The Strategic Value ofEmbodied Carbon Tariffs

Thomas F. Rutherford

Department of Agricultural and Applied EconomicsUniversity of Wisconsin, Madison

Joint work withChristoph Bohringer (University of Oldenberg) and

Jared C. Carbone (University of Calgary)

International Energy WorkshopIEA Paris

June 19, 2013

1 / 37

Carbon Embodied in Trade

Emissions embodied in non-OECD exports to OECD = 14.5% of all OECD emissions.

United States

Rest of EU

Japan Germany

United Kingdom

Italy

France

Canada

India

South Africa

Russia

OPEC

Rest of World

China

-200

0

200

400

600

800

-600 -300 0

Net

Exp

ort

s o

f Em

bo

die

d C

arb

on

to

OEC

D C

ou

ntr

ies

(Tg)

Net Exports of Embodied Carbon to Non-OECD Countries (Tg)

2 / 37

Embodied Carbon Tariffs

Two potential roles as environmental policy:

Regulatory — directly discourage pollution abroad

Strategic — stimulate adoption of pollution controls abroad

3 / 37

Are carbon tariffs likely to stimulatemeaningful pollution control abroad?

Do they benefit users?

Do they punish targets?

What is a target’s best response?

4 / 37

The United States per capita emission rate is four times as big asChina’s. Does that mean we can impose 400 percent tax rates on allimported American goods? If so, the result is a global trade war thatis good for no one and no use at all in the fight against climatechange.

— Zhang Xiangchen, one of China’s permanent representatives atthe World Trade Organisation, October 2009

5 / 37

Policy Game

… …

No Tariff Tariff

Coalition

Non-Coalition1

Non-Coalition2

Non-CoalitionN

D-N C

D-N C

D-N C

D-N R C

D-N R C

D-N R C

…

D-N = “Do Nothing”, R = “Retaliate”, C = “Cooperate”6 / 37

Our Experiment

1 Use GTAP 7.1 and empirical elasticity estimates to calibrate a “typical”CGE model used to study carbon leakage (static, CRS, sectorally-mobilefactors, Armington trade, inelastic energy supply).

2 Enumerate all policy regimes (26 + 36 = 793) and use CGE model togenerate payoffs of the policy game.

3 Solve for Nash equilibria.

7 / 37

Regions

Coalition United States (usa)

EU-27 plus European Free Trade Area (eur)

Other Annex I minus Russia (ra1)

Non-Coalition China and Hong Kong (chn)

India (ind)

Russian Federation (rus)

Other Energy-Exporting Countries (eex)

Other Middle-Income Countries (mic)

Other Low-Income Countries (lic)

8 / 37

Sectors

Energy Coal (col), Crude Oil (cru), Natural Gas (gas), RefinedPetroleum and Coal (oil)*, Electricity (ele)

Energy-intensive Chemical, Rubber, Plastic Products (crp)*, Iron and Steel(i s)*, Non-Ferrous Metal (nfm)*, Non-Metallic Mineral(nmm)*, Water Transport (wtp), Air Transport (atp), OtherTransport (otp)

Other All Other Goods (aog)

* — Indicates energy-intensive and trade-exposed (EITE) sectors that are the subject of

the carbon tariffs and countervailing measures.

9 / 37

Non-Fossil-Energy Production

10 / 37

Fossil-Energy Production

11 / 37

Armington Aggregation

12 / 37

Data Structure

Yir

RAr

Cr Ir Gr Mir

vdfmiIrvdfmiCr vdfmiGr

vifmijr vifmiCr vifmiGr

RYir RC

r

vbr

RGr RM

ir

vimir

vomir

vxmir, vstir

vdfmijr

vxmdisr, vtwrjisr

vpmr vimr

vfmmir

vfmsir

vgmr

13 / 37

Summary Statistics

CO2 GDP CO2

Intensity

CoalitionUnited States 6.07 11701.33 0.52Other Annex-I 2.57 6766.20 0.38Europe 4.08 13563.78 0.30

Non-CoalitionRussia 1.54 571.80 2.70China 4.31 1843.01 2.34India 1.06 641.68 1.65Other Energy-Exporting 2.48 1650.92 1.50Other Low-Income 0.66 478.10 1.38Other Middle-Income 2.96 3861.22 0.77

Notes: CO2 measured in billions of metric tons; GDP mea-

sured in billions of US dollars 2004; CO2 intensity mea-

sured in metric tons per thousand dollars.

