Trade and climate

An article by Yale's Judith Chevalier in last Sunday's New York Times slipped by me, until Greg Mankiw's blog redirected me to it. The piece discusses an issue that has so far received little attention, but which is likely to loom much larger before long: the trade-policy implications of unilateral (or at any rate, imperfectly co-ordinated) US action on climate change. Suppose the US adopts a cap-and-trade regime for carbon, as promised by Hillary Clinton, or as envisaged by the Lieberman-Warner Climate Security Act (yes, make this a security issue, why not) currently before Congress. Also suppose that China does nothing to curb its carbon emissions. Then Chinese imports, it will be argued, will have an unfair cost advantage in US markets.

One goal of a tradeable permit system is to force consumer prices for goods to reflect the harm that the production of those goods causes the planet. For example, if a television were made using a high-emission process, the factory would have to buy many carbon permits, driving up the TV’s price. A television made in a low-emission factory would require fewer permits, lowering its relative price. Consumers, of course, would have an incentive to choose the TV from the low-emission factory, and all factories would have an incentive to lower emissions.

A problem would arise, however, if a producer needed to buy permits to make televisions in a country with a carbon cap, while no permits were required in a country without a cap. The television from the country without the cap would be cheaper, consumers would prefer it, and there would be no economic incentive to cut emissions. Environmentalists call this the “leakage problem”: just as a balloon squeezed at one end will bulge at the other, emissions caps applied in only some economies will lead to emissions surges in others.

A provision in the current version of the Climate Security Act links responsibility to carbon consumption, not production. This idea derives from a joint proposal by the American Electric Power Company and the International Brotherhood of Electrical Workers. The provision requires that importers of goods from countries without carbon caps obtain permits for the emissions resulting from the goods’ production. While this requirement could be used to protect American jobs from foreign competition, if handled equitably, it could provide an elegant solution to the leakage problem.

If the United States adopted a tradable permit system that treated emissions from domestic producers identically to emissions associated with imported goods, then products that are more emissions-intensive, whether domestic or imported, would require more permits and thus be more expensive. Producers in the United States and abroad would have an incentive to reduce greenhouse gases to make their goods more competitive.

Greg points out that the carbon-tax equivalent of this proposal would be border adjustment of tax rates--that is, carbon-based import tariffs and export subsidies. Either approach, as Ms Chevalier puts it, "would face scrutiny under current trade agreements". Given prevailing anti-trade sentiment (no disrespect to  the International Brotherhood of Electrical Workers), the risk that this idea might be co-opted as part of a wider retreat from liberal trade is plain. But if the US is going to get serious about carbon abatement, as seems likely if not next year then in 2009, the issue will have to  be confronted.

A supplementary reading on the scale of the challenge. Daniel Gros points out on Vox that the price of coal has fallen sharply relative to the price of oil, which presages (other things equal) a huge expansion in global coal-fired electricity generation--the most carbon-intensive kind.

It is often thought that high oil prices could contribute to lowering CO2 emissions because they make energy more expensive, thus encouraging lower energy consumption. But this view overlooks that a high price of oil relative to coal encourages the substitution of a hydrocarbon with pure carbon, thus increasing the carbon intensity of energy use. The supply of coal is abundant, especially in the new emerging energy giants China and India, and relatively elastic. This implies that the price of coal is likely to stay low, thus encouraging an increase in the carbon intensity of energy use everywhere. Reaching the goal of reducing CO2 emissions will thus be even more difficult than generally assumed if oil (and thus also gas) prices remain at present levels.

The latest World Energy Outlook from the International Energy Agency already forecasts on a business-as-usual scenario an increase in the share of coal in global energy use. But over the last five years business has not been as usual as one half of the increase in global energy consumption has come from coal, prompting acceleration of global CO2 emissions. Sustained high hydrocarbon prices will intensify this trend, making it highly unlikely that the goal to reduce CO2 emissions can be reached.