Fight against carbon could put shackles on global free trade

Published on Friday 17 July 2009 20:17

THERE is a serious danger the international adoption of cap-and-trade legislation to limit carbon-dioxide emissions will trigger a new round of protectionism.

While aimed at reducing long-term environmental damage, cap-and-trade policies could produce significant harmful economic effects in the near term that would continue into the future.

Scientific evidence appears to indicate that the accumulation of in the atmosphere from the burning of fossil fuels – mainly in electricity production, transportation, and various industrial processes – contributes to gradual global warming, with long-term adverse effects on living conditions around the world. It is with this in mind that representatives of more than 150 countries are scheduled to meet in Copenhagen in December to discuss ways to reduce emissions.

A common suggestion is to impose a tax on all emissions, which would be levied on companies that emit the gas in production, or that sell products like petrol that cause emissions when used.

Such a tax would cause firms to adopt techniques that reduce emissions, as long as the cost of doing so is less than the tax they would have to pay.

The higher cost of production incurred to reduce emissions – and of any emissions tax still due – would be included in the price charged to consumers and they would respond to the tax-induced increase in cost by reducing consumption of those goods and services.

A carbon tax causes each firm and household to respond to the same cost of adding to the atmosphere. That uniform individual cost incentive allows total to be reduced at a lower total cost than would be achieved by a variety of administrative requirements, such as automobile mileage standards and production technology standards (eg, minimum renewable fuel inputs in electricity generation).

Yet we do not see carbon taxes being adopted. Although governments levy taxes on petrol, they are reluctant to impose a general carbon tax because of public opposition. Governments have therefore focused on a cap-and-trade system as a way of increasing the cost of -intensive products.

In a cap-and-trade system, the government sets total allowable national emissions of per year and requires any firm that causes emissions to have a permit per ton of emitted.

If the government sells these permits in an auction, the price would be a cost to the firm in the same way as a carbon tax – and with the same resulting increases in consumer prices.

But this system can cause serious risks to international trade. Even if every country has one and all aim at the same relative reduction in national emissions, the resulting permit prices will differ because of national differences in initial levels and domestic production characteristics. Because the price of the permits in a country is reflected in the prices of its products, the cap-and-trade system affects its international competitiveness.

When permit prices become large enough to have a significant effect on emissions, there will be political pressure to introduce tariffs on imports that offset the advantage of countries with low permit prices. Such tariffs would have to differ among products (being higher on more -intensive products) and among countries (being higher for countries with low permit prices). Such a system is protectionism.

There is no easy answer to the problem. But before rushing to impose tariffs, it is important to remember that cap-and-trade policies would not be the only government source of differences in competitiveness.

Better roads, ports, and even schools all contribute to a country's competitiveness. No one attempts to use tariffs to balance those government-created differences, and there should be no such attempts if a cap-and-trade system is introduced.

If an international agreement to impose a cap-and-trade scheme is adopted in Copenhagen, the countries there should also agree that there will be no attempt to introduce offsetting tariffs that would ultimately threaten our global system of free trade.

&#149 Martin Feldstein, is a professor of economics at Harvard University.