Krugman vs. Obama on border adjustments in the climate bill

Obama’s interview on the climate bill last week had this Q&A (transcript here, my earlier summaries here and here):

Media: One of the provisions that got added very late to this bill that senators had expressed some reservations about was the one that puts tariffs on goods imported from countries that don’t have these sort of restrictions. What do you think of that revision and would you like to see the Senate strip it out?

Obama: At a time when the economy worldwide is still deep in recession and we’ve seen a significant drop in global trade, I think we have to be very careful about sending any protectionist signals out there. There were a number of provisions that were already in place, prior to this last provision you talked about, to provide transitional assistance to heavy manufacturers. A lot of the offsets were outdated to those industries. I think we’re going to have to do a careful analysis to determine whether the prospects of tariffs are necessary, given all the other stuff that was done and had been negotiated on behalf of energy-intensive industries.

So certainly it is a legitimate concern on the part of American businesses that they are not disadvantaged vis-a-vis their global competitors. Now, keep in mind, European industries are looking at an even more ambitious approach than we are. And they obviously have confidence that they can compete internationally under a regime that controls carbons. I think the Chinese are starting to move in the direction of recognizing that the future requires them to take a clean energy approach. In fact, in some ways they’re already ahead of us — on fuel efficiency standards, for example, they’ve moved beyond where we’ve moved on this.

There are going to be a series of negotiations around this and I am very mindful of wanting to make sure that there’s a level playing field internationally. I think there may be other ways of doing it than with a tariff approach.

Krugman disagrees with the President (and I tend to agree with the Nobel Prize winner in Economics):

The truth is that there’s perfectly sound economics behind border adjustments related to cap-and-trade. The way to think about it is in terms of a well-established theory “” the theory of non-economic objectives in trade policy “” that owes its origins to Jagdish Bhagwati, who certainly can’t be accused of being a protectionist. The essential idea is that if you have a non-economic objective, such as self-sufficiency in food production, you should choose policy instruments to align incentives with that objective; in normal circumstances this leads to consumer or producer intervention, rarely to tariffs.

But in this case the non-economic objective is to reduce greenhouse gas emissions, never mind their source. If you only impose restrictions on greenhouse gas emissions from domestic sources, you give consumers no incentive to avoid purchasing products that cause emissions in other countries; as a result, you have an inefficient outcome even from a world point of view. So border adjustments here are entirely legitimate in terms of basic economics.

And they’re also probably OK under trade law. The WTO has looked at the issue, and suggests that carbon tariffs may be viewed the same way as border adjustments associated with value-added taxes. It has long been accepted that a VAT is essentially a sales tax “” a tax on consumers “” which for administrative reasons is collected from producers. Because it’s essentially a tax on consumers, it’s legal, and also economically efficient, to collect it on imported goods as well as domestic production; it’s a matter of leveling the playing field, not protectionism.

And the same would be true of carbon tariffs.

What’s happening here, I think, is that people are relying on what Paul Samuelson called an economic “shibboleth” “” they’re relying on some slogan rather than thinking through the underlying economics. In this case the shibboleth is “free trade good, protection bad”, when what the economics really says is that incentives should reflect the marginal cost of greenhouse gases in all goods, wherever produced “” which in this case happens to imply border adjustments.

Later he added this post:

Testimony on the issue from a real trade lawyer (thanks to Richard Baldwin, who pointed me to this document). The bottom line:

In sum, if carefully calibrated along the lines suggested above, carbon equalization measures at the border, imposed on certain imports, can be modeled in compliance with WTO non-discrimination rules and/or the WTO’s environmental exception.

So the economics are right; it’s WTO-legal; and it would neutralize a major political argument against controlling greenhouse gases. Why, oh, why, would Obama say “Ni”?

A Monty Python allusion, nudge, nudge!

Ultimately, if the world is going to stabilize anywhere near 2°C total warming — no mean feat — then every major country will need to participate.  The world will need very strong sanctions against bad actors.

