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close this bookThe Costs of Climate Protection: A Guide for the Perplexed (WRI, 1997, 60 pages)
close this folder4. TRADE AND EQUITY ISSUES
View the documentA. Trade Issues
Open this folder and view contentsB. Distributional Effects

A. Trade Issues

Concerns about adverse international trade consequences are strong among businessmen who fear that if the United States unilaterally adopted a carbon tax its energy-intensive industries almost certainly would become less competitive in international trade. International shifts in the location of production, so-called 'leakage' effects, would mean that cuts in domestic emissions would be partially offset by increases in emissions abroad as energy-intensive industries expanded overseas (Barrett, 1994; Gaskins and Weyant, 1993). For these reasons, a carbon tax adopted unilaterally would be more costly to the U.S. economy and less effective in reducing global emissions than one adopted by many countries acting together.

Empirical research into the magnitude of leakage effects is somewhat inconclusive. The penalty for acting unilaterally would be greater for small economies than for large economies like that of the United States. Studies of unilateral emissions reduction policies in OECD countries predict leakage rates of between 3.5 and 70 percent12 (Manne, 1993; Oliveira-Martins et al., 1992; Pezzey, 1992; Rutherford, 1992). Studies in the United States suggest that cost differences created by international differences in environmental policies have minor impacts on trade and investment flows (Repetto, 1995).

12 The leakage late is measured as the increase in emissions outside the tax region over the emissions reduction within the region.

There would also be international trade gains, however. Given the size of the U.S. market, a tax-induced fall in U.S. energy consumption would help restrain world fuel prices, improving our terms of trade as a net oil-importing economy. Baseline projections suggest that in the absence of higher energy taxes, fossil fuel consumption in the United States and the rest of the world will continue to grow substantially in coming decades. One implication, given the already declining oil production in this country, is that OPEC will supply an increasing share of world petroleum markets, and the United States will become increasingly dependent on imports from OPEC producers. OPEC's world market share might reach 72 percent by 2015, more than in 1974 when its supply restrictions precipitated the first "oil shock" (U.S. EIA, 1996). A carbon tax would mitigate these energy security and trade risks.

If the United States adopted a carbon tax unilaterally, the risks of climate change faced by other countries would fall, reducing their incentive to act (Barrett, 1994). However, increasing international coordination within the Framework Convention on Climate Change means that unilateral action is unlikely. European countries have stated their willingness to adopt a carbon tax if major trading partners - the United States in particular - do the same (Commission of the European Communities, 1992). Sweden and Norway already have signaled willingness by adopting small taxes. Developing countries are clearly unwilling to commit themselves to action unless industrial countries that have emitted most of the carbon dioxide to date take the lead. Nonetheless, substantial economic reforms and restructuring of energy markets have taken place in developing and transitional economies, for purely economic reasons. Energy subsidies have been reduced, subsidies to energy-intensive industries have fallen, and institutional changes have opened the energy sector to improved technology and greater efficiency. These significant changes have already reduced CO2 emissions in these countries well below their projected levels (Reid and Goldemberg, 1997). Though undertaken for strictly economic reasons, these policy changes in other countries have greatly reduced the risks of unilateral U.S. action.