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 A lot of the offsets were outdated to those industries.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.