Climate Change: Calling time on "leakage"

When New Zealand was trying to implement carbon pricing back in the early 2000s, polluters whined about "leakage", either threatening to take their production overseas so they could continue to pollute for free, or complaining that paying the full cost of their pollution would mean they would be out-competed by those who did not. As a result, the ETS we eventually got had hefty free allocations for "trade-exposed" industries, meaning much weaker incentives for them to cut pollution. But there's another way to deal with leakage: remove the advantage of foreign pollution subsidies at the border, by making high-carbon imports pay for their embodied pollution. And this week, two of the world's biggest economies have taken steps to introduce such border adjustment mechanisms:

Milk, meat and metal exports could one day be stung with border tariffs, if the country falls behind international efforts to cut carbon.

Last week, lawmakers in the European Union and the US announced proposals to put levies on foreign goods that aren’t subject to carbon pricing in their home countries.

The EU tariffs will begin with industrial products, such as aluminium. Experts are divided on whether tariffs could one day extend to our biggest exports, dairy and meat. The goal is to level the playing field, so EU and US-based businesses don’t lose out to countries with softer emissions rules.

New Zealand exports might escape levies if they are covered by the Emissions Trading Scheme, or a proposed scheme to price farming’s greenhouse gases that could kick in from 2025 – if those schemes are deemed tough enough by overseas lawmakers.

[Emphasis added]

As I've said before, this is something New Zealand should welcome, as it punishes climate cheats. But the key is in the last bit. Would an ETS which includes enormous pollution subsidies be regarded as equivalent? Alternatively, the EU's detailed proposal [PDF] allows importers to deduct any carbon price already paid in the country of origin, but the methodology for this is a matter for future regulation, and there's a big question of how it would interact with free allocations. In particular, for aluminium - the NZ industry actually affected by the EU rule - its unclear what deduction they can make, given that their free allocation (1,697,437 tons in 2019) was more than twice their actual emissions (663,620 tons in 2019 according to Emissions Tracker). Will they have to pay more, to compensate for the excessive subsidy?

Of course, that problem simply goes away if we remove subsidies. And major global economies taking this step significantly reduces the case for their continued existence. After all, if New Zealand polluters' competitors can no longer gain a competitive advantage by carbon cheating, why do we need to "compensate" for it? If carbon prices on exports are simply deductible at the EU or US border, why do we need to weaken the pollution-reduction incentive by keeping them artificially low for favoured industries? Instead, we could get rid of them, and make polluters face proper incentives to reduce their pollution. So the quicker the EU and US phase this in, and the broader it is, the better.