Trade vs. the Environment

Editor’s note on our Economics of Climate Change series:

Climate change is happening.  That is science’s unequivocal conclusion.  But what should be done about it is a much more difficult question and the domain, at least in part, of economics.  Determining the costs of inaction and the benefits of action to avoid, mitigate and adapt to climate change is one of the greatest challenges facing the economics profession today.  The results of this cost-benefit calculation will shape the policy that dictates how the world responds to the preeminent policy challenge of our time.  Over the next year we will pay special attention to what economics can tell us about the best ways to respond to climate change.

How much trade is the right amount in the age of climate change?

Economics says that a basic negative externality afflicts trade in the same way as it does other polluting activities. Trade requires transport; transport has environmental costs. In the absence of regulation, those costs are not factored into decisions to import and export goods. So, while trade is generally a very good thing, we might be doing too much of it. Recent empirical research by economist Joseph Shapiro suggest exactly this. He finds, first, that the global gains from international trade exceed the environmental costs of international trade by a factor of 180, suggesting trade is good. Second, he estimates that potential climate policies that regulate trade – he considers three of them – can increase global welfare, suggesting that a little less trade would be better overall for the world.

The ideal version of such a climate policy, from an economics perspective, is a global agreement. But that isn’t looking so likely these days, in spite of United Nations campaigns and People’s Climate Marches. The underlying political economics make cooperation a continual challenge for almost every country. Furthermore, several developing countries “have made it clear in international negotiations that they view the continuation of rapid economic growth as a greater priority than the curbing of emissions”, as researchers Lee Branstetter and William Pizer put it. This priority, of course, applies to all economic activity, but trade is a large part of that (consider China, for instance). And when trade and the environment go head-to-head, trade invariably wins. Naomi Klein’s new book documents this historical record, highlighting several instances in which official international stances on climate have been rephrased and environmental policies dialed back, all in order to accommodate free trade agreements.

Given the difficulty of implementing global climate policy of substance, it is left to individual countries and regions to act unilaterally. This is what the European Union Emissions Trading System (EU ETS) is, and what the United States’ Waxman-Markey Bill of 2009 would have produced. The problem with these unilateral policies is that trade interferes with their efficacy. A regulation in one country that targets emissions could, in theory, simply raise imports from abroad, where competing firms in the affected industry are not subject to such regulation. Or it could encourage the affected industries to migrate to countries without such regulation (sometimes known as “pollution havens”). To put the logic more simply: If a country starts charging for pollution, just get (or produce) your goods elsewhere. This would be problematic for at least two reasons. One, the regulated country would suffer economically from losses in competitiveness and industrial activity. And two, the environmental goals would be compromised, because “dirty” goods from abroad would replace “clean” ones (this is sometimes called “emissions leakage”).

Perhaps the most commonly proposed resolution of this issue is something like a border tariff. If a would-be importer had to pay extra (perhaps in proportion to the emissions required to produce and ship its goods), then domestic industry might not be so “disadvantaged” by carbon regulation and emissions might not “leak” out to other countries. But this flies in the face of free trade agreements. Klein’s book provides several examples of countries, developed and developing alike, signaling their distaste for anything that looks remotely like a free-trade violation.

The good news is, research suggests that competitiveness and leakage issues don’t seem to have been so serious in the past. As Branstetter and Pizer note in the U.S. case (in turn citing work by Joseph Aldy and Pizer), lots of industries aren’t so energy-intensive. And many that are do not face significant international competitive pressure. Further, there are constraints on the mobility of many industries that may help limit the development of pollution havens. All this is to say that maybe unilateral policy doesn’t need to be accompanied by border tariffs.

The bad news is, the above research may not be particularly valid in the future; it is generally based on the study of lower-intensity regulation. Whether or not you believe that drastic emission reductions are necessary right this instant, there are a number of reasons why carbon regulation is going to have to be much more stringent in the future (for a sampling, see Branstetter and Pizer, p.33). And when this happens, countries without regulation are going to have a serious comparative advantage in production. At that point, the countries trying to do something about climate change are going to have to decide whether to implement border tariffs or otherwise compromise both their domestic industries and the global environment. In the words of Branstetter and Pizer, the choice is between “an adherence to free trade principles that has brought a greater measure of prosperity to billions, and preservation of the natural environment on which all of humanity ultimately depends.”

One might counter with the argument that climate change is slated to hurt poorer populations most of all, and so a violation of free trade would actually be a good thing for developing countries if it reduces emissions. Alas, it is not so simple as that. The work by Joseph Shapiro, highlighted earlier, focuses on two regional climate policies affecting trade. The first is the expansion of the EU ETS to cover all air transportation, and the second is the regulation of shipping under the U.S.’ Waxman-Markey Bill. Both have the approximate effect of a tax on the use of shipping fuel. As noted above, Shapiro estimates that both policies raise global welfare. But he also finds that they are regressive – they make poorer countries worse off, at the expense of richer ones. Developing nations suffer in this setting because they generally trade heavier goods at longer distances; this requires a greater use of shipping fuel, which is exactly what is regulated under the aforementioned policies.

The lesson? Even as climate policy is motivated in part by a desire to protect those most at risk, it can all-too-easily have the opposite effect. Most of us care about both the survival of the planet and the reduction of poverty. We must then be careful that policy aimed at one does not cripple attempts to achieve the other.

Image Credit: Navarch41 via Wikimedia Commons


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