Climate Change: Competitiveness Concerns and Prospects

Summary

• The United States is a leading source of greenhouse gas (GHG) emissions-both in total tonnage and on a per capita basis. The major emitting sectors, in the United States and elsewhere, are energy generation and transportation. Manufacturing activity and industrial processes are less important GHG sources.

• Regarding questions 1 and 2 in the Committee's White Paper, any meaningful form of GHG controls-whether the limits take the form of a carbon tax, a cap-and-trade system, or performance standards-will impose heavy costs to the US economy. The control systems adopted by various countries will differ in major respects-both as to the severity of limitations and the details of operation. The combination of enormous costs, huge values and systemic differences will generate tremendous lobbying pressure and protectionist forces.

• Sauce for the goose is sauce for the gander. Any restriction the United States imposes on imports, citing climate change as justification, can just as easily be imposed by other countries on US exports. Any performance standards that the United States imposes on foreign firms, and any "comparability" tests the United States imposes on foreign GHG control systems, can be turned around and imposed on the United States.

• With respect to questions 3 and 6 in the Committee's White Paper, a US-led effort to agree on international rules would certainly help bring developing countries on board in reducing GHG emissions. Early US efforts will strengthen the US hand when it comes to designing the post-Kyoto Protocol regime.

• Application of basic World Trade Organization (WTO) rules to foreseeable GHG emissions controls is far from cut and dried. Only a brave or foolish lawyer would give this Committee strong assurance that such-and-such a system of GHG controls is immune from challenge in the WTO. In a response to question 5 in the Committee's White Paper, almost all trade restrictive measures stand a fair chance of being challenged in the WTO.

• If the United States enacts its own unique brand of import bans, border taxes, and comparability mechanisms-hoping that measures which flaunt GATT Articles I, III and XI will be saved by the exceptions of GATT Article XX-the probable consequence will be a drawn-out period of trade skirmishes and even trade wars. During these battles, some countries will become more fixated on winning legal cases than fighting the common enemy, climate change. Global cooperation in limiting emissions could be the first casualty of a unilateral approach that ignores the basic GATT articles.

Testimony

Mr. Chairman and members of the Committee, thank you for inviting me to testify. My name is Gary Hufbauer and I am a Senior Fellow at the Peterson Institute for International Economics. The Peterson Institute and the World Resources Institute are jointly conducting research on the intersection between controlling greenhouse gas (GHG) emissions, competitiveness, and international trade. This testimony reflects some preliminary findings.

My old friend, William A. Reinsch, President of the National Foreign Trade Council (NFTC), was originally scheduled to occupy this place but cannot be with you today. I am pleased to associate myself with NFTC's views; likewise the NFTC supports what I have to say.

In this statement, I will comment on the relationship between the rules of the world trading system and domestic legislation that would penalize US imports, or foreign countries, when foreign production does not measure up to US standards for limiting GHG emissions. Several tables are appended to my testimony, based on our joint program with the World Resources Institute.¹ For reasons of time, I will only draw broad inferences from the data, but the tables may be useful to the Committee as reference material.

Emission Sources (tables 1, 2, and 3 ). The United States is a leading source of GHG emissions-both in total tonnage and on a per capita basis. However, China probably surpassed the United States in total tonnage in 2007. The major emitting sectors, in the United States and elsewhere, are energy generation and transportation. Manufacturing activity and industrial processes are less important GHG sources. These facts imply that the United States is vulnerable to legislation abroad that might seek to call US practices to account, not only with respect to manufactured exports and industrial processes but also for its high levels of GHG emissions in total and on a per capita basis.

Implied Value of GHG Emissions Taxes or Caps(tables 1 and 2 ). Serious limits on GHG emissions-of the sort proposed by my colleague William Cline, economist William Nordhaus (Yale University), and the Stern Report-will entail heavy costs.² Regarding questions 1 and 2 in the Committee's White Paper, any form of GHG controls-whether the limits take the form of a carbon tax, a cap-and-trade system, performance standards, or some other method-will impose heavy costs to the US economy. One major difference in approaches is whether permits are assigned to private companies, thereby conferring valuable "quota rents" on the recipients, or whether limits are imposed by way of auction or tax systems so that the government collects substantial revenues. Another major difference is the choice of activity where limits are designed to "bite": for example, on power generation and refineries or also on transportation and manufacturing. Other parameters also differ between approaches: trading of permits, domestically and internationally; banking and borrowing of permits; special auctions to curtail price spikes, etc.

