The Leakage effect explained

Conventional business leaders use The Leakage Effect Argument to shut down discussions about genuine sustainability transformations.

They say: "If we don't do it this way, someone else will, and they will do it worse"

But that's not true, and here's why.

First, what is The Leakage Effect?

Let's say, in a highly simplified example, that your company reduces its emissions by 100 kg CO2 in Denmark because of a new and higher CO2 tax, but your (evil) international competitor increases its emissions by 100 kg CO2 because of that. Winning some of your market share.

In that case, 100% of your reductions have "leaked," and ultimately, there is no reduction at all.

If your competitor had increased its emissions by 20 kg CO2 instead, then 20% would have leaked, and we would see a net reduction of 80%.

One concrete example of The Leakage Effect not being 100%

In Denmark, we have a cement producer, Aalborg Portland.

That company was one of the main reasons Denmark got a weaker CO2 tax compared to what experts recommended. Aalborg Portland itself got a big discount.

Why?

Because the company said: If we don't produce this type of cement this way, someone else will do it, and they will do it worse. And it worked despite being false.

That's the power of the leakage effect argument.

Here’s the true story:

(A) Aalborg Portland has higher emissions than other cement producers in Europe (see the literature list for more on this).

(B) The Economic Council of Denmark found the leakage effect in Denmark (across all sectors) to be only 21% with a high CO2 tax (1200 kr/ton of CO2)

(C) In other words, the best guess is that a high CO2 tax would deliver an absolute and global 79% reduction in emissions.

Here’s a screenshot from The Leakage Effect Report, showing that we are not making this stuff up. They did really find it to be 21 pct.

How to think about The Leakage Effect as a business leader

1. The leakage effect is most likely not 100% for your sector, or for your company specifically. There are more cases of this in the further readings. If you reduce your emissions, it will make a difference.
   
   
2. You can analyze the leakage effect based on sectors, countries, and legislation. It's complex, but not a black box. We dive more into what questions you should ask yourself in our course Post Growth Business 101, which we will launch for members tomorrow, and for everyone else on Thursday. Join the waiting list here.
   
   
3. You can consider imposing an internal CO2 tax to align your incentives with the climate crisis and help you make better decisions - especially if the leakage effect is low. You don't have to wait for legislation in that case.
   
   
4. The leakage effect is not static. What others do will influence it, but it also means that you can influence it.

Sources & Further Readings

Beck, U. R., et al.: Carbon leakage in a small economy: The importance of international climate policies

EU Carbon Leakage

Altinget (In Danish): Aalborg Portlands produktion er slet ikke så grøn, som de påstår
(Aalborg Portland’s production is not as green, as they claim).

Ugebrev (In Danish): Aalborg Portland bagefter peers i CO2-reduktioner

(Aalborg Portland behind peers in CO2-reductions)

The Expert Group For A Green Tax Reform: Grøn skattereform - endelig afrapportering
(The Green Tax Reform - The Final Report)

The Economic Council of Denmark: Diskussionsoplæg: Dansk klimapolitik frem mod 2030.

(Discussion Paper: Danish Climate Policy Towards 2030)

Think Tank Kraka: Landbrugets lækageffekt hænger kritisk af udlandets klimapolitik

(The leakage effect of agriculture is critically dependent on foreign climate policy)