Case study

Do higher energy prices affect international trade?

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Author: Misato Sato and Antoine Dechezleprêtre, London School of Economics and Political Science and ESRC Centre for Climate Change Economics and Policy

Date: 18 July 2016

Type of case study: Research

About the research

Dr Misato Sato and Dr Antoine Dechezleprêtre at the Grantham Research Institute on Climate Change and the Environment at the London School of Economics and Political Science have been studying climate change policy and its effects on trade in a research project funded by the European Union Seventh Framework Programme under grant number no. 308481 (ENTRACTE Research Project), the Global Green Growth Institute, the Grantham Foundation and the Economic and Social Research Council (ESRC) through the Centre for Climate Change Economics and Policy.

Emissions trading policies, such as the EU emissions trading system (EU ETS), are regulations implemented by many countries and cities to reduce industrial greenhouse gas emissions cost-effectively. These regulations are a key tool for achieving emissions reduction targets. However, according to the European Commission on Climate Action they can result in carbon leakage and may affect the competitiveness of businesses. In fact, standard trade models suggest that policies that increase energy price put domestic firms at a disadvantage relative to foreign rivals facing lower energy prices. Producers of energy intensive products respond to higher energy prices by producing fewer energy-intensive goods which may lead to a decline in net exports and the partial relocation of production to a region with low energy prices.

In this study Dr Misato Sato and Dr Antoine Dechezleprêtre explored whether and to what degree changes in relative energy prices might influence trade and competitiveness. This is the first study to analyse the effect that energy costs have on global trade using historical data on trade and energy prices. It analysed 62 business and industry sectors in 42 countries over a 15-year period, from 1996 to 2011, using data that covers 60% of global merchandise trade.

Findings showed that changes in relative energy prices have a statistically significant but very small impact on imports. On average, a 10% increase in the energy price difference between two country-sectors increases imports by 0.2%. The impact is larger for energy-intensive sectors but even within these the effect is minor - changes in energy price differences across time explain less than 0.01% of the variation in trade flows. The authors calculated that a 30% increase in energy prices across Europe would cause exports to fall by only 0.5% and would increase imports by 0.07%. They concluded that “contrary to some claims, rises in energy prices do not have much effect on the global competitiveness of businesses. Even a sizeable difference in the price of energy relative to the rest of the world has only a very small impact on a country’s imports and exports.

Methodology

The researchers estimated the short-term effects of energy price differences on bilateral trade at the sector level using a gravity model.

Trade between countries is not only influenced by energy costs but many other factors such as transport costs, labour cost, exchange rates, tariffs, trade agreements, common language and common currencies. The study therefore brings together a variety of datasets to analyse the impact of relative energy prices on trade. The coverage and detailed disaggregation of the data used goes well beyond previous work, allowing the first global ex-post analysis of the relationship between trade and energy prices.

Bilateral trade data were taken from the CEPII's BACI database which contains detailed bilateral import and export statistics from the UN Commodity Trade database.

The researchers also used a unique and comprehensive dataset of industrial energy price indices at the country and sector levels covering 48 countries and 12 industry sectors for the period 1996 to 2011. The dataset was constructed in Sato et al., 2015 and uses data from the International Energy Agency World Energy Balances, the International Energy Agency Energy Prices and Taxes and the World Bank, as well as other sources. The procedures used to construct the dataset including the methodology developed to reduce missing data-points, are documented in the working paper, as are the full set of original data sources. This dataset is made publicly available for download here.

Additionally, the researchers used data on GDP and population obtained from the International Monetary Fund's World Economic Outlook (2012) and data on wages obtained from the United Nations Industrial Development Organization (2011).

Findings for policy

Carbon pricing policies are intended to induce energy intensive industry to reduce carbon emissions by making it more expensive to pollute. However, if the carbon price is set too high, there is a risk that companies will respond by relocating production to regions with lax policies, rather than clean up their production. Whether this 'carbon leakage' occurs is an important issue in the debates around how to design emissions trading schemes, and whether or not leakage occurs is a question in much need of robust empirical evidence.

This study finds unique evidence suggesting that concerns about the risks of carbon leakage may have been overplayed. Dr Dechezleprêtre says: “Concerns about carbon leakage and the competitiveness of European industry are not entirely unfounded, but they have been overstated. Even heavy, energy-intensive industries are more resilient to high energy prices than has been suggested by some companies and politicians. Policy-makers should not allow the prospect of an increase in energy and carbon prices to dictate efforts designed to cut emissions and tackle climate change” (Centre for Climate Change Economics and Policy, 2015).

Impact of the research

The study's findings about the risks of carbon leakage have been included as research evidence in the 'Evaluation of the EU ETS Directive' report carried out by the European Commission in November 2015. The evaluation subsequently informed policy measures implemented by the Commission regarding the revision of the EU ETS Directive, as set out in the framework of measures of the conclusions of the European council in October 2014.

The study has also informed the following reports:

To read the report in full:

Sato, M. and Dechezleprêtre, A. (2015) 'Asymmetric industrial energy prices and international trade', Energy Economics, 52(1), pp. 130-141. DOI: 10.1016/j.eneco.2015.08.020

The research has also been published as a working paper:
Sato, M., Dechezleprêtre, A. (2015) 'Asymmetric industrial energy prices and international trade', Centre for Climate Change Economics and Policy Working Paper No. 202 Grantham Research Institute on Climate Change and the Environment Working Paper No. 178. Available online fromhttp://www.lse.ac.uk/GranthamInstitute/publication/asymmetric-industrial-energy-prices-and-international-trade/

The authors have produced a number of research papers about the climate change policy, trade and carbon leakage, and has been engaging with policy-makers, businesses and other researchers to explore how best to reform it. See a list of their publications: Dr Misato Sato and Dr Antoine Dechezleprêtre.

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