Topic 4.a: Trade and the Environment

1. Topic 4.a: Trade and the Environment • There are two main sets of international environmental linkages: • trade and investment • transboundary environmental impacts • We will talk about trade and investment first • Arguments over whether trade is “good” or “bad” for the environment are typically overly simplistic

2. Topic 4.a: Trade and the Environment • There is a two-way linkage between trade and the environment: • the production and consumption patterns associated with global trade have substantial environmental impacts (trade to environment impact) • the policies designed to manage those impacts have important implications for competitiveness and the pattern of trade (environment to trade impact)

3. Topic 4.a: Trade and the Environment The Trade to Environment Linkage • Trade affects the volume and composition of resource flows and these changes in turn impact on environmental quality. • Three key channels: • a scale effect • a technology effect • a composition effect

4. Topic 4.a: Trade and the Environment The Trade to Environment Linkage • The Scale Effect of Trade • Trade leads to an increase in the volume of production and consumption due to: • specialization according to comparative advantage • the exploitation of scale economies • This trade-induced increase in the scale of economic activity causes an increase in the scale of environmental impact.

5. Topic 4.a: Trade and the Environment The Trade to Environment Linkage • The Technology Effect of Trade • Trade leads to an increase in wealth. This leads to an increase in demand for environmental quality, and pressure for the adoption of cleaner technologies (remember environmental quality is a a normal good) • That is, a substitution of knowledge capital (technology) for natural capital • The strength of the technology effect of trade relies on effective market and political pressure in response to demands for higher environmental quality: • increased market pressure on industry • increased political pressure on government.

6. Topic 4.a: Trade and the Environment The Trade to Environment Linkage • The Composition Effect of Trade • The composition effect reflects the change in relative natural capital intensity across countries in response to specialization. • The environmental impact of the composition effect is: • positive for countries with a comparative advantage in non-natural capital intensive production • negative for countries with a comparative advantage in natural capital intensive production

7. Topic 4.a: Trade and the Environment The Trade to Environment Linkage • Note that an increase in relatively polluting industries in a developing country does not necessarily imply an increase in the absolute level of pollution in that country • The technology effect can mean an absolute reduction in pollution even for countries that specialize in relatively polluting production • Scale effect is negative; technology effect is positive; composition effect is positive for some countries, and negative for others • What is the likely net effect? • The answer depends critically on the type of policies implemented • The key to sustainable growth through trade is the technology effect

8. Topic 4.a: Trade and the Environment The Environment to Trade Linkage • Economies of scale and scope can cause imperfect global competition in global markets and the existence of economic rent • Rent captured by a domestic firm means higher returns to its shareholders, higher wages to its workers and higher taxes to government • However: • higher environmental standards put upward pressure on domestic production costs • cost increases cause a loss of global market share for domestic firms • a smaller share of global economic rents for the domestic country

9. Topic 4.a: Trade and the Environment The Environment to Trade Linkage • National governments may have an incentive to distort environmental policy in an attempt to capture a greater share of global economic rent for their citizens • This can lead to downward pressure on environmental standards • It is in the self-interest of each country to find a balance between environmental quality and capturing a share of global rents All countries acting unilaterally in their own self-interest can potentially precipitate a destructive “race to the bottom” in setting environmental standards

10. Topic 4.a: Trade and the Environment The Environment to Trade Linkage • Three important factors can weaken the negative relationship between environmental standards and competitiveness: • the productivity costs of poor environmental quality • the promotion of technological change • environmental protectionism

11. Topic 4.a: Trade and the Environment The Environment to Trade Linkage • International cooperation, and the integration of environmental agreements with trade liberalization agreements is crucial • The solution lies in comprehensive regional and international policy cooperation • This does not necessarily mean uniformity of policies across countries: policies should be tailored to individual circumstances but set cooperatively

12. Topic 4.b: Transboundary Environmental Impacts • Now we are going back to the second environmental linkage the transboundary pollution problem • Transboundary environmental impacts (TEIs) are impacts of actions taken in one country on environment-related welfare in another country • The prime example of a TEI is global climate change caused by greenhouse gas emissions • Many TEIs involve the physical transportation of air-borne pollutants for example: greenhouse gases (GHGs) and sulphur dioxide

13. Topic 4.b: Transboundary Environmental Impacts • In other instances there is no physical transmission of pollution but there are nonetheless important welfare effects for example: the loss of biodiversity and deforestation • TEIs are international externalities: a cost imposed on other countries for which the source country does not have to pay • Consequence: unilateral action leads to standards that are too low from the perspective of maximizing global welfare • The only resolution to international externalities is through international agreements like the Kyoto Protocol on GHGs

14. Topic 4.c: The Economics of Global Warming • We will begin with a little (very little) background info on the problem of global warming. • Global warming is linked to greenhouse gas (GHG) emissions • increased concentration of GHGs in atmosphere trap heat - hence “greenhouse effect.” • Most common GHGs: Carbon Dioxide, Methane (CH4), Nitrous Oxide (N2O), Clorophluorocarbons (CFCs). • GHG emissions arise from a variety of sources, some anthropogenic (human-made), some “natural.” • First three GHGs are both anthropogenic and natural. • Last four are anthropogenic only. • Note that the distinction between “natural” and anthropogenic emissions can be a little tricky to draw.

