In this policy brief, we offer an introduction to the family of policy instruments known as “flexible performance standards.” We describe and examine the attributes of performance standards that elevate them to be chosen in many jurisdictions, often as a precursor to carbon pricing, and we explain why flexibility improves their cost effectiveness and the potential they may have as complementary policies to strengthen carbon pricing to drive innovation, with a specific focus on the industrial sector.

Introducing a price on greenhouse gas emissions would not only contribute to reducing the risk of dangerous anthropogenic climate change, but would also generate substantial public revenues. Some of these revenues could be used to cover investment needs for infrastructure providing access to water, sanitation, electricity, telecommunications, and transport.

Low-carbon electricity generation, i.e. renewable energy, nuclear power and carbon capture and storage, is more capital intensive than electricity generation through carbon emitting fossil fuel power stations. High capital costs, expressed as high weighted average cost of capital (WACC), thus tend to encourage the use of fossil fuels. To achieve the same degree of decarbonization, countries with high capital costs therefore need to impose a higher price on carbon emissions than countries with low capital costs.

Mexico recently declared ambitious goals in reducing domestic CO2 emissions and introduced a carbon tax in 2014. Although negative effects on household welfare and related poverty measures are widely discussed as possible consequences, empirical evidence is missing.