Until international negotiations are conducted, it is difficult to say which approach will best encourage developing countries to adopt their own GHG emission controls while simultaneously protecting US industry.³ From an administrative standpoint, the simplest approach would be a uniform carbon tax, imposed at the border on imports from countries that do not adopt and enforce the same uniform rate. The carbon tax approach also has well-known efficiency features-reducing the most GHG emissions for the least cost. But it would be extremely difficult to marshal legislative support for such a tax in the US Congress or abroad.

Instead, the more likely outcomes are messy "hybrid" systems that differ from country to country. Each country will favor a mixture of subsidies, border adjustments, and other GHG controls that foster its own producers, especially "national champions." The United States is well along this path with respect to biofuels, having enacted measures that generously support ethanol production and firms like Archer Daniels Midland. President Nicholas Sarkozy of France and other European leaders have pushed the same approach.

Three important implications should be emphasized. First, any meaningful system of GHG controls will entail enormous costs and create huge values. Second, the control systems adopted by various countries will almost certainly differ in major respects-both as to the severity of limitations and the details of operation. Third, the combination of enormous costs, huge values and systemic differences will generate tremendous lobbying pressure and protectionist forces.

Tables 1 and 2 illustrate the cost/value implication. A control system, which, in terms of effect, equates to $100 per metric ton of emitted carbon-equivalent (a middling figure for 2020), would generate costs/values of around $190 billion annually for the United States alone at current emission levels.⁴ For the European Union or China, the costs/values would be around $130 billion annually. Even if countries agree that limits of this severity are justified, no two political systems will agree on the same methods for imposing their controls. Lobbying pressure will be intense to exclude "preferred" activities from any limits (e.g., residential electricity and heat, agriculture), and industrial firms will do their utmost to acquire free emission permits for their own activities. Out of the political maelstrom, it is certain that some countries will use domestic GHG controls as a rationale for curtailing imports.

Trading System Dangers (tables 4, 5, and 6 ). WTO rules and decided cases are summarized in my tables. Before surveying the rules, an overriding observation must be stressed. Sauce for the goose is sauce for the gander. Any restriction the United States imposes on imports, citing climate change as justification, can just as easily be imposed by other countries on US exports. Any performance standards that the United States imposes on foreign firms, and any "comparability" tests the United States imposes on foreign GHG control systems, can be turned around and imposed on the United States. An example will illustrate. The United States might impose its own carbon tax or performance standards on imports of steel rebar products from India, citing an exceptionally high level of carbon emissions per ton of Indian rebar production. In turn, India might impose a duty on all imports from the United States, citing the exceptionally high figure of US per capita CO₂ emissions compared to the world average (table 3 ).

Does this observation mean that, out of fear of retaliation, the United States should do nothing while the planet heats up? Of course not. But it does mean that the United States-as leader of the world trade and financial system-should make an exceptional effort to negotiate agreed international rules before blocking imports or penalizing foreign GHG control measures. The open system of world trade and investment has delivered enormous benefits to the United States since the Second World War. Our calculations indicate that globalization delivers about $1 trillion of benefits annually to the US economy, around $10,000 per American household.⁵ It would be a tragedy to endanger even a small part of these benefits by charging ahead with GHG legislation that takes no account of views abroad.

With respect to questions 3 and 6 in the Committee's White Paper, a US-led effort to agree on international rules would certainly help bring developing countries on board in reducing the GHG emissions. An early US effort will strengthen the US hand when it comes to designing the post-Kyoto Protocol regime. Any legislation enacted by the US Congress in the next year should emphasize foremost the urgency of international negotiations and postpone the imposition of import penalties or comparability mechanisms for at least three years.

