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The upcoming Copenhagen confer-ence on climate change has led to calls forthe United States to adopt a climatechange abatement program in advance. Inan effort to minimize adverse effects oncertain domestic industries from higherenergy costs, however, proponents of acap-and-trade program for greenhouse gasemissions have loaded up their proposal with giveaways, loopholes, and barriers toimports from nations with less stringentemission caps. These trade measures arelikely to be ineffective at best and harmfulto U.S. interests at worst.First, the key targets of the proposedimport barriers, India and China, are rela-tively minor sources of imports of energy-intensive goods. Most carbon-intensiveimports to the United States come fromother developed countries that havestricter emissions controls than the UnitedStates and will therefore likely escapeimport penalties. Second, and more funda-mentally, the trade provisions may becounterproductive. Global trade rules allow import barriers to protect the environmentunder certain conditions, some of whichthe main climate change bill appears tocontradict. A trade dispute and possibleretaliation is not in anyone’s interest, espe-cially in a global downturn. Even if theUnited States was able to avoid formal dis-pute settlement proceedings, copycat regu-lations in other countries may be designedin a manner unfavorable to U.S. interests. To the extent that global warming is a realproblem warranting action, it needs to beaddressed globally rather than through uni-lateral efforts. Antagonizing trade partnersthrough probably illegal trade measures willundermine efforts to secure global coopera-tion on climate change. A freer, more pros-perous economy is a more auspicious path toensuring a more rapid spread of environmen-tal technology and the global consensusneeded to combat climate change.
A Harsh Climate for Trade
How Climate Change Proposals ThreatenGlobal Commerce
by Sallie James
Executive Summary
September 9, 2009No. 41
L I C Y A N A L Y S I S T R A D E P O L I C Y A N A L Y S I S T R A D E P O L I C Y A N A L Y S I S T R A D E P O
Daniel T.Griswold is associate director ofthe Cato Institute’s Center for Trade PolicyStudies.
Sallie James is a trade policy analyst at the Cato Institute’s Center for Trade Policy Studies.
Introduction
Advocates of aggressive measures to combatclimate change have settled on a cap-and-tradeapproach for controlling the greenhouse-gasemissions that are supposedly responsible forclimate change.
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Under a cap-and-trade pro-gram, firms would lower their greenhouse-gasemissions in response to a government-imposedcap on total national emissions. Those emittingless than their allotted cap would be able to selltheir excess emission allowances to firmsexceeding their emissions quotas. As the overallemissions cap is tightened over time, the price of emissions increases and incentives to cut emis-sions intensifies.Even assuming that aggressive actions toreduce greenhouse gas emissions are necessary,however, a national cap-and-trade program pre-sents a fundamental quandary: this national solu-tion is inadequate to address what is an essential-ly international problem. That is, U.S. emissionsamounted to about 20 percent of global emissionsin 2006, and are forecast to fall to about 10 per-cent by 2050, even without any active emissionspolicy.
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Clearly, U.S. actions alone will not be suf-ficient to combat global warming. This mismatch between the internationalscope of the problem and the proposed solutionpresents several difficulties. First, in terms of pol-icy effectiveness, the comprehensive climatechange bill recently passed by the House of Representatives (dubbed the Waxman-Markey bill, after its cosponsors) will have only negligibleeffects on global temperatures. Using a modeldeveloped by the National Center forAtmospheric Research, climate researcher ChipKnappenberger estimates that after the full emis-sions reductions envisioned by the Waxman-Markey bill take effect, global temperatures would fall by only nine hundredths of one degreeFahrenheit, compared to business-as-usual pro- jections for 2050.
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Second, cap-and-trade presents politicalobstacles: convincing energy-intensive industriesto take on extra costs in the name of reversing cli-mate change has proven to be controversial.Concerned that their efforts to reduce emissions will put them at a competitive disadvantage com-pared with firms located in jurisdictions withmore lenient emission policies, energy-intensiveindustries have called for government assistance. The prospect of inaction by others while theUnited States acts—and pays—to reduce emis-sions has produced misguided proposals as politi-cians attempt to assuage competitiveness con-cerns and exert leverage on the rest of the world.Proposals have included provisions that domesticaction on climate change be conditional uponsimilar regulations in competing countries; thatespecially energy-intensive and/or “trade-vulner-able” industries receive free emissions permits;and that policymakers introduce import barrierson imports from “uncapped” countries to offsetenergy-cost differences. The Waxman-Markey bill, for example, has incorporated some of theseproposals. It attempts to address competitivenessconcerns by giving up to 85 percent of emissionpermits away free to certain industries and by implementing border measures to restrict importsfrom jurisdictions with fewer restrictions ongreenhouse gas emissions.In so doing, however, the bill creates a host of other problems, notably by running afoul of globaltrade rules and exposing U.S. industry to retalia-tion and copycat regulations that would negative-ly affect U.S. exports. Furthermore, by irritatinglarge developing countries that are most crucial tosecuring an international agreement on climatechange, the bill may undermine the very purposefor which it was ostensibly designed. This paper will not attempt to outline thecase for or against actions to curb climatechange, or to debate the relative merits of differ-ent types of greenhouse-gas abatement policies.
