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The Dangers of a Carbon Trade War

Author: Michael A. Levi, David M. Rubenstein Senior Fellow for Energy and the Environment and Director of the Maurice R. Greenberg Center for Geoeconomic Studies
August 12, 2009
The Boston Globe


Climate policy and trade policy are on a collision course. Last week, 10 Democratic senators sent a letter to President Obama demanding that cap-and-trade legislation include tariffs against dirty imports. Precisely such tariffs, aimed at countries that are not doing enough to cut their greenhouse gas emissions, were part of the climate legislation recently passed in the House. Proponents argue that the tariffs are needed to prevent the loss of US jobs and the shift of emissions-generating activities to other countries. Free trade advocates are horrified at the prospect, which they worry could violate global trade rules and spark an economic war.

Both sides have a case. The tariffs are a good idea in principle. But they would probably be a nightmare in practice. Congress should look for other ways to accomplish its objectives.

The argument for carbon tariffs is simple. Cap-and-trade legislation will impose new costs on energy-intensive industries like steel, cement, and petrochemicals. Many of those industries are exposed to competition through international trade. If major rivals, such as China and India, do not impose similar new costs on their own companies, the playing field will tilt toward them. Not only will the United States lose manufacturing jobs, it will also fail to rein in emissions, as polluting activities move to places with even dirtier production processes.

A carbon tariff would help avoid this. Goods imported into the United States would see their prices rise by the same amount as their domestically manufactured counterparts. Regulatory foot-dragging by US competitors would thus fail to win their companies increased market share. And by penalizing a wider range of polluters - not just US companies but also those who export goods to the United States - the tariff would encourage more emissions-cutting. Indeed, despite attacks on carbon tariffs by many economists, textbook theory suggests that well-designed carbon tariffs would make climate policy more economically efficient, not less. Those same tariffs would probably comply with global trade rules too.

The problem is that real-world carbon tariffs would almost certainly be a bastardization of the ideal. Those twisted tariffs are far more likely to be economically damaging and to ignite the trade battles that critics fear.

It will be almost impossible to set carbon tariffs at the "right'' level. Suppose that the United States cuts its emissions by adopting an economy-wide cap-and-trade system that increases the costs of producing a ton of steel by $30. Imagine, though, that rather than imposing its own similar system, China requires that all new steel factories meet certain technological standards.

How will US regulators decide if those Chinese rules are commensurate with the US system - particularly if they have little ability to see inside the Chinese economy and know exactly how those rules are being implemented? What if the Chinese government provides tax breaks or cheap fuel to offset the cost of meeting the new technology standards - will the United States impose higher tariffs to compensate? And what will they do about complex products like iPods and bicycles whose manufacturing history is extremely difficult to determine?

In the face of such an opaque situation, US regulators will face heavy political pressure. There will be strong calls for them to simply slap the same penalties on imports as the cap-and-trade system does on domestically produced goods - regardless of whether those imports are already subject to emissions-cutting costs (other than from cap-and-trade) at home. Such tariffs would likely go far beyond leveling the playing field - they would protect US industries for protectionism's sake. That would violate global trade rules and could set off international battles that would damage the US economy along with global climate negotiations.

Instead of pursuing tariffs against foreign producers, the US government should focus on the industries that it already governs. It would be fairly simple to give particularly vulnerable US firms rebates that offset most of their cap-and-trade costs. Indeed the House legislation attempts to do just that. (It goes too far, though, "rebating'' so much money that it will ultimately provide illegal subsidies to many firms.) Such a scheme is far harder to abuse since the US government has detailed knowledge of its firms' compliance costs. That makes it the right way to go for the foreseeable future.

In the long term, though, big rebates will prove too costly. All major countries will eventually need to take similarly strong steps to control their emissions. (If they don't, climate policy will be a failure, even with carbon tariffs.) That would remove any need for rebates or tariffs. In the meantime, a carbon trade war with dubious benefits is the last thing we need.

Michael A. Levi is the David M. Rubenstein senior fellow for energy and the environment at the Council on Foreign Relations.

This article appears in full on CFR.org by permission of its original publisher. It was originally available here.

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