The Fight Over Border Adjustment

So the President, who during the 2008 campaign traipsed through Ohio turning into a second coming of Paul Wellstone, vowing to tear up every free trade agreement and ensure they under his Administration complied with labor and environmental statutes, wants you to know that elements of the Waxman-Markey bill are protectionist.

President Obama on Sunday praised the energy bill passed by the House late last week as an “extraordinary first step,” but he spoke out against a provision that would impose trade penalties on countries that do not accept limits on global warming pollution.

“At a time when the economy worldwide is still deep in recession and we’ve seen a significant drop in global trade,” Mr. Obama said, “I think we have to be very careful about sending any protectionist signals out there.”

He added, “I think there may be other ways of doing it than with a tariff approach.” [...]

The House bill contains a provision, inserted in the middle of the night before the vote Friday, that requires the president, starting in 2020, to impose a “border adjustment” — or tariff — on certain goods from countries that do not act to limit their global warming emissions. The president can waive the tariffs only if he receives explicit permission from Congress.

The provision was added to secure the votes of Rust Belt lawmakers who were wavering on the bill because of fears of job losses in heavy industry.

In the floor debate on the bill Friday, one of its authors, Representative Sander M. Levin, Democrat of Michigan, said, “As we act, we can and must ensure that the U.S. energy-intensive industries are not placed at a competitive disadvantage by nations that have not made a similar commitment to reduce greenhouse gases.”

In the interview on Sunday, Mr. Obama said American industries like steel, aluminum, paper and glass had legitimate concerns about competition from developing nations. But he warned that trade sanctions based on the extent to which other countries curbed carbon dioxide emissions might be illegal and counterproductive.

You can read the transcript of these remarks here.

The thing about global warming is the word "global." More than that, the policy objective of cap and trade is to limit greenhouse gas emissions used by people in this country. Energy companies have already made the threat that, in the event of Waxman-Markey taking hold, they would simply process fuel and coal offshore and bring it to the United States to avoid the emissions cap. Border adjustment is a perfectly reasonable way to avoid that outcome, as Paul Krugman explains:

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.

If the WTO can look at border adjustments and offer its blessing, surely the United States can. The dirty little secret is that countries use very real protectionist policies all the time - it explains the existence of Toyota. In this case, the goal is simple to avoid unintended consequences from the policy. I assume Barack Obama does want to reduce greenhouse gas emissions. This is the way to ensure that cap and trade doesn't simply result in leakage. In addition, making China concerned about a trade war is a good way, perhaps the only way, to get them on board with global climate change talks.

In addition, there's that dirty little secret about the Congress and also this nation: we have a lot of fair traders, enough to scuttle the bill:

First, I may be wrong on this, but given the closeness of the vote, is anybody sure that Waxman-Markey would've passed without the border adjustments? I'm not, and, I'm also pretty sure that nothing passes the Senate without them (maybe not even with them), so this surely deserves much larger weight on the 'pro' side of the ledger than people seem to be granting.

Second, the potential scale of losses from leakage don't sound trivial to me. A report by RFF says that the benefits of unilateral US carbon pricing are reduced by 25% if nothing is done to stop leakage. And, comparing border adjustments to other ways to curb this leakage while we wait on an international agreement make them look pretty good to me.

I am not very sanguine about the politics of losing a quarter of the benefits of an incredibly hard-fought legislative win every year while we wait on an international agreement - how durable do people think the WM win will be if opponents can come back every year with (not totally in-credible) estimates of how many jobs we've lost to trading partners because of it? The border adjustment in WM buys more than a decade to reach an agreement before it kicks in. This seems entirely reasonable to me.

Third, where I think Krugman is most right about this stuff is how bizarre it is that a (literally) textbook economics solution (albeit a second-best one) to this problem (that is probably even allowed under existing international trade law) has inspired such ferocious hand-wringing about protectionism, coercion, and making other countries furious. There is no rational reason at all why a carbon tariff that any country can unilaterally disarm through its own actions should be a serious hold-up to an international agreement.

Nobody wants to talk about the populist elements of the House, which is this case are the only ones who get the economics of the situation, IMO. But they must be reckoned with.