Those worried about the future of the earth’s climate are hoping that this year’s climate change convention in Lima, Peru, December 2014, will yield progress toward specific national commitments, looking ahead to an international agreement at the make-or-break Paris meeting to take place in December 2015.
Markets can fail. But market mechanisms are often the best way for governments to address such failures. This has been demonstrated in areas from air pollution to traffic congestion to spectrum allocation to cigarette consumption. Markets for emission allowances – in which those firms that can cheaply cut pollution trade with those that cannot – achieve desired environmental goals at relatively low economic costs. As of a decade ago, that long-standing economic proposition had become widely recognized and put into action. Yet the political tide on both sides of the Atlantic has been against “cap and trade” over the last five years.
In the United States, the highly successful trading system for allowances in emissions of SO2 (sulfur dioxide) has all but died since 2012. In the European Union as well, the Emissions Trading System was in effect overtaken by other kinds of regulation in 2013.
Cap-and-trade was originally considered a Republican idea. Market-friendly regulation was pushed by those who thought of themselves as pro-market, rather than by those who thought of themselves as pro-regulation. Most environmental organizations were opposed to the novel approach; many of them thought it immoral for corporations to be able to pay for the right to pollute. The pioneering use of the cap-and-trade approach to phase out lead from gasoline in the 1980s was a policy of Ronald Reagan’s Administration. Its successful use to reduce SO2 emissions from power plants in the 1990s was a policy of George H.W. Bush’s administration. The proposal to use cap-and-trade to reduce SO2 and other emissions further was a policy of George W. Bush’s administration ten years ago under, first, the Clear Skies Act proposed in 2002 and then the Clean Air Interstate Rule of 2005. (See Schmalensee and Stavins, 2013, pp.103-113.)
The problem is not that cap and trade is a theoretical proposal from ivory-tower economists that cannot survive application in the real world. To the contrary, its performance in action surpassed expectations. The mechanism in the 1980s allowed lead to be phased out more rapidly than predicted and at an estimate savings of $250 million per year compared to the old-fashioned approach that did not permit trade. (Stavins, 2003.) SO2 emissions were curbed at a much lower cost than even the proponents of cap-and-trade had predicted before 1995, let alone what the cost would have been under the old command-and-control approach. As expected, the electric power sector chose to close down those plants where it was cheapest to achieve pollution cuts. The flexibility of the cap-and-trade system also allowed the industry to take advantage of unexpected developments such as new scrubber technology and newly accessible low-sulfur coal, to a much greater extent than would have been possible without the market mechanism. (Among those explaining why costs came in so low are Ellerman, et al, 2000.)
The Republican candidate for president in 2008, Senator John McCain, had sponsored US legislative proposals to use cap-and-trade to address emissions of carbon dioxide and other greenhouse gases responsible for global warming. (He had co-sponsored the Climate Stewardship Act with Senator Joe Lieberman in 2003. It was defeated in the Senate by 55 votes to 43. They tried again as recently as 2007, but got no further. McCain continued to advocate a cap-and-trade approach to climate change during the 2008 presidential campaign; Washington Post, May 13, 2008, p. A14; and Financial Times, May 13, 2008, p.4.)
Republican politicians have now forgotten that this approach was ever their policy. To defeat the last major climate bill in 2009, they worked themselves into a frenzy of anti-regulation rhetoric. (The American Clean-Energy and Security Act, sponsored by Congressmen Ed Markey and Henry Waxman, was passed by the House of Representatives that year, but not the Senate.) The Republican rhetoric successfully stigmatized cap-and-trade. Schmalensee and Stavins (p.113) sum it up: “It is ironic that conservatives chose to demonize their own market-based creation.”
This stance left in its place alternative approaches that are less market-friendly (Stavins, 2011) — especially after court cases pointed out that the 1970 Clean Air Act and its 1990 Amendmentswere still the law of the land (originally signed into law by Republican Presidents Richard Nixon and George H.W. Bush, respectively, with heavy bi-partisan congressional majorities both times).
The non-market alternatives, such as “command and control” regulation requiring that particular energy sources or particular technologies be used, are less efficient. Nonetheless they are again the dominant regime. The number of SO2 allowances specified by the cap-and-trade regime has not been adjusted since 2000. As a result, emissions have since 2006 been steadily declining below the ceiling. The cap is no longer binding. People aren’t willing to pay for something if they already have more of it than they need. So the price of emission allowances has fallen steeply, essentially hitting zero since 2012, which indicates that it no longer affects behavior in the electric power sector. (Schmalensee and Stavins, p.106-07; 114.)
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In Europe, the peak of cap-and-trade came 10 years ago. The European Union adopted the Emissions Trading System (ETS) in 2003, as a cost-effective way to achieve the commitments it had made under the Kyoto Protocol on Global Climate Change. It rapidly became the world’s biggest market in the trading of carbon allowances. But ETS has in recent years been pushed aside by older “command-and-control” approaches, in which the government dictates who should use which technologies, in what amounts, to reduce which emissions.
