11.7.2 Carbon leakage
Carbon leakage is defined as the increase in CO2 emissions outside the countries taking domestic mitigation action divided by the reduction in the emissions of these countries. It has been demonstrated that an increase in local fossil fuel prices resulting, for example, from mitigation policies may lead to the re-allocation of production to regions with less stringent mitigation rules (or with no rules at all), leading to higher emissions in those regions and therefore to carbon leakage. Furthermore, a decrease in global fossil fuel demand and resulting lower fossil fuel prices may lead to increased fossil fuel consumption in non-mitigating countries and therefore to carbon leakage as well. However, the investment climate in many developing countries may be such that they are not ready yet to take advantage of such leakage. Different emission constraints in different regions may also affect the technology choice and emission profiles in regions with fewer or no constraints because of the spillover of learning (this is discussed in Section 11.7.6).
Since the TAR, the literature has extended earlier-equilibrium analysis to include effects of trade liberalization and increasing returns in energy-intensive industries. A new empirical literature has also developed. The literature on carbon leakage since the TAR has introduced a new dimension to the analysis of the subject: the potential carbon leakage from projects intended for developing countries to help them reduce carbon emissions. One example is Gundimeda (2004) in the case of India (discussed in Section 11.7.3 below).