Can trade policy and climate policy work hand-in-hand? 4

This past weekend, while traveling in India, Secretary of State Hillary Clinton received the message, courteous but firm, that India has no intention of capping carbon.  The rationale provided is that India has low per capita emissions.  This is, to be sure, India’s best argument.  Her overall emissions are soaring as her population spirals upward—India, only two thirds as populous as China a decade ago, will pass China to become the world’s most populous country, with almost 1.5 billion people in 2030.  India’s per capita emissions are rising too from industrialization.  But they remain below those in developed countries.  China, the other key holdout on capping emissions, can make a similar per capita argument, though it recently passed the U.S. to become the world’s largest emitter, and its emissions are soaring as it develops.

While the posture of India and China are problematic on their own, they make it harder for other countries to take action.  After all, if the world’s two most populous and dynamic economies, growing at about 7 percent (although down from China’s 13 percent growth in 2007), won’t opt in, why should the U.S., which contracted last quarter at a 5.5 percent rate?  With America’s standard of living under siege, putting America at a further competitive disadvantage—no matter how much carbon we emit per capita—is a tough sell to voters.  And what emerges is a classic collective action stalemate.

This dilemna highlights one of the diferences between greenhouse gas emissions and other environmental issues. Unlike cleaning the air or water, where the benefits are realized locally, keeping costs and benefits within one country, reducing emissions benefits the entire planet, but costs whomever does it growth.  This is what makes a global solution—such as that promoted by the UN through the Kyoto and now Copenhagen process—so attractive.  However, if China and India won’t come to the table, what should the U.S. do?

One solution attracting interest of late is the use of trade policy to punish carbon havens. Indeed, at the last minute, the House inserted into the Waxman-Markey bill a provision to impose tariffs on countries that do not take action to limit emissions.  In announcing his support for the House bill after its passage, President Obama flagged the provision as troubling insofar as it runs counter to free trade principles.

So is trade policy a valid tool in climate policy?  The New York Times recently argued that it is if enacted multilaterally, but not if it’s enacted unilaterally.  Paul Krugman, my professor of trade policy at Princeton, has endorsed the idea in theory.  My view is that trade policy is a problematic tool from a practical standpoint that would require significant new infrastructure to work at all.

The problem with using trade policy for an environmental purposes are fourfold.

First, trade actions have an unfortunate tendency to invite retaliation and provoke trade wars even in a multilateral context.  No matter how good your case, other countries can respond in kind.  The result is then a lengthy negotiation or WTO process that ultimately harms both parties.

Second, while the temptation to use trade policy to protect clean domestic industries against dirty foreign ones may be great, the track record for mixing the environment with trade is poor.  More often than not, environmental regulations have functioned as non-tariff trade barriers.  Domestic companies claim them when threatened economically, and verifying them becomes a political football. 

Third, as with food safety regulations, labor regulations, and other hard to measure quantities, measurement is labor intensive and becomes an impediment to good regulation.  This would complicate administering any tariff.  It might overwhelm the WTO.

Fourth, increasing the price of an import to protect a domestic industry can have the adverse consequence of increasing the price of inputs for other domestic products.  A classic example is that when the U.S. slapped a tariff on LCDs to protect LCD domestic manufacturers in the 1980s, it drove American laptop manufacturing offshore.  Taxing imports from carbon havens to protect domestic industries could raise manufacturing costs for other companies, causing the latter to shift their production to carbon havens. 

Those are the arguments against. On the other hand, giving imports a total pass not only harms domestic producers, but is tantamount to a cordial invitation to domestic companies to shift production—and jobs—offshore.  This issue came up, of course, in the NAFTA debate.  Ideally, there ought to be some middle ground.

To view how a tariff might succeed or not, consider the case of electricity-intensive aluminum production.  Rio Tinto, as one example, produces aluminum using hydro power in Canada but coal-based power in Australia.  Were the U.S. to slap a tariff on aluminum produced with coal-based power (hard enough to determine in and of itself), aluminum produced with hydro power would be cheaper. One outcome would be for Rio Tinto to phase out coal in favor of hydro in the production of aluminum.  Were that to occur, one might call a US tariff an environmental and economic success.

Another possible outcome, however, would be for Rio Tinto to fulfill U.S. demand with an unchanged mix of product that would cost buyers more due to the tariff.  In that case, U.S. companies might decide to shift the production of products using aluminum overseas.  This would be an environmental and economic failure.  The deciding factors between the two outcomes would probably be Rio Tinto’s ease of substituting a zero carbon energy source for coal, and the domesic companies’ difficulty of moving production of products using aluminum overseas.

In short, it is hard to predict in advance just how the tariff would impact the market, but it is clear that the more carbon havens that exist, the greater the likelihood that production will seek them out.

Currently a workable regime is not readily at hand.  Were a trade regime to ultimately be invoked, here are some thoughts to guide its development.

First, as with the capping of carbon emissions themselves, putting a price on emissions in imports should be pushed as far up the value chain as possible. This is because as products grow more complex, tracking their carbon footprint becomes more difficult and trade restrictions multiply.  Any trade-based taxes on carbon intensive goods should be directed upstream at basic goods such as steel or aluminum, not at finished products made from those commodities.  While this could drive downstream industries overseas, on balance, I think, it would be far less distortionary to address a few commodities than many products.

Second, some sort of standardized process for measuring carbon footprints needs to be devised.  However, it would be preferable for some private body to administer standards, rather than a governmental organization.  A number of creative startups are trying to devise novel ways of tracking carbon.  One such venture is Greenerone.com which uses crowd sourced information—or information gleaned for free by numerous reporters to track the environmental profile of products.  Others are working on more industry-focused products.  Whatever system is used should involve as little bureaucracy as possible, consistent with being stable and standardized. 

Another idea, admittedly bold, would be to devise some sort of average duty—product independent—to penalize countries that choose not to limit their emissions during production.  Such an approach would have to be administered multilaterally, lest it lead to an immediate trade war, thus it is not something the U.S. could do in and of itself.

The very complexity of using a trade hammer shows that it is far preferable to develop a coordinated multilateral regime than to use trade policy.  Free trade has created wealth since the days of the Minoans and since then for the Athenians, Carthaginians, Romans, Indians, Venetians, Portuguese, Spanish, British and yes, Americans, to name only a few.  It is, in contrast, a clumsy tool for achieving environmental goals.  Nonetheless, if India and China—and for that matter the U.S.,  refuse to address the problem of a changing climate, the pressure to use trade policy to achieve those goals will only increase.

• Comments