These ideas are developed in (Rozenberg et al., 2013b) using a two-sector growth model. They show that a transition toward a low-carbon economy can be triggered by either supporting green investments (e.g., through subsidized loans) to favor green sectors in the absence of a carbon tax, or by complementing a carbon tax with a subsidy to polluting capital to smooth the negative impact on the tax. Both these approaches are found sub-optimal when measured in terms of inter-temporal welfare. However, they result in a lower short-term loss of income and protect the owners of polluting capital and the workers that depend on them. As such, they may be easier to implement. Unsurprisingly, many countries follow this second-best approach to green policies, with subsidies and “feebates” (e.g. for hybrid or electric cars (Anderson et al., 2011)), feed-in tariffs (e.g. for solar and wind electricity), free allowance of carbon permits for energy-intensive sectors, and sectoral regulation (e.g., CAFE standards on cars in the US) creating an incentive for green investments without _directly_ penalizing polluting activities.<sup>11</sup>

# **Competitiveness considerations**

It is unrealistic to expect all countries to implement comparable environmental policies. Differences in income levels and socio-political context mean that some countries are moving first and will continue to do so. There is thus a risk of pollution leakage from countries with strict environmental regulations to laxer countries. Fears of deindustrialization and job losses have played a large role in national debates on carbon tax and cap-and-trade system. For instance the European cement industry financed a study that—perhaps unsurprisingly—found that 80% of the European cement market would be captured by importers if a 25 euros per ton of carbon price was introduced.

However, the potential for leakage should not be overestimated. Pollution abatement costs represent only a small fraction of production costs for most industries. According to (Copeland, 2012), “ _the evidence suggests that factors such as capital abundance, labor abundance, location, institutions, and agglomeration effects are more important than environmental policy in determining firm location choice and competitiveness_ .” (Branger and Quirion, 2013) provide a review of existing ex ante and ex post analyses of this problem. Ex ante modeling studies suggest that existing policies should generate a limited leakage at the macro-level, with significant sector-scale effects in heavy industries. In the analysis of 12 different models investigating a 20% emission abatement in all Annex I countries of the UNFCCC, for instance, leakage is estimated between 5 and 19% (with a mean at 12%), with loss of output by 0.5-5% in energy-intensive sectors (Böhringer et al., 2012). Moreover, most of the leakage in these models is not due to competitiveness effects, but to the green paradox (the fact that reduced current and expected demand in countries with climate policies leads to an increase in extraction and a reduction in oil price that increases demand in other countries).

Ex post studies fail to identify a significant impact of existing environmental policies, even in heavy industries (e.g., Sartor, 2013). (Demailly and Quirion, 2008) provide a detailed analysis of the European iron and steel industry, showing that the impact of the European Emission Trading Scheme on the competitiveness of the European industry remains limited, with an impact on marginal cost smaller than inter-annual exchange rates variations. Also, panel data from the UK production census suggest that the introduction of the Climate Change Levy (an energy tax) had a significant impact on energy intensity, but no detectable effects on economic performance or plant exit (Martin et al., 2009). The same conclusion is reached by (Anger and Oberndorfer, 2008) on German firms and the EU ETS system. These conclusions suggest that the impact of current environmental regulation on firm

> 11 Polluting capital is however indirectly penalized through the competition with green capital production.

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