European directives say that 20% of energy must come from renewables by 2020. Renewable energy has been promoted by mandates and subsidies. These policies along with excessive allocations have collapsed the price of emissions permits in the ETS, because demand for the permits now falls short of any binding constraint. The price of carbon fell below 3 euros a ton in April 2013, rendering the market almost irrelevant. It remains very low (5 euros a ton). This in turn contributes to the burning of coal – the worst energy source, from the viewpoint of global warming or local pollution – which would not have happened if the central policy to address these problems were still a mechanism to put a price on carbon.
On top of that, the EU methods of encouraging renewables have proven ruinously expensive. This has been giving pause to European officials as they decide how to extend the 2020 framework to goals for 2030. The European Council will discuss this at a meeting scheduled for March 2014. The EU should abandon its numerical targets for renewables and go back to relying on the ETS, with whatever limits on permit quantities are necessary to keep the price up. This route can achieve greater progress at reducing Greenhouse Gas emissions at lower cost to the European economies.
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There is nothing inevitable or irreversible about the recent trend away from cap-and-trade. Indeed in some parts of the world, such as China, governments seem to be moving in the direction of emissions trading as an efficient way to address global climate change.
Even in the US, where it began, there is still grounds for hope. The Environmental Protection Agency is currently developing federal guidelines for state programs to reduce CO2 emissions from power plants under the Clean Air Act [Section 111(d)]. As a good model for putting a price on carbon, the EPA should consider the cap and trade schemes that have been developed by the northeastern RGGI, California, and some Canadian provinces. The Regional Greenhouse Gas Initiative (RGGI) began trading permits among large power plants in 2008 and continues to operate among nine northeastern states. California recently started an important new emissions trading system. But the Golden State is another example where policies to set standards for particular fuels or particular modes of power generation are in danger of undermining the emissions trading plan [“Assembly Bill 32“].
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- 1. Ellerman, A. Denny, Paul Joskow, Richard Schmalensee, Juan-Pablo Montero, and Elizabeth Bailey, 2000, Markets for Clean Air: The US Acid Rain Program (Cambridge University Press: Cambridge UK).
- 2. International Carbon Action Partnership, Emissions Trading Worldwide — ICAP Status Report 2014, Feb. 2014.
- 3. Littell, David, “Putting a Price on Carbon,” Public Utilities Fortnightly, Feb. 2104.
- 4. OECD, Effective Carbon Prices, November 2013.
- 5. Schmalensee, Richard, and Robert Stavins, 2013,”The SO2 Allowance Trading System: The Ironic History of a Grand Policy Experiment. Journal of Economic Perspectives, vol.27, no.1, winter, pp. 103-122.
- 6. Stavins, Robert, 2003, “Experience with Market-Based Environmental Policy Instruments,” Ch. 9, Handbook of Environmental Economics, edited by Karl-Göran Mäler and Jeffrey Vincent, 355-435 (Elsevier Science: Amsterdam).
- 7. Stavins, Robert, 2006, “Vintage-Differentiated Environmental Regulation,”Stanford Environmental Law Journal, vol.25, no.1, winter, pp. 29-63.
- 8. Stavins, Robert, 2011, “AB 32, RGGI, and Climate Change: The National Context of State Policies for a Global Commons Problem.” An Economic View of the Environment, March 31.
[This is the first of a two-part post, which is the extended version of an op-ed published at Project Syndicate. Comments may be posted there — or at Economist’s View where there is a lively debate. The full version is also to appear at VoxEU.]
On July 27 negotiators reached a compromise settlement in the world’s largest anti-dumping dispute, regarding Chinese exports of solar panels to the European Union. China agreed to constrain its exports to a minimum price and a maximum quantity. The solution is restrictive relative to the six-year trend of rapidly rising Chinese market share (which had reached 80% in Europe), and plummeting prices. But it is less severe than what had been the imminent alternative: EU tariffs on Chinese solar panels had been set to rise sharply on August 6, to 47.6%, as the result of a “finding” by the EU Trade Commissioner that China had been “dumping.” The threat of likely retaliation by China helped persuade the Europeans to back off from their determination to impose such high protective walls around their own solar panel industry.
The China-EU dispute parallels a similar one running between China and the United States. Last fall, tariffs went into effect against US imports of Chinese solar panels, at 24%-36%, after the Commerce Department “found dumping” into the American market. China has already retaliated in a targeted way: imposing tariffs, which could reach prohibitive levels in excess of 50%, on imports from the US of polysilicon. (It had not yet done the same on imports from the EU.) China cited its own finding of US dumping of polysilicon into its market. The material is a key input into the production of solar panels, which gives poetic justice to its choice as target of retaliation.
