The China/India hole in the American climate strategy

[Annex II countries] are required to provide financial resources to enable developing countries to undertake emissions reduction activities under the Convention and to help them adapt to adverse effects of climate change.

According to EIA, in 2006 seventeen countries accounted for about three-fourths of all CO2 emissions. Let’s think of these as the “big” nations. The other 175 countries account for the other quarter of CO2 emissions. I think of them as relatively “small” in this context.

In 2007, President Bush created the Major Economies process, in which the largest economies meet as a group to see if they can reach agreement on climate change. If they are successful, that agreement can serve as the starting point for a broader discussion involving all 192 countries in the UNFCCC. The Major Economies process has been productive so far, and has been continued by the Obama Administration.

This table shows how these two approaches divide countries into four groups. The UNFCCC developed/developing breakdown is the separation between the rows of the table, in which there are greater obligations imposed on countries in the top row than in the bottom row. The Major Economies process is the separation between the columns of the table, based on the presumption that if the seventeen countries that represent about three-fourths of global emissions can reach agreement, then it should be much easier to get agreement with everyone else. It is hard to negotiate with 192 countries in the same room, and clearly China has a bigger impact on the global climate than Burkina Faso.

	Major	Not major
Developed	AustraliaCanada European Union France Germany Italy Japan United Kingdom United States         (9 countries, about 36% of global CO2 emissions in 2006)	AustriaBelgium Denmark Finland Greece Iceland Ireland Luxembourg Netherlands New Zealand Norway Portugal Spain Sweden Switzerland         (15 countries, about 5% of global CO2 emissions in 2006)
Developing	BrazilChina India Indonesia Korea Mexico Russia South Africa         (8 countries, about 38% of global CO2 emissions in 2006)	everyone else         (160 countries, about 21% of global CO2 emissions in 2006)

Source: U.S. Energy Information Administration for CO2 data

To simplify even further, we can see that the four biggest CO2 emitters in 2006 accounted for half the global total:

Rank		Millions of Metric Tons of CO2 (2006)	% of world total	cumulative % of world total
1	China	6,018	21%	21%
2	U.S.	5,903	20%	41%
3	Russia	1,704	6%	47%
4	India	1,293	4%	51%
5	Japan	1,247	4%	55%
6	Germany	858	3%	58%

Source: U.S. Energy Information Administration for CO2 data

China and the U.S. dominate everyone else in CO2 emissions. Each is larger than the next five biggest emitters combined. China has recently passed the U.S., and the gap is expected to grow as China industrializes at a rapid rate. If you believe that we need to slow the growth of global emissions, the arithmetic demands that you slow the growth of emissions not just from the U.S., but also from (China + Russia + India). It is arithmetically infeasible to get significant reductions in future total global greenhouse gas emissions if this >30% of the total is allowed to grow unchecked. This point is only strengthened if you include the additional 7% from the five other major developing economies: Brail, Indonesia, Korea, Mexico, and South Africa, or if you include the additional 21% from the 160 small developing countries.

There are huge national differences in the effects of climate change. Some differences are geographic: Russia would probably benefit from a warmer planet, as they would face lower heating costs and have more arable land. Low-lying island states are at greater risk from a significant sea rise. Other differences are economic: a rich country like the U.S. can better adapt to a changed environment than can a poor country. These differences mean that that countries will have different views on the importance of addressing the risk of severe long-term climate change. As an example, if one ignores diplomatic considerations, from a pure national self-interest standpoint it is hard to see why the government of Russia should sacrifice anything to keep the planet from warming.

For the sake of this discussion, the form of a national policy that limits a country’s carbon emissions is less important than the size of that effect. There are important differences between a cap-and-trade policy and a carbon tax, but for the sake of this discussion I think we can hand-wave past them and just think of a country imposing an incremental price added to the cost of carbon emissions, either directly through a tax, or indirectly through a quantity-limiting cap. A positive carbon price addresses some or all of the damage that we’re stipulating is done to the (global) environment by your carbon emissions. This price results in slower economic growth in your country, as it generally raises the price of energy.

The strategic challenge (for the world, not just the U.S.) is that the governments of China, Russia, and India are big economies with big shares of total world emissions. They have so far not indicated any willingness to self-impose a positive carbon price, and its resulting economic burden, on their economies.

What, then, is the rational American strategy? Let me construct a much simpler example to crystallize the negotiating issues. Let’s pretend we live in a two-country world, the U.S. and China, and that each emits half of the world’s total carbon emissions. Let’s further assume that a ton of carbon emissions does $30 of damage to the world, and that the damage is again split evenly, so that a ton of carbon emissions from either nation does $15 of damage to the U.S. and $15 of damage to China.

I imagine a member of Greg Mankiw’s Pigou Club might say, “Just impose a global carbon tax/price of $30 per ton of carbon and you’re done. The market will handle everything else, as long as you have solid and consistent enforcement. Individual actors will then appropriately balance the costs and benefits of their carbon-producing actions. It is clean, simple, and fair.”

