Global carbon pricing and international trade

ABSTRACT

This paper provides policies other than trade restrictions to induce global carbon pricing. It shows that bilateral increases of domestic taxes between large open economies represent a useful first step toward global carbon pricing. Specifically, the paper recommends that the production tax of the importing country and the consumption tax of the exporting country be increased together. Unlike a tariff-induced carbon pricing, the proposed policy mix is robust to trade distortions and increases market access. What is more, it addresses world price volatility and emissions leakage.

KEYWORDS:

• Global carbon pricing
• trade restrictions
• international tax coordination
• price volatility
• energy subsidies

Acknowledgements

I would like to thank an anonymous referee for useful comments on an earlier version of this paper.

Disclosure statement

No potential conflict of interest was reported by the author.

Notes

1 Fischer and Fox (2011) and Böhringer, Rosendahl, and Storrøsten (2017) abstract from the fuel market channel. Instead, they focus on the competiveness channel, whereby unilateral climate policies provide a competitive trade advantage to other nations and thereby cause the relocation of emission-intensive and trade-exposed (EITE) industries.

2 Still another reason for not adopting OBR is that it encourages domestic production at the expense of foreign production; consequently, production and consumption of EITE goods will be excessive under OBR. That is why Böhringer, Rosendahl, and Storrøsten (2017) provide an approach to overcome this difficulty; that is, supplementing output-based rebating with a consumption tax. This policy combination is equivalent ipso facto to tariffs: which means this policy can be used to manipulate the terms of trade.

3 There is no consensus yet about the appropriate level of the carbon tax and about the precise way in which a tax should be introduced. For example, Uzawa (2003) recommends that the rate should be made proportional either to the level of national income in the countries where green-house gases are emitted or the sum of the national incomes of all countries in the world.

4 Exceptions are Hoel (1994), Rauscher (1997) and Horn, Giovanni, and Staiger (2010), in which both consumption pollution and production pollution exist in large open economies. These authors, however, do not explore welfare-and trade-increasing internationally coordinated tax reforms—reforms which are the central to the present paper.

5 It is not uncommon for the large open economy literature to assume that income effects on consumption goods are zero (see, for example, Keen and Kotsogiannis 2014; Tsakiris, Michael, and Hatzipanayotou 2014; Eisenbarth 2017).

6 If foreign production pollution (consumption pollution) rises with domestic production tax hikes (consumption tax hikes), this can be thought of as production leakage (consumption leakage). See Kortum and Weisbach (2016) for various details classifications of carbon leakage.

7 Böhringer, Lange, and Rutherford (2014) show that the argument for the terms of trade motivated emission price differentiation is less convincing than we have previously thought. However, their analysis abstracts from foreign policy response. In addition, their results are quite sensitive to Armington elasticities. Haibara (2017) shows that environmental policy as a means of pursuing terms of trade gains does not occur in the absence of global pollution externalities and foreign environmental policy response.

8 Let define the total level of global emissions $g\equiv z+z_c$. Then, one can obtain: $\mathrm{d}g/\mathrm{d}t{|}_{t-t^{\ast }}=2(R_{pp}{E}_{pp}^{\ast }-E_{pp}{R}_{pp}^{\ast })(M_{pp}^{\ast }{)}^{-1}$. Thus the level of global emissions rises under the assumption of $\left|E_{pp}\right|<\left|E_{pp}^{\ast }\right|$ and $R_{pp}>R_{pp}^{\ast }$.

9 The value of $R_{pp}$ does not matter for Home welfare if $s>t$: i.e. tariff alleviates the production distortion associated with s – by enough to more than offset the production distortion introduced by t.

10 The net effect of the policy mix on global pollution emissions ($g\equiv z+z_c$) is as follows:$\mathrm{d}g/\mathrm{d}t{|}_{t-s^{\ast }}=E_{pp}+E_{pp}^{\ast }<0$. As indicated by (14), the large absolute value of $\left|E_{pp}\right|$ induces a relatively large increase in $s^{\ast }$, thereby offsetting the increased production pollution associated with Home tariffs.

11 Recently, Eisenbarth (2017) points to the WTO dispute settlement case on Chinese export restrictions for rare earths: the complainants hold that China uses export restrictions to manipulate the terms of trade to its favour, especially since China is a leading producer of the good in question (see WTO 2014). Eisenbarth examines a sample of products for which China exports less than 15% of global exports and concludes that China does not use export taxes to manipulate the terms of trade. But it implies that, with larger market shares, the possibility of using environmental policy to manipulate the terms of trade is more likely.

12 According to Cooper (2008), the countries that stand to lose most from a decline in global demand for coal are the big exporters of coal: South Africa, Australia, the United States, and Colombia. The first three, as importers of oil, will be partially compensated by a decline in oil prices; but that will hit Colombia, as well as the many other net exporters of oil.

13 Obviously, market access falls with a combination of Home tariffs and Foreign production taxes:$\mathrm{d}M/\mathrm{d}{s}^{\ast }{|}_{t-s^{\ast }}=p(E_{pp}-R_{pp})+(M_p+p{M}_{pp})(\mathrm{d}p/\mathrm{d}t{)}_{t-s^{\ast }}<0$.

14 In the environmental economics literature, this phenomenon is called as ‘strong’ double dividend (i.e. the efficiency effects abstracting from environmental benefits). See Bovenberg (1999) and the literature cited therein.

15 See Haibara (2017) for the derivation of optimal taxes.

16 Note, however, that decreased energy prices hamper efforts to remove subsidies. The exporter of fuels experiencing a terms of trade decline may be reluctant to remove energy subsidies because environmental stringency is proportional to real income levels (see Copeland and Taylor 2005).

17 The Carbon Pricing Leadership Coalition is a voluntary partnership of national and sub-national governments, businesses, and civil society organizations. The aim is to advance the carbon pricing agenda by working towards the objective of a carbon price applied throughout the global economy. It was convened by the World Bank Group.

18 The same is not true for a cap-and-trade system alone: because a reduction in permits could be offset by an increase in permits to neutralize world fuel prices. Such adjustment prevents price volatility, but at the expense of emissions reductions.

19 But it does not imply that nothing can be done. Think of Carbon Pricing of Americas (CPA), whereby leaders of Canada, Chile, Colombia, Costa Rica, México, the Governors of California and Washington, and the Premiers of Alberta, British Columbia, Nova Scotia, Ontario and Quebec strengthen the alignment of carbon pricing systems and introduce harmonized systems for measurement.