EU Energy Policy Blog

The latest blog by Steven Stoft is like always well argued – but towards the end also suggests to consider trade sanctions as an instrument to enforce a global cartel on carbon pricing. Let me summarise the results of a long discussion we had on this topic last night:

First – countries have to pursue a multitude of actions to shift to low-carbon trajectories, including evolving institution, regulation and market design, providing information and supporting development and diffusion of low-carbon and energy efficient technologies. It is difficult to see how any of these can be imposed by trade sanctions. They need to be driven by domestic self interest.

Second – developed countries have frequently used border measures to protect their industry. This makes developing countries suspicious about any revival of border measures in the disguise of climate policy. Threatening other countries with trade sanctions is unlikely to be an effective way to create trust and confidence necessary to cooperate on climate policy. Many far more creative, and most likely also more effective, approaches are currently discussed, and should not be overshadowed by threats of trade sanctions.

Third – we might require border adjustments as economic instrument – but undermine any opportunity for constructive international discussion on the topic, as long as the threat of trade sanctions prevents constructive cooperation. Let me explain.

Concerns about leakage, the relocation of production and emissions to regions with lower carbon prices, have been used by industry to successfully argue for very generous free allowance allocation. These concerns are constrained to a few – albeit the carbon intensive-, sectors, and we economists failed so far to provide sufficiently robust evidence that emission trading with full auctioning does not create any leakage. Hence, the current discussions envisage free allowance allocation linked to activity levels (Europe) or production volumes (USA). This does however seriously undermine the effectiveness of the carbon price:

- Detailed provisions for allowance allocation create administrative barriers for innovation, production optimisation and trade.

- Subsidies to carbon intensive production undermine market opportunities for alternative processes, products and services.

- If industry cannot access cost-effective emission reductions, carbon prices increase to target more costly reductions. Anticipating this effect, policy makers define less ambitious emission targets.

These distortions are particularly disconcerting in the industry sector, as diverse production processes and technologies are difficult to regulate with other policy instruments. Implementing border adjustment would allow for a shift from free allowance allocation to full auctioning and at the same time address leakage concerns. Such border adjustments do not need to be discriminating against other countries or foreign producers in order to be effective.

Only a few basic commodities would have to be covered – e.g., pursuing adjustments for steel at the carbon intensity of best available technology. Domestic producers pay for their carbon emissions, importers pay as if they would have produced with best available technology. Thus the full carbon price signal creates incentives for emission reductions of producers and more efficient use by domestic users are created. Costs for importers increase thus avoiding relocation of production and emissions. Domestic producers pay the full carbon price, thus avoiding discrimination against importers and using the full carbon price signal to create incentives for efficiency improvement, substitution and innovation.

However, as long as border measures are considered as trade sanctions, this interferes with any attempt to explore the options to use it as a non-discriminating instrument to support effective carbon pricing as an instrument of domestic climate policy. Therefore we need to initiate international cooperation to avoid that border adjustments will be used as trade sanctions.

Karsten Neuhoff, Faculty of Economics, University of Cambridge

P.S. A summary of the arguments can be found at climatestrategies.org.

This entry was posted on Friday, July 17th, 2009 at 8:44 am and is filed under Climate Change. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.