But suppose the government of China says, “We’re not going to impose any additional cost on the Chinese economy to limit our carbon emissions. No carbon tax, or if we agree to a cap, it will be sufficiently high that we are confident it won’t require us to slow our economic growth. We are happy to do things like adopt energy efficiency technologies and limit more traditional forms of pollution, and some of those actions will also result in reduced greenhouse gas emissions. But we are not going to impose a positive price of carbon on the Chinese economy. Near-term economic growth is far more important to us than possible long-term climate change benefits decades or centuries from now.”

What, then, are the U.S. options? I think there are two decisions U.S. policymakers need to make to have a complete strategy:

1. What tools should we use to try to convince the government of China to impose a positive carbon price as part of a global effort? (choose one or more)
   1. Leadership: U.S. goes first and self-imposes a price. Then we use diplomacy to try to convince the Chinese to do the same.
   2. Carrots: The U.S. pays the Chinese to reduce their emissions.
   3. Sticks: The U.S. imposes import tariffs on Chinese goods as long as the government China does not impose a carbon price.
2. What carbon price should we set in the U.S. while the government of China is telling us they’re at zero?
   1. $30 – We are altruistic and will account for all damages that U.S. emissions do to the world.
   2. $15 – We will account for all damages that U.S. emissions do to the U.S.
   3. $0 – We will wait until China joins us.

On decision (1), we need to consider the effectiveness of each tool: how likely is it to convince the government of China to change their policy? This is a question for the intelligence community and diplomats.

The risk of (1A) is that it could be ineffective. In a true global context (rather than my simplified two-country example), I believe there is power in moral and diplomatic suasion, but I question how much of a $30/ton gap diplomacy alone can close.

In (1B), the payments can be direct through higher U.S. taxes and direct transfers to China. Or we could follow the path of the Waxman-Markey bill and cap U.S. emissions. If the U.S. policy then allows U.S. emitters to buy carbon offsets from Chinese firms, we would be choosing a policy that will transfer American resources to China as the most efficient path to reductions in carbon emissions. This what the Europeans have been doing. I think this is probably unacceptable to most Americans and their representatives in Congress.

(1C) risks starting a global trade war. In a world with more than two countries, it is also possible that we would impose a tariff that would hurt American consumers of Chinese goods, and other nations would not do the same. The government of China might then choose not to change their carbon policy, and instead just sell more goods to countries other than America.

On decision (2), we need to consider that firms and workers in China compete with firms and workers in the United States. The difference between the self-imposed U.S. and Chinese carbon prices is a direct and measurable disadvantage to U.S. firms and workers relative to their Chinese counterparts. So if we preemptively impose a $30/ton of carbon price in the U.S. while China has a zero carbon price, then we are significantly handicapping American firms and American workers relative to their Chinese competitors.

The Waxman-Markey bill attempts to solve this problem by having U.S. taxpayers subsidize those disadvantaged firms. Setting aside the impossibility of a government accurately targeting those subsidies, and ignoring the likelihood that this will become a rent-seeking regulatory process, this solution merely shifts the costs from one subset of the U.S. to another. The underlying economic disadvantage to Americans would remain unaddressed.

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America appears to lack a high-probability strategy for how to get China, India, and Russia to agree to self-impose a significant positive carbon price.

The Administration and its Congressional allies are trying to impose a significant carbon price in the U.S. through something like the Waxman-Markey bill, while entering an international negotiation process in which as much as 60% of global carbon emissions could face little to no carbon price. The likely outcome would dramatically tilt the global economic playing field, harming U.S. workers and firms relative to their counterparts in China and India. At the same time, it would make little progress toward addressing the risk of severe global climate change, as a large portion of global carbon emissions would remain effectively uncapped.

From an American standpoint this seems extremely unwise. It is an incomplete climate change strategy, with a hole about how to deal with China, India, and other large developing nations.

Here are questions for the Administration and those House Members supporting the Waxman-Markey bill:

1. Given that China, India, and Russia account for 30% of global carbon emissions, and given the apparent lack of a high-probability American strategy to convince their governments to impose a carbon price on their workers and firms, how large of an additional cost are you willing to impose now on U.S. workers and firms before knowing the likely economic and emissions endpoints?
2. What is your strategy to get the governments of China, India, and Russia to impose a carbon price on their economies that is comparable to the one you would impose on American workers and firms?
3. Given the competitive effects on American workers and firms, how big of a difference between the carbon price imposed by the U.S. and that imposed by China and India is acceptable at the end of the international negotiating process? How much of a competitive disadvantage are you willing to impose on U.S. workers and firms because the U.S. is comparatively wealthy relative to China, India, Russia, and other developing countries?

I believe the answers to these questions are more important than any detail of the Waxman-Markey bill, and that legislation should not move forward until Congress has answers to each of these questions.

If the Administration and its Congressional allies are going to propose imposing large costs on American workers and firms, let’s at least have a complete strategy.

(I would ask and challenge commenters to focus on these strategic questions, rather than the usual scientific back-and-forth. And please remember the comments policy: I hope we can have a vigorous and yet civil debate.)