Global climate policy with differentiated carbon price floors

ABSTRACT

We use a state-of-the-art global general equilibrium model to quantify the effects of an International Carbon Price Floor (ICPF) proposal for the coordination of global climate policy. With the ICPF proposal, countries would implement a carbon price floor that is differentiated according to their level of development. The price floor could be implemented by an actual carbon price or other policies with equivalent stringency. Implementing such a joint effort would be a big step towards aligning global emissions with the Paris Agreement. The study highlights three main findings. First, the ICPF is progressive in terms of emission reductions and demands considerably more effort from high-income countries (HICs). Unlike proposals based on equity principles, however, it requires neither extremely high emission reductions from HICs nor massive financial transfers. Second, the differentiated carbon prices cost only an additional 0.3 percent of global GDP compared to a global uniform carbon price. Third, the ICPF can be as effective as border carbon adjustment (BCA) mechanisms at preserving competitiveness of HICs despite the differentiation in carbon price floors. This means, there would be no need for BCA with an ICPF. Compared to a BCA, HICs can avoid the administrative burden and low-income countries (LICs) will not face the cost of BCA. As a first step to global climate policy, a sectoral ICPF for the EITE sector could be introduced. It would address competitiveness concerns almost as well as the full ICPF.

Key policy highlights

• An International Carbon Price Floor (ICPF), with carbon price floors differentiated by development level, would incur only small economic costs compared to baseline economic growth.

• The ICPF would allow for international burden sharing, with HICs incurring higher cost than middle – and low-income countries.

• The ICPF reduces distortions to competitiveness as much as BCA, so that no BCA would be necessary.

• A ‘sectoral ICPF’ in energy-intensive and trade-exposed sectors would be effective against leakage and loss in competitiveness and would thus be an attractive alternative to border carbon adjustment.

KEYWORDS:

• Climate policy
• border carbon adjustment
• international coordination
• Computable General Equilibrium model

Disclosure statement

No potential conflict of interest was reported by the author(s).

Data availability statement

IMF-ENV uses various data sources to calibrate both model equations and model projections.

The main source to calibrate the model is the GTAP-POWER database V10, including satellite accounts for CO2 emissions, non-CO2 emissions, air pollutants and energy. All this data is available at the GTAP center at https://www.gtap.agecon.purdue.edu/databases/v10/index.aspx.

The baseline calibration of the model makes use of macroeconomic projections built upon the IMF World Economic Outlook Database (October 2021) available at https://www.imf.org/en/Publications/WEO/weo-database/2021/October up to 2026. After this year macro data is extrapolated using (Dellink et al., 2017). These GDP, employment and current account projections are available upon request.

Population projections are from United Nation https://population.un.org/wpp/, using the 2019 Revision.

Energy projection used for calibrating long run energy system is a mix of the IEA World Energy Outlook projection for 2018 with some revisions from the 2020 projections, see https://www.iea.org/reports/world-energy-outlook-2020 and https://www.iea.org/reports/world-energy-outlook-2018.

Notes

1 The high prices are also a reflection of using carbon pricing as the only policy instrument in this analysis. Other policy instruments, such as regulations or targeted research and development to develop low-carbon technologies for hard-to-abate sectors could strongly reduce the need for high carbon prices. The international carbon price floor proposal allows for the use of alternative policies to carbon pricing and mixed approaches. Finally, anticipation effects – in which forward-looking agents front-load their adjustment to expected future carbon price increases – can also reduce the need for high up-front carbon prices (IMF, 2020).