Let me now turn to existing WTO rules that bear on climate change legislation. They contain several disciplines, summarized in tables 4, 5, and 6 . At the same time, they permit many trade restrictions and penalties, in the name of ensuring human health and safety, and protecting the environment. But the existing rules do not preclude the eruption of tit-for-tat retaliation if a major player, such as the United States, the European Union, or China, imposes its own brand of GHG trade policy without the prior blessing of a multilateral agreement.

Any US climate legislation which includes trade restrictive measures should reflect the core disciplines of the existing WTO system. If and when WTO members negotiate a new code on trade rules with respect to GHG emissions, these core disciplines are almost certain to be included.

• GATT Article I (Most Favored Nation Treatment): Nondiscrimination is a core principle in the GATT/WTO system, and is reflected in GATT Articles I and III. Article I requires members to ensure that-in the absence of an exception-when favorable treatment is accorded to the goods or services imported from one country, the same treatment must be accorded to the products of all WTO members.
• GATT Article III (National Treatment): This article requires that the products of WTO members be treated no less favorably than "like" products made by firms in the importing country. In decided cases, this requirement has been strictly applied.
• GATT Article XI (General Elimination of Quantitative Restrictions): This article prohibits the imposition of quotas, import or export licenses, or other measures on trading partners unless they fall into one of the exceptions listed in paragraph 2 of GATT Article XI.
• GATT Article XX (General Exceptions): Even though an import restriction on imports violates another GATT article, including the articles discussed above, it might be acceptable if the trade measure conforms to the chapeau of GATT Article XX and falls under one of the subsections. Relevant to climate change, these subsections allow otherwise inconsistent trade restrictions if they are "necessary" to protect human, animal, or plant life or health (Article XX [b[) or if they conserve exhaustible natural resources (Article XX [g]), a term which covers GHG emissions.

Application of these basic rules to foreseeable GHG emissions controls is far from cut and dried. The NFTC published an excellent paper in December 2007, titled WTO Compatibility of Four Categories of US Climate Change Policy, which explores many nuances. I commend this paper to your attention. Only a brave or foolish lawyer would give this Committee strong assurance that such-and-such a system of GHG controls is immune from challenge in the WTO. When the Committee hears such assurances, it should ask its own legal staff to prepare a "devil's advocacy" memo describing the WTO vulnerabilities of the proposed system.

For now, the most reliable guidance for incorporating trade measures in the US climate policy in a WTO-consistent manner can be found by examining the Appellate Body's decisions on previous dispute cases and its interpretation of the shelter available under GATT Article XX. It must be remembered, however, that Appellate Body decisions are made case-by-case; they depend on the particular facts and circumstances, and the rule of stare decisis does not strictly apply. The Appellate Body's rulings in previous cases (table 6 ) show considerable sympathy with environmental concerns and have increased the likelihood that trade restrictions in furtherance of GHG emissions controls would pass muster under WTO rules.

However, in the absence of a negotiated compact that defines WTO "red lines" and "green spaces" with respect to trade measures that foster GHG controls worldwide, tit-for-tat retaliation and prolonged WTO litigation are all but certain if each country goes its own way with climate legislation. In a response to question 5 in the Committee's White Paper, almost all trade restrictive measures stand a fair chance of being challenged in the WTO. The best guidelines I can offer are these: Engage in good faith international negotiations before restricting trade; ensure that the measures adopted make a genuine contribution to the reduction of GHG emissions; and avoid discrimination, both among foreign partners and between US producers and foreign producers.

If the United States enacts its own unique brand of import bans, border taxes, and comparability mechanisms-hoping that measures which flaunt GATT Articles I, III, and XI will be saved by the exceptions of GATT Article XX-the probable consequence will be a drawn-out period of trade skirmishes and even trade wars. During these battles, some countries will become more fixated on winning legal cases than fighting the common enemy, climate change. Global cooperation in limiting emissions could be the first casualty of a unilateral approach that ignores the basic GATT articles.

Notes