14 / 37

Key Assumptions: Non-Coalition Actions

Cooperate (C) — non-coalition regions restrict domestic emissions by an amountequal (as a percentage of BaU emissions) to the reductionsundertaken by the coalition. Non-coalition abatement takes place viaa regional carbon tax (or regional tradable permit system) that isuniform across all of a given region’s sectors.

Retaliate (R) — non-coalition region raises a uniform import tariff on EITEgoods from all coalition countries such that the added revenuegenerated by this tariff equals the revenue generated by the carbontariffs imposed on them collectively. It continues to operate withunrestricted emissions.

Do Nothing (D-N) — non-coalition region operates with unrestricted emissions.

15 / 37

Key Assumptions

Coalition commitment consistent with constant (∼10%) global abatementacross policy regimes (⇒ full crowding out)

Embodied carbon = direct + electricity

Carbon and retaliatory tariffs on EITE goods only

(Refined Oil Products; Chemicals, Rubber and Plastics; Iron and Steel; Non-Ferrous

Metals; Non-Metallic Minerals)

Embodied carbon = direct + electricity

Cooperation means equal abatement as % of BaU

16 / 37

Nash Eq. vs. “No Tariff” Best Response

% Welfare Loss ∆

Coalition Action: Tariff No TariffNon-Coalition Actions: CHN,RUS=C All D-N

Others=R

All 0.19 0.37 -0.18Coalition 0.10 0.31 -0.21Non-Coalition 0.51 0.62 -0.11

China 0.25 0.23 0.02Russia 2.77 3.21 -0.46

17 / 37

Nash Eq. vs. “No Tariff” Best Response

% Abatement ∆

Coalition Action: Tariff No TariffNon-Coalition Actions: CHN,RUS=C All D-N

Others=R

All 9.88 9.88 –Coalition 14.31 22.00 -7.69Non-Coalition 5.55 -1.95 7.50

China 14.31 -0.84 15.15Russia 14.31 -2.33 16.64

18 / 37

Two Things Drive Cooperation

1 Effect of carbon tariffs

2 Cost of abatement

Direct abatement costs

Changes in terms of trade when abatement shifts

19 / 37

Effect of Carbon Tariffs

% Welfare Loss ∆

Coalition Action: Tariff No TariffNon-Coalition Actions: All D-N All D-N

All 0.35 0.37 -0.02Coalition 0.22 0.31 -0.09Non-Coalition 0.89 0.62 0.27

China 0.35 0.23 0.12Russia 4.71 3.21 1.50

20 / 37

Direct Abatement Costs

Carbon Price (2004 US $/ton)

Coalition Action: Tariff No TariffNon-Coalition Actions: CHN,RUS=C All D-N

Others=R

Coalition 20.14 37.78

China 5.34 –Russia 12.78 –

21 / 37

Terms of Trade

% Welfare Loss ∆

Coalition Action: No TariffNon-Coalition Actions: All C All D-N

All 0.13 0.37 -0.24Coalition 0.01 0.31 -0.30Non-Coalition 0.59 0.62 -0.03

China 0.19 0.23 -0.04Russia 2.60 3.21 -0.61

22 / 37

Summary

China — moderate losses from carbon tariffs but economy is largeenough and abatement cheap enough that can shift terms oftrade in their favor at relatively low cost.

Russia — large losses from carbon tariffs. Abatement cost is higherthan for China but terms-of-trade advantages in EITE andenergy sectors larger as well.

23 / 37

Sensitivity Analysis

Armington and energy-supply elasticities

Smaller coalition

No crowding out

***Tariff definitions***

24 / 37

Reflections

Presumption that opportunity cost of abatement is high for developingworld needs closer inspection.

While carbon tariffs are politically inflamatory, they cannot be so easilydismissed as wrong-headed.

Design of tariffs and retaliatory measures available is likely to beimportant.

