The regional economic effects of a reduction in carbon emissions

Concern about climate change has led to policy to reduce CO2 emissions although it is likely that policy will have differential regional impacts. While regional impacts will be politically important, very little analysis of them has been carried out. This paper contributes to the analysis of this issue by building a small model involving two regions, incorporating the right to emit CO2 as a factor of production with the level of permitted emissions set by the national government. We argue that there is likely to be pressure on governments to use other policies to offset the possible adverse regional economic consequences of the pollution-reduction policy; we also consider a range of such policies. Using numerical simulation, we find that a 10 per cent reduction has relatively small but regionally differentiated economic effects. Standard fiscal policies are generally ineffective or counterproductive while labour market policies are more useful in offsetting the adverse effects.