Internalizing Externalities: A Call for Pragmatic Climate and Trade Policies

credit: World Trade Organization credit: World Trade Organization[/caption]

The classic conversation on climate change does not speak much about trade policy. Maybe it should . . .

The nations of the world face the intersection of two global dilemmas: enhancing economic welfare through trade liberalization and mitigating climate change.

With a “point of no return” for the latter of these predicaments rapidly approaching and evidence that unilateral action on either of these problems proving minimally, if it all, effectual, the world faces a pervasive and imminent threat. However, recent international jurisprudence and global sentiment has allowed for a single solution to each of these quandaries in the form of a carbon tax regime.

While increasing numbers of countries have adopted domestic policies to encourage energy efficiency within their borders and penalize those who fail to comply with such regulations, the lack of a uniform international policy leads to a situation which economists and policy makers named, “carbon leakage.”

Carbon leakage occurs where emissions reductions in one country precipitate an increase in emissions in countries with less strict climate policies.

Economists of nearly all methodological and ideological stripes concur that the best way to attempt to stave off the worst impacts of climate change is through some form of carbon taxation. To that point, one policy which more and more economists seem to find as the most efficient solution is to allow for a carbon tax regime consisting of both domestic carbon taxes and border adjustments.

Border adjustments are, in a simple explanation, a tariff imposed upon goods from countries that do not act in a way to limit their emissions as strictly as the importing country. They act as would a (domestic) carbon tax and only to the goods actually imported to receiving country. The goal of the tariff is to make up for that difference, by raising the price to what it may be expected to cost if produced in the importing country.

The one international assembly with the potential power to deal with international commerce and trade policy that facilitates carbon leakage is the World Trade Organization. The WTO periodically scrutinizes trade policies and practices of its 159 member states to ensure they do not impose an unfair barrier to trade.

While some commentators believe a border adjustment might constitute an unfair or protectionist trade policy, others, including the WTO, disagree.

The WTO has looked at the issue, and its recent administrative decisions indicate that carbon tariffs may be viewed the same way as border adjustments associated with value-added taxes. Although the opinions of those who believe that border adjustments would be an “unfair barrier to trade” must be taken into consideration, so must the practical and societal implications of a border adjustment.

Currently, throughout most of the world, pollution remains a negative externality, an untaxed burden that adversely affects each member of the public. As former Chief Economist and Senior Vice President of the World Bank, Joseph Stiglitz, has stated, “Not paying the cost of damage to the environment is a subsidy.” Additionally, as Nobel laureate Paul Krugman notes, “it’s a matter of leveling the playing field, not protectionism.”

Although “carbon tax” and “border adjustments” are not terms within the contemporary lexicon, they soon may enter as part of the growing and urgent debate on climate change and climate security.

The current trade regime provides for an imperfect market that lacks accountability for the direct and indirect costs of negative externalities, such as carbon emissions, inflict upon the planet.

However, the embrace of a solution such as a carbon tax regime may be influential in not only mitigating climate change, but in trade liberalization when such measures are seen not as an obstacle, but as a means to leveling a playing field that comports with international law and regulations.