So I think it is an important precedent to start with what appear to be completely legal and appropriate border adjustments.  The judges are giving this round to Krugman.

8 Responses to Krugman vs. Obama on border adjustments in the climate bill

  1. NFJM says:

    A border tax adjustement is not necessarily a distortion of the market but rather creates an even playing field. It would consist in requiring from the importers to surrender (and therefore purchase) emission allowances based on their real emissions. Off course if free emission allowances are distributed to domestic producers, then importers should receive the same level of allowances for free per tonne of product.
    Indeed with a border adjustment, emission allowances and its associated bureaucracy are no longer needed. The full cost of carbon can be passed to steel leading to its efficient use and therefore a decarbonization of the economy through its efficient production AND efficient use. With the distribution of free allowances, the price signal to use less steel or use it less efficiently is weakened.
    Is it really bad to contract the steel demand and replace it by efficiency (=good engineering)? I would said not bad considering the US imports roughly 1/5 of its need.

    Additional “benefits” of border adjustment are:
    – the need for a data collection from the producer (you can’t control what you can’t measure… and we want to control GHG emissions, right?)
    – an negotiation card which strongly invites countries with heavy industries into “sectoral approaches” in which their own production would face similar constraints
    – a uniform price signal and no carbon leakages

    As you see the solutions rated from the best to the worst are:
    – an even playing field for a certain type of goods with full auctionning of emissions worldwide (e.g. country with caps + sectoral cap for industrial sector in developing countries), OR
    – A sectoral agreement worldwide for a specific sector

    – a cap in developed countries only with free allocation of emission allowances.
    – a cap in developed countries only with full auctionning of the emission allowances (maximum market distortion).

    Many industries I worked with have a clear preference for border adjustments in sectors where the number of products or sub-categories of products is limited and the number of plants to survey worldwide for the proper number crunching is also limited.

  2. KJ says:

    Why not consider import subsidies on low-GHG goods? Tariffs and subsidies can be used in combination to preserve revenue neutrality. If we’re considering output-based allocation for our trade-sensitive industries, why not apply the same principle to imports?

  3. Greg Robie says:

    Asserting that WTO rules constitute what is “legal” is, while not inaccurate, likely a euphemism for what is, at best, extra-Constitutional (and from a strict Constitutional view, unconstitutional).

    That aside (which it should not be!) the devil is in the details. As I consider this I have to wonder whose competitor gets hammered and whose doesn’t—at least when it comes to enforcement; to practice. Do I see a new source of political contributions opening—and more sausage making that has little to do with clean or secure energy, or GHG regulation?

    In addition, is the inclusion of tariffs a conflict regarding the stated jurisdictional rational for the legislation (regulating GHG emission from U.S. sources)? Isn’t the conundrum of this legislation (if it isn’t just a jobs bill) that unless the jurisdictional is Constitutional the legislation is flawed, and unless the legislation is framed to cover all the global sources that are the result of what is consumed and/or invested in by United States citizens, it is scientifically ineffective relative to the reported need to reducing CO2 emissions to 1990 levels by 2050? Isn’t what is “legal”—but not rational/sane—that we are free to pursue, with “legal” limited liability (relative to precedents of common law) profit and consumption as we feel is best for us?

    BTW, my read of the transcript says words are being put into the President’s mouth that he did not say. Is his phrasing, like his use of language during the campaign relative to “hope” and “change,” such that one can project into it whatever ones feelings say should be there?

  4. Well, the obvious reason border tariffs are a bad idea is that the threat of them makes a global climate deal impossible. We are not setting the terms here, folks.

  5. Peter Wood says:

    I’m a strong supporter of border tax adjustments (BTAs) for the reason that Joe stated quite succinctly: “The world will need very strong sanctions against bad actors.”

    But when it comes to the BTAs in the Waxman-Markey bill, there is trouble in the fine print. The relevant sections of the Waxman-Markey bill are Sections 765-769 of the bill, especially 767 (c). In my opinion, BTAs should apply if a country is not participating in, or in compliance with, an international agreement.