17. Trends in atmospheric concentrations and human-generated emissions of GHGs

21. Global warming will be a problem for a LONG time….

22. Topic 4.c: The Economics of Global Warming • Effects on the natural system are likely to be wide-ranging and cannot be known with certainty. • But effects will not be uniform across the world. Likely to be worse impacts in poorer nations. • Some estimates from climate scientists: • Sea levels rising, from both melting of polar ice caps and expansion of ocean volume as it warms. • IPCC estimates: sea level rises of between 7 and 23 inches by 2100 (compares to 6-9 inches last century). • One estimate: rising sea levels “likely” to  land area of Bangladesh by 15%, displacing 13-20 million people.

23. Topic 4.c: The Economics of Global Warming • Heat waves and heavier precipitation in some parts of the world (like here). • Droughts or cooling in other parts of the world. • Some species threatened (polar bears), others will thrive (ants!). • Events arising from climate change disproportionately affect women and children.

24. Topic 4.c: The Economics of Global Warming • Majority of scientists agree that anthropogenic emissions of GHGs are driving (at least in part) climate change. • Alternative view: anthropogenic emissions of GHGs constitute just 5% of overall emissions. • Our emissions are too small to be causing global warming. • This is a minority view. • Effects of global warming are uncertain. • To reverse effects we need to incur costs now in order to receive benefits far off in the future. • So what, if anything, should be done to halt/reverse/slow climate change? • We will look at what policies have been proposed, and what economists have to say about them.

25. Topic 4.c: The Economics of Global Warming • First: some info on the Kyoto Protocol. • Goals of Kyoto: • Reduce aggregate emissions to 5% below 1990 levels by 2008-2012. • Annex I countries (essentially industrialized countries) given various emissions reduction goals. e.g. Canada to reduce to 6% below 1990 levels. • Developing countries emissions not restricted (yet). • Mechanisms under Kyoto: • Emissions trading system (ETS) among Annex I countries. • Clean Development Mechanism (CDM) to incorporate developing countries. • Details of implementation are still unclear, though CDM projects and some emissions trading are going ahead..

26. Topic 4.c: The Economics of Global Warming • Where is Kyoto at? • For Kyoto to be binding, treaty had to be ratified by at least 55 governments from countries responsible for 55% of Annex I country emissions. • Five years ago, it looked like Kyoto was dead: neither Russia nor US would ratify, making 55/55 target impossible. • Late 2004, Russian changed course and ratified, meaning that the 55/55 target was achieved. • US & Australia are only Annex I countries not to have ratified. • Kyoto came into effect on February 16 2005. • Europe has begun carbon permit trading. • Some CDM projects are taking place. • Most countries are a long way off meeting Kyoto targets. • We want to try to get a sense of the economic impacts of Kyoto targets, relative to alternative policy targets.

27. Topic 4.c: The Economics of Global Warming • EU Emissions Trading Scheme (EU ETS) • Phase I launched in January 2005, scheduled to run to end of 07. • Phase II: 2008-2012. • EU ETS targets specific large industrial sectors. • Energy, metal production, cement, bricks, pulp & paper. • Covers about 40% of EU GHG emissions. • Each of 27 member states sets National Action Plan (NAP) to decides their own national-level quota as well as the initial distribution of permits among firms. • Most permits given away; only 0.2% of total permits were auctioned during Phase I. • NAPs are subject to EU approval. • NAP must show progress towards meeting Kyoto target. • But…. very little actual abatement to date (<1.0%).

29. Topic 4.c: The Economics of Global Warming • Other carbon trading schemes? • Norway: cap and trade for heavy industry and major energy generation introduced in 2005. • Japan and South Korea: small pilot programs currently underway. • Australia (non-Kyoto signatory): a form of state-level (NSW) emissions trading for electricity retailers. • US (non-Kyoto signatory): • Some companies have volunteered to reduce emissions by certain amounts and “comply” via carbon trading on the Chicago Climate Exchange. CCX emitting Members make a voluntary but legally binding commitment to meet annual GHG emission reduction targets.

30. Topic 4.c: The Economics of Global Warming • The Western Climate Initiative began in February 2007 when the Governors of Arizona, California, New Mexico, Oregon, and Washington signed an agreement directing their respective states to develop a regional target for reducing greenhouse gas emissions, participate in a multi-state registry to track and manage greenhouse gas emissions in the region, and develop a market-based program to reach the target. • The Premiers of British Columbia, Manitoba, Ontario, and Quebec, and the Governors of Montana and Utah have since joined the original five states in committing to tackle climate change at a regional level. • Regional targets are to be set in 2009.