Thursday, December 2, 2021

Luc Laeven, Alexander Popov

CEPR Discussion Paper No. 16745 | November 2021

Not a single country in the world taxes carbon-intensive activities at the levels recommended by economists. This hesitancy is partially driven by free-riding: national authorities are afraid that imposing carbon taxes unilaterally would hurt their economies as carbon-intensive activities migrate to different jurisdictions. 

In a new CEPR paper, Luc Laeven and Alexander Popov show that such carbon tax arbitraging can indeed happen because of adjustments in multinational banks’ lending portfolios. Using data on syndicated loans, the research shows that: 

  • The introduction of a domestic carbon tax is associated with an increase in domestic banks' lending to coal, oil, and gas companies in foreign countries. 
  • The reallocation of fossil lending across national borders is immediate, economically meaningful, and statistically significant.
  • After a carbon tax is introduced in a country, foreign lending to fossil companies increases by at least 4.3%. At the same time, because domestic fossil lending declines, overall fossil lending goes down by about 0.6%.
  • The same effect holds for the introduction of Emissions Trading Schemes.
  • The reallocation of lending in response to carbon taxes is not confined to coal, oil, or gas companies, but it is observed for other carbon-intensive sectors, such as metallurgy and cement production.
  • There are significant differences within the group of banks, firms, and countries affected by the carbon tax. Banks are much more willing to continue lending to fossil firms by reallocating lending across national borders if they already have relatively large fossil exposures. 
  • They are also more likely to increase the amount of fossil lending to countries which do not have a carbon tax themselves. Finally, they are more risky to increase fossil lending to relatively riskier firms.

The research demonstrates how domestic carbon taxes led banks to reduce lending to coal, oil and gas companies domestically, but also had the perverse consequence of causing them to increase such lending abroad. The findings highlight the importance of a global carbon tax to prevent the reallocation of carbon emissions across national borders via financial markets.

Figure:  Countries with a carbon tax, an ETS, or both: 1988–2020

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