Commentary on Political Economy

Wednesday, 6 January 2021


The West Can Stop Climate Free Riders Like China

A low-carbon trade area between the U.S. and Europe would be good for the climate, the geopolitical West and the world.

Membership pays in Club Atlantic.
Membership pays in Club Atlantic. Photographer: Paul Ellis/AFP via Getty Images

There’s a great way the U.S. and the European Union could together address two huge challenges in one policy sweep. It’s to create a transatlantic “carbon club,” which I’ll describe in a moment.

The geopolitical promise of this idea is to resurrect the notion of the “West” at a time when the U.S. and Europe are drifting apart but still hoping to rejuvenate their alliance after Joe Biden becomes president. The even bigger goal is to win the struggle against global warming, which both Biden and the EU cite as their priority.

The only way to slow climate change is to dramatically reduce our planetwide emissions of greenhouse gases. And the best approach to that is to put a price on carbon that’s both high and rising. This signal will make producers and consumers adopt behaviors and technologies to pollute less.

Within a given jurisdiction, we already know how to set such a carbon price. You can tax emissions directly. Or you can limit their overall amount by law, then issue carbon allowances which firms can buy and sell in an open market, at a price that constantly changes. This way emissions will be cut fastest wherever it’s easiest and cheapest to do so.

Of these cap-and-trade systems, the EU, Norway, Iceland and Liechtenstein jointly have the world’s largest. Still, it only covers sectors — from power generators to steelmakers and airlines — that account for 40% of European emissions, so the system must be expanded. Even then it still faces a bigger problem.

It’s that the rest of the world isn’t in the system. This both slants the economic playing field against European companies and leads to “carbon leakage.” Take a European steel company, for example. It must buy allowances to emit carbon, which is a cost. To avoid that cost, it can invest in technology that makes production cleaner, but that’s also expensive.  

By contrast, a Chinese steelmaker doesn’t incur this cost yet. A European firm that uses steel could therefore simply switch to buying it more cheaply from China than from the home market. The European steelmaker and its workers lose. And the world loses because the same amount of carbon — or even more — has been emitted, just elsewhere. Only the Chinese supplier wins.

This is the classic problem of free riding, as analyzed by the economist William Nordhaus among others. In a nutshell, countries have an incentive to share in the benefits of a global public good — saving the climate — while shirking the costs of abatement. This logic, also known as the “tragedy of the commons,” explains why purely voluntary international climate deals such as the defunct Kyoto Protocol or the Paris Agreement tend to disappoint.

The solution to the free-riding dilemma is the club model proposed by Nordhaus and now endorsed by sharp minds such as Guntram Wolff, the director of Bruegel, a think tank in Brussels. Here a group of countries would agree on a minimum international carbon price.

All club members would then set about reaching that price with either a carbon tax or a cap-and-trade system, the equivalent of their club dues. As long as their domestic carbon prices are high enough and comparable, there’s no need for club members to punish each other’s imports, so they trade freely (if you ignore other tariffs and quotas for the moment).

Non-members of the club, by contrast, would have to pay countervailing carbon duties on their exports to the club. The EU calls this a “carbon border adjustment mechanism” (CBAM). Unlike ordinary tariffs, the surcharges wouldn’t aim at making domestic producers more competitive but at spreading the cost of global carbon abatement. So they should be allowed by the World Trade Organization.

To existing members, the benefits of membership would be obvious, so the club would be a stable coalition. All others would quickly see the upside of joining the club by aiming for the same international carbon price at home.

As a first and relatively small demonstration project, the EU could link its emissions trading system with whatever the U.K. implements, now that it’s left the European regime (thereby causing that system to shrink by 11% overnight). Simultaneously, the Biden administration could work on the bigger goal of introducing a national cap-and-trade for the U.S.

All the while, diplomats on both sides of the pond would be preparing the transatlantic carbon club, a trade zone without internal carbon duties. Compared to negotiating comprehensive free-trade deals, such as the moribund Transatlantic Trade and Investment Partnership, this should be a cinch.

In the process, the Western democracies would once again act as world leaders playing on the same team. But their club isn’t meant to be exclusive. Rather, it would measure its own success largely by how many new members it can attract over time. It would welcome the world’s biggest emitter of greenhouse gases, China, with particular enthusiasm.

If we still have a shot at controlling global warming, this might be it. Moreover, this kind of positive cooperation between rivals in east and west would have other benefits. Anxiety is growing that the enmity between the U.S. and China could one day end as the contest between Imperial Germany and the British Empire once did: in war. A successful collaboration against the common enemy, global warming, could defuse this conflict — and save the planet along the way.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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