The solar panel disputes sound narrow and esoteric, as if they might be of interest only to those in the industry. But in fact they offer a revealing “data point” in the long-running debate over globalization, a point that does not seem to be widely recognized.
The globalization debate
Recall where we were in the debate that was launched by anti-globalization protests around the turn of the millennium. (E.g., Rodrik, 1997.) The opponents of globalization did not, by and large, question that rising international trade has a positive effect on economic growth. Trade allows countries to specialize in some products while buying others from partners at lower cost, making real incomes higher than if everybody had to produce everything themselves. (Yes, some workers or industries are likely to be hurt by trade in the short run, specifically those that had been producing the products that are now being imported rather than exported; but a strategy of preserving inefficient industries would lead to economic stagnation in the long run. In this regard, trade works analogously to technological progress.) The most powerful of the anti-globalization arguments seemed to be that even if trade is good for economic progress overall, it might be bad for public goods such as protection of the environment.
What effects does international trade have on environmental quality? (For a survey, see Frankel, 2005 or 2009.) Some effects do indeed work to hurt the environment. Under the well-known “race to the bottom” hypothesis, countries that are open to international trade, in general, are thought to adopt less stringent environmental regulations out of fear of adverse effects on their international competitiveness, as compared to less open countries. But trade can also have beneficial effects on the environment, which tend to be less known. When specialization allows people in each country to attain more of the things they want, opportunities are not limited to material products measured in GDP. The things people want include also cleaner air and water — especially at higher levels of income. When trade brings down costs, it can benefit environmental goods just as easily as other goods.
Which dominate in practice, the pro-environmental effects of trade or the detrimental effects? Some empirical studies of cross-country data find net beneficial effects of trade on some measures of environmental degradation such as local SO2 (sulphur dioxide) air pollution. Trade and growth give countries the means to clean the air and water at the national level, provided they have effective institutions of governance in place.
The evidence does suggest that trade and growth can exacerbate other measures of environmental degradation, however, particularly CO2 emissions (carbon dioxide). The difference can be explained by the observation that CO2 is a global externality, which cannot be addressed at the national level due to the free rider problem.
For example, Copeland and Taylor (2003, 2004) conclude that the net effect of trade liberalization on SO2 concentrations is likely beneficial. Dean (2002) reaches the same conclusion for water pollution. Antweiler, Copeland and Taylor (2001) acknowledge that correlation is not causation and one cannot necessarily tell whether trade might be the result of other factors rather than the cause. Frankel and Rose (2005) seek to address the causality problem. The finding is that trade is beneficial for some measures of environmental quality such as SO2, but harmful for others such as CO2.
Trade could be the savior of solar power
The solar power industry is a perfect example of how trade can have beneficial effects on air quality. Most Europeans, and many Americans, would in principle like to be able to get more of their energy from renewable sources like solar power — but not so much if the cost is exorbitant. Skeptics of solar power have long argued that its share in electricity generation cannot rise above a few percentage points without massive subsidies, because it is too costly unaided to compete with alternatives such as coal. Proponents, for their part, have long made sunnier forecasts, arguing that if moderate subsidies were used temporarily to expand the solar industry, economies of scale and learning-by-doing would then bring down costs sharply.
But proponents have focused too much on subsidies by their own governments and paid insufficient attention to the contribution of international trade. Trade has been a very positive development in the industry of solar power generation in recent years, as the bonanza of cheap solar panels from China had helped keep down costs. Conversely, the new protectionism in solar panels is a negative development. Remarkably, European imports of products that facilitate renewable energy are apparently now the target of almost ¾ of the Trade Defense Instruments currently in force in the EU (by import value; Kasteng, 2013).
High subsidies had also helped drive the European industry until recently. But the subsidies were unsustainably expensive and have now been cut back for budget reasons. With the loss of subsidies and the loss of cheap solar panels from China, the share of solar power in Europe will far short of environmentalists’ goals. (Of course the loss of subsidies also helps explain why hard-hit European solar panel makers lobbied for protection against imports from China.)
Solar-loving Westerners should send Chinese producers of panels a note of thanks for their contribution to keeping solar power viable, rather than letting the US and EU governments impose barriers or blackmail China to restrain the exports “voluntarily.” Apparently western producers of polysilicon, for their parts, are more efficient than Chinese producers, and so they too should be sent a note of thanks by anyone favoring solar power, rather than being penalized in anti-dumping battles. Efficient production in our globalized world economy means different countries specializing in different stages of the process (Deutch and Steinfield, 2013).
What is “dumping”?
But surely “findings of dumping” warrant some response, even if the ensuing damage goes beyond the cause of international trade and growth and falls on a specially valued activity like solar power? Actually, no.
