Problematic new study overestimates effects of carbon pricing in Canada
Yesterday, the Conference Board of Canada released an analysis of the impacts of carbon pricing on Canadian industry called Tipping the Scales: Assessing carbon competitiveness and leakage potential for Canada’s EITEIs. The report explains and unpacks some key nuances around competitiveness and leakage. But shortcomings in its framing and methodology ultimately detract from its accuracy and usefulness.
Some quick background
Federal carbon pricing came into effect earlier this year. The federal system includes an “output-based pricing system” (OBPS) for large facilities that produce a lot of GHG emissions. An OBPS is a way to reduce greenhouse gas emissions by improving emissions intensity rather than by driving GHG leakage (i.e., where production and emissions simply shift to other jurisdictions). Put simply, it helps businesses get cleaner instead of smaller.
So how does the Conference Board report assess leakage risk? Let’s consider some of the methodological choices the authors make.
First, they cast a broad net on the sectors they consider to be emissions-intensive and trade-exposed (EITE). For example, their methodology ends up including electrical utilities even though they aren’t really EITE (as we detail here). This broad filter picks up sectors that don’t get the OBPS treatment in the federal system, and has the effect of pulling down the average support for EITE sectors estimated in the study. As a result, it overemphasizes the competitiveness risks that Canadian industry as a whole is likely to face.
Second, the authors assume that no costs are passed through to consumers. For highly trade-exposed sectors, this can be a valid assumption. Sectors like cement, for example, trade a mostly generic product in a fiercely competitive global market — they have limited scope to pass carbon costs on to consumers. But sectors such as wood products manufacturing have a much lower trade exposure. Assuming that they can pass on none of their costs significantly over-estimates the compliance burden they will face. And it causes the policy’s total effects on leakage, employment and the broader economy to get over-estimated too.
The authors also take a totally static view of the Canadian economy. In their analysis, firms do not respond to the policy by finding ways to reduce their emissions (and thereby improve their competitiveness). And they estimate economic costs on the assumption that compliance costs result in an equivalent loss of value added — with these costs then multiplied to estimate a total cost to the economy. By failing to account for the dynamism of firms’ and the broader economy’s response to policy, the study significantly overestimates costs to both EITE sectors and the economy as a whole (it leads to the problem described here, but in reverse). It also exaggerates the risk of GHG leakage in Canadian industry.
Potential vs. actual
On top of these methodological problems, the report also frames its findings and overall narrative in ways that can be misleading. For example, it shows results for a “policy relief” scenario (i.e., output-based pricing) as well as a “full costs” scenario — even though no jurisdiction in Canada prices carbon in EITE sectors on a full cost basis. Similarly, the study questions the applicability of empirical evidence from the European Union’s carbon pricing system to the Canadian context in part on the basis that the system was designed to minimize leakage — even though the Canadian system was also designed to do exactly this.
Perhaps most importantly, the study frames leakage itself in a highly problematic way by implicitly suggesting that potential leakage corresponds to a material risk of leakage. In short, the study effectively states: ‘If we assume that leakage is a big problem, then leakage is a big problem.’
GHG leakage and output-based pricing are complex topics. While the Conference Board’s study is not without merit, its methodology and framing ultimately do a disservice to these important topics. The study consistently emphasizes worst-case, non-credible outcomes for costs, employment and GHG emissions. In this way, Tipping the Scales appears to have put its thumb on the scale.