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While carbon offshoring occurs as developed countries continue to shift emission-intensive industries to the developing world, weak environmental laws remain not the sole source of comparative advantage driving offshoring.

By Saatwik Panigrahi

The complexity surrounding the issue of carbon offshoring is often shrouded in its simplicity. Consider the cases of European countries like France, the United States, the United Kingdom and Germany. Often, these countries are considered as prime contributors to global carbon offshoring. Such arbitrary categorizations of countries, however, ignore the rather complex and nuanced contours of the subject and we shall actually see datasets to reach a conclusion.

A regression model is devised in MATLAB to test the correlation between the production and consumption-based carbon emissions (in tons) for the sampled countries. The dataset ranges over thirty years (1990-2019) and comprises 120 data points.

The regression model estimates a robust positive correlation of 0.998 between the tested variables, such that there is likely a very strong correlation between production and consumption-based carbon emissions in the four countries. 

If consumption-based emissions increased while production-based emissions decreased (a negative correlation) it suggests that considerable or significant amounts of emissions were being offshored elsewhere; a positive correlation would indicate the opposite. Though all of these countries have higher consumption-based carbon emissions, the positive correlation between consumption-based emissions and production-based emissions suggests that these countries have genuine reductions in their consumption of carbon-intensive goods without outsourcing or offshoring the emissions. This further hints at the possibility of further emission reductions. Though countries became richer at the cost of increased environmental degradation fueled by carbon emissions, they are not always correlated. These four countries, among several others, have become richer while achieving a reduction in emission levels.  

Let’s deepen our understanding of the issue by studying the country and firm-level impact of carbon offshoring.

Studying the United Kingdom’s carbon footprint profiling between 1997-2018 reveals that carbon consumption-based emissions have consistently remained higher than territorial emissions. This is most likely due to a sectoral shift in the economy that has made the service sector the most important economic sector and thus, has prompted the outsourcing of the secondary sector commodities. These commodities, often imported from countries with lax climate regulations, end up bringing in higher carbon-emissions into its consumption figures.

On the firm level, a study on French firms reveals that carbon leakages prevent aggressive climate policies and relegate the efficiency of domestic emission mitigation measures. The study Carbon Offshoring: Evidence From French Manufacturing Companies fails to find compelling evidence of the impact of carbon offshoring on total emissions, but instead portrays that emission efficiency enhances in companies that engage in offshoring, owing to an increase in the production scale. However, this effect is twice as small as that of domestic energy prices, and a “pollution haven” or a “carbon haven” motive is hence not present. 

Secondly, while carbon havens do exist, it is unclear to what extent weak environmental regulations determine relocation. On the other hand, it has been clearly established that there is a more robust causality between trade liberalization and labor cost differentials. Furthermore, however coincidentally, most carbon haven countries have cheap labor. This makes it unclear as to which of the two factors — labor cost differentials and weak environmental regulations — is a stronger motivator for offshoring and thus, demands research to quantify their relative significance.

Evaluating Potential Solutions to Carbon Offshoring

The issues surrounding carbon offshoring clearly reveal the inherent flaws in the production-based carbon accounting method. A possible solution to this is the implementation of consumption-based accounting approach. Such an approach accurately identifies climate policies that seek to promote the externalization of carbon emissions to other countries. Moreover, this approach also creates intricate linkages between national climate policy and global emission reduction by discouraging the localization of climate policies and instead fostering a global spirit in their implementation. 

However, a consumption-based approach would exert inordinate costs on consumers since it is now the consumers who must be held accountable for buying commodities whose production entails large quantities of carbon emissions. This defeats the main purpose as it serves no motivation to producers, who must switch to cleaner technologies to ultimately achieve the outcome of reducing carbon emissions. Secondly, Jakob et. al argue that consumption-based accounting does not result in a greater reduction in emissions. Citing the example of regulation of Chinese imports of the EU, they argue that reversing the impact of the policy by shifting production from export to domestic markets, which are even more carbon-intensive. This, in fact, achieves the opposite of the goal. In conclusion, there is limited evidence of the positive impacts of this accounting methodology on global emission levels. 

Consumption-based accounting could motivate investments in emission reductions and energy efficiency. The current literature, in view of such investments, highlights a potential outcome: rebound effect. In their paper on the consumption-based carbon accounting approach, Liu, Isenhour, and Feng suggest that addressing consumption emissions through technology transfer to developing countries “simply rationalizes accelerated consumption”, causing a “rebound effect.”  

Another approach, akin to the production-based carbon accounting that premises on producer responsibility and the income approach, is the extraction-based accounting approach. The measure calls for the producers and extractors of fossil fuels to pay for social costs associated with the income that they gain by selling the extracted fossil fuel. In essence, downstream emissions would be allocated according to the earlier steps in the value chain according to the value they add to the production. 

The third approach takes the form of a carbon-border adjustment mechanism, or CBAM for short. This system utilizes a carbon border tax to reverse carbon offshoring-inspired international relocation. Bohringer et. al. asserts that CB taxes could stem carbon leakages by 2 to 12%. California’s cap-and-trade system has been successful, between 2006-17, with California’s GHG (Greenhouse Gas) emissions plummeting by 13%. Cap and trade systems are carbon taxation structures, where the government sets a cap or a limit on the carbon that can be emitted by a certain industry and the firms could then trade emission allowances, which are limited in supply. However, the cap-and-trade system in its electrical sector, with a framework like a carbon border tax, has encountered several challenges that have eroded the efficiency of the carbon taxation structure. 

In another example, the European Union has also instituted the EU-ETS (Emission Trading Scheme) in the domestic carbon market. However, it has become ineffectual because it carried a very low carbon price that ultimately overallocated permits and thus, had limited impact on emissions. Thus, extending such a system to carbon imports would not have much impact either. But most importantly, the main challenge posed to the design of any carbon emission mitigation measure suffers from carbon pricing complexities due to a poor understanding of carbon intensities of differing forms of production. Lastly, the simultaneous existence of carbon policies of the importing and exporting countries further complicates the design of such a border adjustment mechanism. Furthermore, efforts by Brussels to implement CMAMs have been met with resistance as it stands in contravention of several pre-existing trade and climate agreements in place. CMAMs were a point of contention in the COP26 and threaten conflict in WTO. This is precisely because CBAMs violate the charter of WTO. Clauses like “most favored nation,” “national treatment,” etc. may be evoked by the nations who are discriminated against and thus stands to create policy gridlocks in the WTO. Thus, usage of this mechanism is likely to be deferred until countries address the inherent issues plaguing its design, implementation, and legality.

Conclusion

The grim reality of climate policy is that the asymmetry would continue to exist, rendering policies sub-global. Though differing mitigation targets are justified under the principle of common but differentiated responsibilities, a large variance in policy stipulations can cause carbon leakages. Arguably, the articles observed clear evidence of carbon leakages but the current policy sphere is yet to embrace methodologies that clarify and tackle leakages. Assuming the presence of asymmetries in policy among countries, policy failure is not an excuse for policy absence, and, instead, carbon pricing policy failure should be combated by initiating measures that bolster their efficiency. 

Every reader must have this tradeoff in mind: competitiveness vs climate policies. As Prof. Paul Krugman contends that ‘competitiveness’ is a “dangerous obsession” for macroeconomic policy;  it may be so for climate policy too, and the instance of the European Union’s ETS is a testimony to this. With everything said, the issue of CBAM remains contentious, with opinions that it might erode the competitiveness of developing and emerging economies. Despite complexities in their designs,  CBAMs might actually offer some solutions if a portion of revenues earned from CBAMs is directed to aiding manufacturing economies in attaining carbon neutrality. □