“Dumping” into a foreign market in such cases is defined as selling at a price below cost. (It used to be defined only as selling in the foreign market at a price below the home market price. But the United States wasn’t finding enough cases of dumping under the old definition and so changed it.)
Why would any producing country sell below cost, a recipe for losing money? How does one measure cost, anyway? And why do I keep putting those quotation marks around “finding,” “dumping,” and “cost”? The answers to these questions are closely related.
First, the motive for “selling below cost.” Even those who are generally sympathetic to trade and markets are often given the impression that anti-dumping laws are laws against “predatory pricing:” a large producer is selling below cost in order to drive its competitors into bankruptcy, under a plan subsequently to exploit the absence of competition to raise the price and reap monopoly profits. But in fact, that is not even the way anti-dumping laws are usually written, let alone applied. To put it simply, anti-dumping proceedings, such as the US and EU tariffs against Chinese solar panels, are a means of reducing competition, not of fostering it.
If predatory pricing is not the producers’ motive for selling below cost in these cases, then what is? This leads us to the second question, the definition of cost. The world solar panel industry has a glut of productive capacity on all three continents: in China, in Europe, and in the US. As a consequence, the competitive market intersection of supply and demand occurs at a global price that is below long run average cost per unit, which is defined to include a share of the cost that has already been incurred in building the factories. But that global market price is not below the short run cost of keeping the factories running once they are built. In other words, it is at what economists call Marginal Cost, though below Average Cost. Producers sell at prices where they lose money because, having already built the factories they will lose even more money if they charge above the competitive market price or if they shut down production altogether. That low price is the appropriate competitive outcome. When the US or EU government finds that China is “dumping” solar panels below cost, or when China finds that the US is “dumping” polysilicon below cost, they are using the irrelevantly high measure of average cost instead of marginal cost. By this criterion, dumping occurs every time a store has a clearance sale.
Some have compared the accusations of dumping in the solar panel case, and the subsequent avoidance of anti-dumping tariffs by means of negotiated agreements to limit exports, to past “Voluntary Export Restraints” (VERs) or “Orderly Marketing Arrangements” (OMAs) in the steel and consumer electronic industries, especially those that Japan agreed to apply to its exports to the United States in the 1980s. But an even more illuminating precedent is Japan’s VERs on exports of autos around that same time. American automakers had found it harder and harder to compete against imports of Japanese autos that were not only better value for the money, but were also smaller and more fuel-efficient. Antidumping cases and VERs under the Reagan Administration gave temporary protection. When free trade was eventually restored, the increasing imports of fuel-efficient Japanese autos benefited both American pocketbooks and air quality. The healthy competition even forced a slimmed down American auto industry to become more efficient.
Trade was good for the environment in the case of automobiles thirty years ago. The same is true of trade in solar equipment today. Westerners should celebrate the contribution of trade to reducing the cost of solar power, not block it with protectionist anti-dumping measures.
[This article is expanded from a Project Syndicate column. Comments can be posted there.]
Antweiler, Werner, Brian R. Copeland and M. Scott Taylor, 2001, “Is Free Trade Good For The Environment?,” American Economic Review, 91, no.4, Sept., 877-908.
Copeland, Brian, and Scott Taylor, 2003, Trade and the Environment: Theory and Evidence (Princeton University Press: Princeton).
Dean, Judy, 2002, “Does Trade Liberalization Harm the Environment? A New Test,” Canadian Journal of Economics 35, no. 4, Nov., 819-842.
Deutch, John, and Edward Steinfield, 2013, A Duel in the Sun: The Solar Photovoltaics Technology Conflict between China and the United States, A Report for the MIT Future of Solar Study (MIT Chemistry Department).
Frankel, Jeffrey, 2005, “The Environment and Globalization” in Globalization: What’s New, edited by Michael Weinstein, (Columbia University Press: NY), 129-169. NBER WP 10090. Reprinted in Economics of the Environment: Selected Readings, edited by Robert Stavins, 6th edition, 2012 (W.W. Norton: NY).
Frankel, Jeffrey, 2009, “Global Environment and Trade Policy, in Post-Kyoto International Climate Policy, edited by Joe Aldy and Rob Stavins (Cambridge University Press), 493-529.
Frankel, Jeffrey, and Andrew Rose, 2005, “Is Trade Good or Bad for the Environment? Sorting out the Causality,” Review of Economics and Statistics, 87, no. 1, 85-91.
Kasteng, Jonas, 2013, Targeting the Environment (Swedish National Board of Trade), June.
Rodrik, Dani, 1997, Has Globalization Gone Too Far? (Institute for International Economics).
Taylor, M. Scott, and Brian R. Copeland, 2004, “Trade, Growth, and the Environment,” Journal of Economic Literature, 42, no. 1, Mar., 7-71.