Monday, December 17, 2007

Carbon Caps, Competitiveness and the "leakage problem"

The post-Bali fall out continues. I have resisted posting endless commentary on what it all means but this New York Times piece by Judith Chevalier has some economic analysis that illustrates some of the difficulties ahead.

The key objection trotted out endlessly in the US is:

Critics also object that it would damage American competitiveness to commit to domestic reductions without parallel commitments from developing-country trade partners like China.

One way of thinking about this is to think of Bali as 180 countries all sitting in the audience waiting for a play to start on the Titanic (a tragedy of course). The US will not let the play start until they have been given the best seats in the house. However, China and India also want a good seat and don't see why they should give up their seats to the big bully US. The result - the titanic sinks killing all the delegates before the play even got started.

That make sense? ;-)

The actual idea outlined below would appear to have some merits. The problems are of course "enforcement", the inevitable increase in prices for consumers and producers - never politically popular and finally the possibility of this approach being used as a protectionist measure to "protect US jobs".


“The best policy — both in terms of the environment and in terms of economic theory — would be to have all countries take on binding emissions caps under an international agreement,”

I think we can all agree on that.

A Carbon Cap That Starts in Washington [NYT]

THE United Nations conference on climate change wrapped up in Bali, Indonesia, last week without a firm commitment from the United States or China to reduce emissions of carbon dioxide and other greenhouse gases. While a binding global agreement would be the best way to cut back on those emissions, a more limited but still useful approach is available, and it is wending its way through Congress.

In its current version, the Lieberman-Warner Climate Security Act, as the bill is known, would cap American carbon consumption through a tradeable permit plan. Even among those who support tradeable permits, there is considerable debate about what level of emissions reductions is realistic. Critics also object that it would damage American competitiveness to commit to domestic reductions without parallel commitments from developing-country trade partners like China.

But instead of using Chinese inaction as an excuse to avoid dealing with the problem, we should consider why emissions from China are soaring. There are numerous factors, all stemming from China’s rapid economic development. Yet one of the biggest is the enormous increase in China’s production of manufactured goods for export. Indeed, a study by the Tyndall Center for Climate Change Research in Britain estimated that in 2004, net exports accounted for 23 percent of Chinese greenhouse gas emissions.

We know where most of those Chinese exports are headed — to developed countries, like the United States, which accounts for about a quarter of them. A rough calculation suggests that almost 6 percent of Chinese carbon emissions are generated in the production of goods consumed here. That is the rough equivalent of the total emissions produced by Australia or France.

The Tyndall Center argues that carbon reduction policies should focus on carbon consumption, not emissions. That makes sense, especially in the absence of a binding global agreement.

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.

Of course, such a plan would have an immediate cost for Chinese producers and American consumers. Chinese production methods are now much more carbon-emission-intensive than American methods, so the plan would probably raise the average price of Chinese imports. The alternative, however, is to try to force the Chinese to adopt binding carbon caps similar to those considered in the United States. But that would also raise the Chinese imports’ price. Moreover, Chinese adoption of carbon caps would apply to the whole economy and would be much more costly for China; an American carbon consumption permit system would shield the Chinese domestic sector.

“The best policy — both in terms of the environment and in terms of economic theory — would be to have all countries take on binding emissions caps under an international agreement,” said Nathaniel Keohane, director of economic policy and analysis at Environmental Defense, a nonprofit advocacy group. “But we have to recognize that’s not going to happen overnight.” In the meantime, he said, the United States and other developed countries “need to take the lead.” He called carbon consumption caps “a good first step.”

“FROM an environmental point of view,” Mr. Keohane said, “it would ensure that the pollution we cut here at home doesn’t simply end up coming out of a smokestack somewhere else. It levels the playing field for American companies in the global economy. And it also helps us move toward a truly international system, by providing an incentive for developing countries to take on binding caps of their own.”

The carbon consumption provision will face scrutiny under current trade agreements, but there is sound logic for including it in any emissions legislation. Most important, it would eliminate an excuse for doing nothing.

Judith Chevalier is a professor of economics and finance at the Yale School of Management.


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