Induced Innovation and Carbon Leakage

We explore the ability of unilateral climate policies to induce innovation and diffusion of technology and its impacts on carbon leakage. We consider both energy-saving and carbon-saving (end-of-pipe) technologies, such as carbon capture and storage. To do so, we combine a computable general equilibrium model of North-South trade with assumptions about R&D-based technological change to simulate counterfactual climate policies in the North. We model a carbon tax and a carbon tariff levied on imports from South to North. Both policies drive an increase in R&D in carbon-saving technologies which comes primarily at the expense of investment in other sectors. Carbon-saving technology allows the North to meet its carbon reduction target without abating as much fossil fuel use, leaving demand and international prices for fossil fuels closer to pre-policy levels. Reduced R&D in energy and energy-intensive sectors raises the cost of production in these sectors. Both effects mitigate carbon leakage in the South. Technology diffusion to the South has a modest effect on leakage under the carbon tax. It leads to somewhat larger reductions in leakage when the cap is paired with carbon tariffs, as the tariffs provide an incentive for the South to adopt carbon-saving technologies developed in the North.