    The provisions in W-M are different, and impose other conditions on countries. While I can see the temptation to do that, I don’t think it will help. The W-M provisions require that countries satisfy one of the following requirements in order to avoid BTAs:

    (1) The country is a party to an international agreement to which the United States is a party that includes a nationally enforceable and economy wide greenhouse gas emissions reduction commitment for that country that is at least as stringent as that of the United States.
    (2) The country is a party to a multilateral or bilateral emission reduction agreement for that sector to the which the United States is a party.
    (3) The country has an annual energy or greenhouse gas intensity, as described in section 763(b)(2)(A)(ii), for the sector that is equal to or less than the energy or greenhouse gas intensity for such industrial sector in the United States in the most recent calendar year for which data are available.

    This could imply that India, with per-capita emissions something like 16 times less than the United States, could be subject to BTAs. We should not forget that the Kyoto Protocol is now in force, but the US has not ratified, even though the US negotiated a 7% reduction for the commitment period. If any country should be subject to BTAs, the US (and possibly Canada) would be prime candidates.

  6. Eli Rabett says:

    Might I suggest, Eli Rabett’s Simple Plan to Save the World, first published in December 2007

    Nations wishing to make major progress on decreasing greenhouse gas emissions should introduce emission taxes on all products. These taxes should be levied on imports as well as domestic goods at the point of sale, and should displace other taxes, such as VAT, sales taxes, and payroll (e.g. social security, health care) in such a way that tax revenues are constant, and distributed equitably.

    These should be introduced as an Emissions Added Levy (avoiding the bad jokes). EAL would be imposed on sale for emissions added in the preceding step and inherent to the consumption of the product, as would be the case for heating oil and gasoline. Manufacturers would pay the EAL on electricity they bought, and incorporate this and the levy on emissions they created into the price of the product they sell.

    Imports from countries that do not have an EAL would have the full EAL imposed at the time of import. The base rate would be generic EALs based on worst previous practices in the countries that do have EALs, which would be reduced on presenting proof that the actual emissions were lower.

  7. Peter Wood says:

    A related issue is what happens if a country, that has a carbon price and is in compliance with an international agreement, but exports fossil fuels to a country that is not. There is an argument that a border adjustment should be levied in this situation as well — the exporting country should tax the fossil fuel.

  8. Stefanie Feldman says:

    While President Obama’s concern regarding protectionist signals is reasonable, something – whether border adjustments or another alternative – needs to be done in order to decrease the emissions from the production of the goods we consume.

    Leakage of American demand to other countries could set back some progress made toward answering the challenge of global warming. In order to have the greatest impact on climate change, we should ensure that calculation of emissions consider the entire lifecycle of products, a lifecycle that includes manufacturing and transportation in other countries.

    Preventing this leakage is particularly important given the potential of a clean energy bill to recharge our economy and, in the words of Speaker Pelosi on June 26th on the House floor, create “jobs, jobs, jobs, and jobs” for Americans.

    Ideally, all countries would take global warming emissions into account as a cost of production. A global agreement is one solution to the problem of uneven emissions standards. It would be a great success if President Obama leaves Copenhagen this fall with an international agreement, and much more likely to happen if the Senate passes a strong cap-and-trade program.

    But, until such an agreement takes place, a border tax adjustment should not be off the table. This policy could be the answer. An effective energy bill with a border tax adjustment can provide a level playing field for American businesses and motivate changes internationally.

    And such tariffs do not need to be considered punitive; as stated by the President of the United Steel Worker, Leo W. Gerard, in a June 25 letter to the House of Representatives endorsing their recently passed cap-and-trade program, the tariff could acknowledge that “The privilege of being able to sell to the American consumer brings with it the shared responsibility to improve the global environment for future generations.”

    Stefanie Feldman, Environment America Global Warming Intern