Climate Change Legislation and Protectionism

Martin Feldstein opposes border adjustments related to cap-and-trade:

Will Cap-and-Trade Incite Protectionism?, by Martin Feldstein, Commentary, Project Syndicate: There is a serious danger that the international adoption of cap-and-trade legislation to limit carbon-dioxide emissions will trigger a new round of protectionist measures. ... 150 countries are scheduled to meet in Copenhagen in December to discuss ways to reduce CO2 emissions.

Governments have ... focused on a cap-and-trade system as a way of increasing the cost of CO2-intensive products... The cap-and-trade system ... imposes a carbon tax without having to admit that it is really a tax.

A cap-and-trade system can cause serious risks to international trade. Even if every country has a cap-and-trade system and all aim at the same relative reduction in national CO2 emissions, the resulting permit prices will differ because of national differences in initial CO2 levels and in domestic production characteristics. Because the price of the CO2 permits in a country is reflected in the prices of its products, the cap-and-trade system affects its international competitiveness.

When the permit prices become large enough to have a significant effect on CO2 emissions, there will be political pressure to introduce tariffs on imports that offset the advantage of countries with low permit prices. Such offsetting tariffs would have to differ among products ... and among countries (being higher for countries with low permit prices). Such a system of complex differential tariffs is just the kind of protectionism that governments have been working to eliminate since the start of the GATT process more than 50 years ago.

Worse still, cap-and-trade systems in practice do not rely solely on auctions to distribute the emissions permits. ... Such complexities make it impossible to compare the impact of CO2 policies among countries, which in turn would invite those who want to protect domestic jobs to argue for higher tariff levels.

There is no easy answer to this 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 in competitiveness, 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 agree as well that there will be no attempt to introduce offsetting tariffs that would ultimately threaten our global system of free trade.

Paul Krugman on what to do if other countries refuse to participate:

Climate, trade, Obama, by Paul Krugman: I think the president has this wrong:

President Obama on Sunday praised the energy bill passed by the House late last week as an “extraordinary first step,” but he spoke out against a provision that would impose trade penalties on countries that do not accept limits on global warming pollution. ...

The truth is that there’s perfectly sound economics behind border adjustments related to cap-and-trade. The way to think about it is in terms of a well-established theory — the theory of non-economic objectives in trade policy — that owes its origins to Jagdish Bhagwati, who certainly can’t be accused of being a protectionist. The essential idea is that if you have a non-economic objective, such as self-sufficiency in food production, you should choose policy instruments to align incentives with that objective; in normal circumstances this leads to consumer or producer intervention, rarely to tariffs.

But in this case the non-economic objective is to reduce greenhouse gas emissions, never mind their source. If you only impose restrictions on greenhouse gas emissions from domestic sources, you give consumers no incentive to avoid purchasing products that cause emissions in other countries; as a result, you have an inefficient outcome even from a world point of view. So border adjustments here are entirely legitimate in terms of basic economics.

And they’re also probably OK under trade law. The WTO has looked at the issue, and suggests that carbon tariffs may be viewed the same way as border adjustments associated with value-added taxes. ... Because it’s essentially a tax on consumers, it’s legal, and also economically efficient, to collect it on imported goods as well as domestic production; it’s a matter of leveling the playing field, not protectionism.

And the same would be true of carbon tariffs.

What’s happening here, I think, is that people are relying on what Paul Samuelson called an economic “shibboleth” — they’re relying on some slogan rather than thinking through the underlying economics. In this case the shibboleth is “free trade good, protection bad”, when what the economics really says is that incentives should reflect the marginal cost of greenhouse gases in all goods, wherever produced — which in this case happens to imply border adjustments.

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Update: On the effects of climate change legislation, this is from a July 4 post at the CBO Director's blog:

Estimated U.S. Emissions under the House-passed Bill