Which net zero?

Originally published in Economic Review magazine which provides articles to make recent academic research accessible for A-level students, apply economic theory to real-world situations and sharpen students’ skills.

Climate change doesn’t care about national borders. Carbon dioxide (CO2) and other greenhouse gases emitted in one part of the world can contribute to floods, forest fires and heatwaves in all other parts of the world.

Unfortunately, policymakers don’t have the same global toolkit. National governments, or international groups like the EU, are limited to implementing policies that affect their share of global emissions. But how should we think of what a country’s share is? And how can countries such as the UK best contribute to reducing emissions?

Get off my land – a territorial approach

There are different ways of thinking of a country’s emissions. Since the 1992 UN Framework Convention on Climate Change, the international standard has been a ‘territorial’ definition of emissions. For example, the UK government has committed itself to achieving net zero territorial emissions by 2050. This means that the government is targeting emissions released within the territory of the UK, from fossil-fuel burning power stations in North Yorkshire to gas cookers in homes in South London. 

In order to meet their net zero target, the government has to either stop all emissions within the UK, or offset them by planting trees or using new technology to suck greenhouse gases out of the atmosphere. This is what the ‘net’ in net zero refers to – emissions from some activities can be positive, as long as they are offset elsewhere. 

 At first glance, this seems like a sensible way to define the emissions that a country should target. If the greenhouse gas is emitted in a country, that country’s government is probably best placed to deal with it.

However, there are problems with this territorial approach. Taken literally, a territorial definition means that the UK government could achieve net zero by taking all of its polluting factories, power stations and so on, and moving them to France.

This isn’t just a hypothetical problem. The UK government has been focusing on territorial emissions and has had a lot of success in bringing them down. Between 1998 and 2019, the UK’s territorial emissions fell by 41%. However, over that same time period, emissions occurring overseas to produce what we then import didn’t fall at all. We may not be getting the whole picture by only looking at territorial emissions.

An alternative measure

A different way to measure a country’s emissions is based on the consumption (purchases) of people who live in a country, regardless of where the underlying products were made.

For example, if a polluting factory is only selling to people in the UK, then all of its emissions would be counted in the UK. This would be the case whether the factory was based in the UK, France or any other country. If this measure of emissions were targeted by policy, there would no longer be an incentive to shift dirtier factories to a different country.

However, if we only took a consumption-based approach and ignored the territorial emissions, we may see firms moving their polluting activity to the UK and then exporting it overseas, potentially to countries which wouldn’t tax them.

There is, of course, an ethical question here. Who, ultimately, should be responsible for emissions - the polluting factory that makes the product, or the customer who buys it? Coupled with the fact that it is often wealthier countries that consume the most, whereas more and more of the manufacturing is moving to poorer countries, this question has important ethical and political bite.

Beyond the ethical question, there is also an economic question – what would a policy that targeted consumption-based emissions look like? And, more generally, what can a single government do, given that they can only tax certain emissions but are affected by global emissions?

Who to tax?

If you take a standard economic textbook model, the solution to pollution is straightforward. There is an externality, a cost associated with the burning of fossil fuels that is not included in the price of the fuel. The standard way to deal with externalities is to put a tax on the good equal to the size of the externality – in this case, equal to the social cost of the greenhouse gases released. In principle this tax could be charged either when fossil fuels are taken out of the ground, when they are burned to make products, or when those products are ultimately sold. If this were done consistently in all countries, all producers and consumers would take the climate effects of the good into consideration when deciding how much to buy and sell. It wouldn’t matter whether we taxed what we bought or what we made, so long as we all agreed.

But in the real world, it does matter who and how you tax. Not least because governments aren’t all taxing emissions in consistent ways. A key concept here is mobility. If the UK taxes factories for the greenhouse gases they emit, the factories might move to a different country which wouldn’t tax them. This could completely undo any reduction in emissions that might have happened through bringing in the tax. In fact, it may even make the situation worse. The UK has a lot of regulations on factories and power plants, which often require the factory to be cleaner and more efficient when producing their product. If the factories move to a different country which doesn’t tax emissions, factories may not have as many regulations to follow. This could mean that they end up emitting more. This problem is known as ‘carbon leakage’.

This shows how some policies can be good for a territorial definition of emissions but be bad for a consumption-based definition. A policy targeting consumption-based emissions should tax the carbon content of all the goods people in the UK consume. This would not be a problem for goods produced in the UK - they are already the target of our territorial net zero - but it would mean we’d have to tax goods we import.

Why not tax the carbon in imports?

To reference the 2009 Meryl Streep rom com - it’s complicated. To properly tax consumption-based emissions, the government would need to know how much CO2 was released in the production of every single item we import. Consider just one good regularly imported – a smartphone. The government would need to know how much CO2 was released by the factory to assemble the phone. Then, it would need to know where all the parts came from, and how much CO2 was released from making the parts. Then, the government would need to know where all the raw materials, the metals, came from – how much from which mines, and how pollutant each of those mines is. Adding up all of these emissions, the government would then know how much CO2 was released in order to make that one smartphone. Following this global supply chain backwards is difficult enough for one good. The UK government would have to do this for all goods coming into the country to properly tax consumption-based emissions.

Taxing territorial emissions is much simpler. Most UK-based factories and power stations over a certain size are required to report their emissions. Taxing them is then just a question of making them pay the social cost of CO2 for each tonne of CO2 (or equivalent greenhouse gases) they emit. Of course, none of this is a walk in the park, but relative to following supply chains all around the world, taxing producers in the UK is more straightforward.

What is the UK government doing in practice to stop firms moving their pollution overseas?

Recently, the UK (following the EU) has announced a new policy that hopes to limit the number of factories moving out of the UK to avoid paying for their emissions. Known as a Carbon Border Adjustment Mechanism (CBAM), the idea is that firms producing in countries without a carbon tax (or an equivalent system) will have to pay a carbon tax on the products they sell in the UK. This removes the incentive for firms selling in the UK to move their polluting activity to a less regulated country as they will still have to pay a carbon tax, no matter where they put their factory. This is a step away from the territorial emissions model towards the consumption-based approach.

At the moment, the UK is still at a very early stage of introducing a CBAM. It looks like it will only apply to a small number of goods – certain industrial products like steel and cement – and a lot of important details are still yet to be decided. However, it could offer a blueprint for preventing firms relocating their dirty factories elsewhere, giving carbon taxes in deindustrialising countries real bite.

Conclusion

So, what have we learnt? There are different ways to measure emissions associated with a country. This brings up important ethical debates about which emissions a country should take responsibility for. A key challenge for policy is that governments don’t all coordinate to tackle emissions, leaving plenty of unintended consequences for policymakers to watch out for. So far, the UK government has mainly targeted territorial emissions, but there are growing concerns about this shifting emissions overseas. Switching to taxing what people buy, rather than what we make, has benefits but comes with a lot of practical difficulties. Despite these difficulties, the EU and the UK are both making steps towards this by introducing CBAMs.

Addressing a global problem with local tools is bound to be a challenge. Governments have a set of imperfect choices and not much time. But with new policy ideas and innovative economics, we can hope to make the choices a little bit less imperfect.