, develop and implement new low-carbon technologies or practices to enable a company to sell its surplus allowances to others who need them to comply with the cap. Thirdly, the system is easily implementable and requires little or no administrative work. Unlike CBAMs which require a lot of administrative work, cap, and trade require little government oversight CITATION Gou13 \l 1033 (Goulder & Schein, 2013).
However, it is important to note that the system can be abused and have little or no significant impact on the nation's carbon footprint. Sometimes the cost of the credit is too low such that there is little to no pressure to reduce carbon footprint. Therefore, for Canada, the carbon cap ought to be reduced each year, and all unused credits can be designed to expire. If the plan is implemented well, it could be easy to achieve net zero in the foreseeable future.
3 The free allocation of emissions permits
In the European Union (EU), the emission trading system (ETS) is a key climate change mitigation mechanism. Under the ETS, a country issues a limited number of emission permits issued in a market-based system. Having a carbon emission price is critical in incentivizing businesses to reduce their emissions and consider alternative cleaner technologies CITATION McA15 \l 1033 (McAusland & Najjar, 2015). However, such action works better for industries that are not trade exposed. When the government imposes a price on carbon emissions, industries that are not trade-exposed can easily comply, assisting in combating climate change. However, such a measure has adverse effects on trade-exposed industries since it will make the cost of doing business high, hence disadvantaging local industries, making it possible for businesses in other countries without proper climate change policies to produce and sell goods cheaply. Due to the disadvantages of ETS, the Canadian government can issue them for free, particularly for industries at a high risk of carbon leakage. Complying with ETSs can be expensive, especially in countries with strict climate change policies. Canada is one of these countries that endeavor to reduce carbon emissions, meaning that the ETS will be expensive for most businesses w...