International spillovers¹⁰ arise when mitigation in one country has an impact on sectors in other countries. The main factors are:

1. improvement in the performance or reduction in the cost of low-carbon technologies;
2. changes in the international prices, exports and outputs of fossil fuels, especially oil; and
3. relocation of energy-intensive industries.

Table 9.8 shows how different policies and measures may give rise to such spillovers. These effects may be included in the design and assessment of policies, particularly in the search for internationally equitable strategies. Chapter 8 considers the macro aspects of spillovers; this section considers the sectoral aspects.

In the sectoral perspective of this chapter, it appears that there are three routes by which technology policies in one country affect sectoral development in others. First, R&D may increase the knowledge base and this will benefit every country. Second, increased “market access” for low-CO₂ technologies, through niche-markets or preferential buyback rates in one country may induce a generic improvement in technology in others. Box 9.1 explains how this process can be modelled. Third, domestic regulations on performance and standards, whether imposed or voluntary can create a strong signal for foreign industrial competitors (Gruber et al., 1997). For example, the ratio of emission standards for carbon monoxide, hydrocarbons, and NO_x for automobiles in the EU relative to those in the US has been reduced from a factor of more than 3 in the seventies to a factor 1.5 to 2 in the nineties (Anderson, 1990; IFP, 1998).

Spillover effects from tax and subsidy policies for mitigation are less direct. The global economic impacts of the policies are examined, both in a theoretical and in a modelling perspective, in Chapter 8 (8.3.2.1 to 8.3.2.4). Their impacts on sectors are also analyzed in section 9.2 above. The sectoral effects of these policies can be summarized as follows.

1. They will reduce the demand for carbon-based fuels, and thus introduce a downward pressure on their prices e.g., in the world price of crude oil;
2. They may reduce the industrial competitiveness of sectors with higher costs in the mitigating country, raising competitiveness and hence market shares for sectors in other countries;
3. They may create an incentive to industrial relocation and thus give rise to “carbon leakages”;
4. However, they may also stimulate the development of alternative technological solutions.

The effects of carbon taxation on international competitiveness are reviewed by Ekins and Speck (1998) and Barker and Johnstone (1998). Clearly, a carbon tax will raise the cost of production of some sectors of the economy, causing some consumers to switch from their products to the products of the sectors in other countries, changing international trade. National losses (and/or gains) for price competitiveness will be the net sum of the sectors’ losses (and/or gains) for price competitiveness. The outcome for a particular sector will depend on the policy instruments used, how any tax revenue has been recycled, and whether the exchange rate has adjusted to compensate at the national level. The conclusions from these surveys are that the reported effects on international competitiveness are very small, and that at the firm and sector level, given well-designed policies, there will not be significant loss of competitiveness from tax-based policies to achieve targets similar to those of the Kyoto Protocol.

These conclusions are confirmed by later studies, although in general the effects of environmental taxation in one country on sectors in other countries are not well covered by the literature. Using an econometric model (E3ME), Barker (1998a) assesses policies reducing CO₂ emissions in 11 EU member states at the level of 30 industries and 17 fuel users, comparing unilateral with co-ordinated policies. The carbon tax reduces imports of oil and increases imports of carbon-intensive products. However, the results for trade are negligible.

Ban (1998) assesses the effects of an ad-valorem tax on coal (20%), oil (10%), and gas (10%) using an applied general equilibrium model (GTAP) with 12 world regions and 14 industry sectors. He has three taxation cases, (a) Japan only, (b) OECD only, and (c) the world, with revenues used to increase government expenditure. The results are all shown against a reference case for 1992. Table 9.9 shows the effects on the industrial output in Japan: the effects are very small when the tax is for Japan only, but they are even smaller when the taxation is at the OECD or world level, illustrating the size of the competitiveness effects. These results depend critically on the assumptions adopted as Ban points out.

Table 9.9: Effects on sectoral output of Japan (in per cent) of an ad-valorem fuel tax
	Change of output (%)
Sector	Japan only	OECD	World
Agriculture Forestry Mining Oil and coal Chemistry Metal Other manufacture Elec. water, gas Transportation other services Capital goods	0.0998 0.1744 0.0488 -0.3983 -0.5143 -0.1619 -0.0604 -0.3081 0.0548 0.0349 0.0007	0.0646 0.2044 0.1311 -0.1212 -0.3929 -0.1032 -0.0065 -0.3145 0.0480 0.0376 0.0797	-0.0295 0.0687 0.1415 0.6689 -0.3884 0.0126 -0.0500 -0.3080 0.0364 0.0364 0.1078
Source: Ban (1998).

There are other aspects to spillovers not well captured in existing models. As energy efficiency is generally higher in Annex B countries than in the rest of the world, some studies suggest that relocation of industry to developing regions would increase global CO₂ emissions (e.g., Shinozaki et al., 1998). However, this conclusion would be altered if the relocated industry used up-to-date technologies rather than the average technology in developing countries. The international diffusion of improved technologies in response to CO₂ constraints is not captured in existing models and would tend to counteract the negative environmental aspects of spillovers.

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