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But the discussion that follows should make itclear that policymakers need to avoid regulationsand policies that unnecessarily damage the glob-al economy and trading system. Policies thatsupport a more open and prosperous globaleconomy will ultimately provide a cleaner pathto a healthier environment.
Unfounded Fears about “Competitiveness”
By increasing energy costs, proposals to
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Policymakers needto avoid regulationsand policies thatunnecessarily damage the global economy andtrading system.
reduce greenhouse gas emissions have drawncriticism that American firms will be at a com-petitive disadvantage compared to their“uncapped” counterparts (i.e., firms producingin countries that have not adopted equivalentemission-abatement strategies). These competi-tiveness concerns are based on the theory thatasymmetrical commitments on climate changeregulations will affect the relative competitive-ness of U.S. producers compared to others, par-ticularly developing country trade partners orcompetitors. As firms move to countries withlower emissions caps, total global emissionscould increase. Academic lawyers RobertHowse and Antonia Eliason summarize theposition as follows:If developed countries reduce theiremissions while developing countriesare exempted from making reductions,the cost disparity between goods pro-duced in developed and developingnations could increase further, givingdeveloping countries a competitiveedge and harming the balance of tradefor developed countries. Furthermore,companies in developed countries may choose to move production to coun-tries where reducing emissions is notmandatory, thus undermining thereductions achieved in the developedcountry.
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The (theoretical) tendency of firms to movetheir production facilities to less stringent juris-dictions, thus undermining economic growthand efforts to control greenhouse gas emis-sions, has been dubbed “leakage.”During testimony to the House Science and Technology Committee hearing in March,Energy Secretary Steven Chu invoked carbontariffs as a way to “level the playing field” if trade partners don’t impose greenhouse gasreduction measures. In response to a questionabout the consequences if China refuses tolimit emissions, Secretary Chu clarified that“We talked about, in terms of internationaltrade, of adjusting duties as a way. Becauseagain, we don’t want to disadvantage our indus-tries at home.”
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More recent statements fromPresident Obama suggest some welcomerethinking on the part of the administrationabout the harmful effects of carbon tariffs.Policymakers concerned about economicrecovery in the United States and abroad would do well to resist the siren song of pro-tectionism under any guise.Fears about loss of competitiveness are notlimited to the United States. Canada hasrecently delayed implementing greenhouse gasemissions caps until the U.S. regime is settled,citing concerns about industrial competitive-ness and Canadian reliance on the U.S. marketas a reason for the delay.
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Australia’s carbonemissions scheme, which includes a cap-and-trade system and giveaways to certain indus-tries, is currently held up in the AustralianSenate over competitiveness concerns.
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Potential adverse effects on domestic outputand employment in energy-intensive industries isonly one half of the “leakage” problem. As pro-duction moves from “capped” to “uncapped”countries to take advantage of cost differences,goes the argument, efforts to combat climatechange are undermined. Evidence suggests thatconcerns about carbon leakage are overblown.Brookings Institution policy scholar Jason Bordoff points out that most U.S. emissions of greenhousegases come from nontradeable sectors (e.g., trans-port and housing) that could not, by definition,move offshore in search of more lenient jurisdic-tions.
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Furthermore, despite the popularity of the“race to the bottom” theory of firm migration, theevidence does not support the notion that invest-ment flows to countries that impose relatively few environmental restrictions. On the contrary, asFigure 1 shows, there is in fact a weak
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rela-tionship between environmental standards andnet inflows of foreign direct investment. Firmsapparently place relatively little weight on environ-mental compliance costs when making theirinvestment decisions.Surveying the literature on carbon leakagespecifically, Bordoff suggests that only about 10 per-cent of reduced U.S. emissions would “leak” to othercountries. In other words, a 20 percent reduction inU.S. emissions would see only a 2 percent offsettingincrease in emissions abroad. Because energy costs
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Evidence suggeststhat concerns aboutcarbon leakage areoverblown.
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