Cheating Carbon Pricing

Carbon pricing is an efficient mechanism for reducing carbon emissions. Carbon taxes can be a way to force polluters to pay for harming the environment by burning fossil fuel. The World Bank has estimated that 45 countries and 34 subnational jurisdictions have adopted some form of carbon pricing – carbon taxes or emissions trading systems. While these schemes have helped reduce emissions in these countries, they’ve had unintended consequences.

A recent study by Luc Laeven and Alexander Popov of the Centre for Economic Policy Research (CEPR) examined more than 2m loan tranches involving banks doing cross-border lending between 1988 and 2021. This was the period during which time many countries imposed carbon pricing. The study finds that the imposition of carbon taxes at home led banks to reduce lending to coal, oil and gas companies. At the same time, it had a perverse effect of banks increasing lending abroad. The shift was most pronounced for banks with big fossil-fuel-lending portfolios. Thus, the lending simply shifted from countries with carbon taxes to countries with no carbon taxes. Another paper suggests that banks increase cross-border lending in response to stricter climate policies at home. This is a regulatory arbitrage tool to shift dirty loans to countries with relatively lax climate policies. This is akin to companies moving their production facilities to countries with lower compliance requirements, climate or otherwise.

EU’s proposed carbon border adjustment mechanism attempts to level the playing field. However, more countries and blocs need to adopt methods to thwart such actions. The shift to net zero may be in peril without such measures.

Published by Utkarsh Majmudar

Utkarsh Majmudar is a Fellow, IIM Ahmedabad and a professional with experience encompassing academics and administration at top business schools in India (IIM Lucknow, IIM Udaipur, and IIM Bangalore) and working with large corporations. His interest areas include corporate finance and CSR.

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