Daiquiri

The tension between free trade and capping emissions

Nov 19th 2009

STATEMENTS by Barack Obama on his travels through Asia have lowered expectations that December’s global summit on climate change in Copenhagen will lead to binding cuts in carbon emissions. The urgency of dealing with climate change means that many countries are drawing up national policies to limit emissions. Yet in a globalised world, where production is increasingly mobile across national borders, some worry that there is a fundamental tension between the effectiveness of such policies and a commitment to open trade.

These carbon-reduction policies, such as America’s proposed cap-and-trade scheme, typically put a price on carbon in the hope that this will force producers to bear the costs that their activities impose on the climate. But if different countries cut emissions by different amounts, as is likely, then the price of carbon will vary across nations. If so, manufacturers in countries with tighter environmental rules will face added costs which foreign competitors do not. This could in turn prompt them to relocate some of their production to “carbon havens”, where the cost of polluting is lower. If enough production emigrates, global emissions might even increase.

The likely scale of relocations may be overstated. A new study* by economists at the World Bank and the Peterson Institute for International Economics, a think-tank in Washington, DC, finds that some production would migrate, but that the net increase in emissions in poor countries would be small.

Just as bananas are best grown in warmer places, imposing a higher carbon price does not compel German manufacturers of capital goods to decamp to China. Also, the increased output of some energy-intensive goods in poorer countries draws some productive resources away from other industries there. Overall, the authors find that if Europe and America were to reduce emissions by 17% from their 2005 levels by 2020, the additional increase in developing-country emissions would be only 1%. Global emissions would still be almost 10% lower than if nothing had been done. So rising global emissions due to carbon leakage are hardly as big a worry as some make them out to be.

That has not stopped many from proposing taxes that would penalise exports from countries that benefit from low carbon prices. From the point of view of countries with stricter environmental rules, it is easy to see why. According to the study, to reduce its emissions by 17% America would have to cut its exports of energy-intensive goods, such as steel, by 12% and its production of such goods by 4%. Domestic producers of energy-intensive goods, on whom much of the burden of adjustment will fall, will demand some form of compensation or protection. No wonder the climate bill passed by the House of Representatives in America has a provision for taxing imports from countries that have laxer rules on emissions. Nicolas Sarkozy, France’s president, has proposed that Europe adopt a similar strategy, arguing that not to do so would amount to “massive aid to relocations”.

It would be best for trade (and only marginally costly for the environment) if there were no carbon-based tax adjustments. But assuming they were put in place, what might be their effect? That in turn depends on the nitty-gritty: would they be based on the amount of carbon dioxide emitted when making an equivalent good at home, or on the amount actually emitted to make the imported good? The latter would penalise developing countries, because they tend to use much more carbon-intensive technologies. So, if making an American car produced ten tonnes of carbon dioxide, taxed at $60 per tonne, then the tax on a foreign-made car arriving in America would only be $600. But if the tariff were based on the carbon dioxide emitted in the process of making a car in China, it could be double that.

Assuming the economists are ignored…

A tax based on the carbon footprint of imports, the authors reckon, would certainly benefit America’s energy-intensive industries, which otherwise bear the full cost of plans to reduce emissions. Their output would fall by only 2.5%, instead of 4%. The trouble is, developing countries would be whacked, since their exports would become markedly less competitive. China’s manufacturing exports would decline by a staggering 21% and India’s by 16%. The border tax adjustment would amount to a prohibitive tariff of 26% on China’s exports and 20% on India’s. No wonder that Chinese officials warned angrily of trade wars if border taxes were imposed. A tax based on the carbon footprint of domestic production would be much more benign in its trade effects, reducing China’s and India’s exports by around 3%.

From a global perspective, the case for a trade tax to reduce emissions is weak. But the politics of shrinking dirty industries in rich countries could well mean that such taxes will be imposed anyway. In the long run this climate protectionism could hurt not only trade but also the environment. Trade promotes the adoption of newer, cleaner technology from rich countries by developing ones, improving the techniques of production in poorer countries gradually over time.

And all countries may find that the inevitable changes in weather patterns due to human activity will mean that meeting varied food needs domestically will become even more difficult. Open markets in agriculture, in particular, will be even more crucial in a world plagued by a changing (and more uncertain) climate than they are now. Keeping trade going will therefore help countries adapt to climate change. The risk is that border taxes are erected to protect energy-intensive industries in the rich world, badly hurting trade—and doing little to help the environment.

http://www.economist.com/node/14926073