25 / 37

% Welfare Loss: Nash Eq. vs. Benchmarks

Tariff No Tariff UnrestrictedCHN,RUS=C All D-N All D-N* All C Int’l Permit

Others=R* Trade(1) (2) (3) (4) (5)

All 0.19 0.35 0.37 0.13 0.09Coalition 0.10 0.22 0.31 0.01 0.07Non-Coalition 0.51 0.89 0.62 0.59 0.16

CoalitionEurope 0.13 0.26 0.39 0.01 0.05United States 0.06 0.13 0.19 – 0.09Other Annex-I 0.15 0.30 0.40 0.04 0.09

Non-CoalitionChina 0.25 0.35 0.23 0.19 -0.59Russia 2.77 4.71 3.21 2.60 1.38

India -0.20 -0.26 -0.37 -0.12 -0.26Other Energy-Exporting 1.75 2.80 2.28 1.81 1.07Other Middle-Income 0.03 0.17 0.06 0.16 0.00Other Low-Income 0.34 0.48 0.31 0.63 0.33

* — Indicates policy regime that represents a best response for all non-coalition countries for a

given carbon tariff regime.

26 / 37

Welfare Cost of Deviation from Nash Eq.

Deviation Welfare Change

China Retaliate 0.34Do Nothing 0.52

Russia Retaliate 1.06Do Nothing 1.06

Other Energy-Exporters Cooperate 2.30Do Nothing 0.16

India Cooperate 0.70Do Nothing 0.03

Other Low-Income Cooperate 1.13Do Nothing 0.02

Other Middle-Income Cooperate 4.67Do Nothing 1.15

27 / 37

% Welfare Loss: Europe-Alone Coalition

Tariff No TariffCHN,RUS=C CHN=C CHN=C All C

Others=R* Others=D-N Others=D-N*(1) (2) (3) (4)

All 0.06 0.07 0.07 0.03

CoalitionEurope 0.10 0.11 0.15 0.00

Non-CoalitionChina 0.07 0.09 0.12 0.04Russia 0.92 1.14 0.75 0.75

United States -0.01 -0.00 -0.00 -0.01Other Annex-I -0.02 -0.01 -0.01 -0.00India -0.01 0.01 -0.02 -0.04Other Energy-Exporting 0.42 0.43 0.30 0.48Other Middle-Income 0.01 0.02 0.01 0.03Other Low-Income 0.14 0.14 0.07 0.17

* — Indicates policy regime that represents a best response for all non-coalition countries

for a given carbon tariff regime.

28 / 37

Equilibrium Outcome andWelfare Change Sensitivity Analysis

Arm’tn Ene. Regional Strategy Welfare ChangeElas. Elas. CHN RUS EEX IND MIC LIC All Coalition Non-Coal.

1/2x 2x C C C R R R 0.18 0.09 0.571x C C R R R R 0.18 0.06 0.681/2x C C R R R R 0.18 0.02 0.83

1x 2x C C R R R R 0.19 0.12 0.431x C C R R R R 0.19 0.10 0.511/2x C C R R R R 0.19 0.08 0.62

2x 2x C C R D-N R R 0.19 0.15 0.361x C C R D-N R R 0.19 0.13 0.421/2x C C R D-N R R 0.19 0.11 0.51

29 / 37

% Welfare Cost of Deviation fromNash Equilibrium Sensitivity Analysis

Do Nothing Retaliate

Armington ElasticityChina 2x 0.54 0.65

1x 0.52 0.341/2x 0.87 0.45

Russia 2x 1.54 1.631x 1.06 1.061/2x 1.19 1.12

Energy ElasticityChina 2x 0.67 0.50

1x 0.52 0.341/2x 0.21 0.02

Russia 2x 0.66 0.661x 1.06 1.061/2x 1.38 1.37

30 / 37

% Welfare Loss by Region andPolicy Regime: Europe-Alone Coalition

Tariff No TariffCHN,RUS=C CHN=C CHN=C All C

Others=R* Others=D-N Others=D-N*(1) (2) (3) (4)

All 0.06 0.07 0.07 0.03

CoalitionEurope 0.10 0.11 0.15 0.00

Non-CoalitionChina 0.07 0.09 0.12 0.04Russia 0.92 1.14 0.75 0.75

United States -0.01 -0.00 -0.00 -0.01Other Annex-I -0.02 -0.01 -0.01 -0.00India -0.01 0.01 -0.02 -0.04Other Energy-Exporting 0.42 0.43 0.30 0.48Other Middle-Income 0.01 0.02 0.01 0.03Other Low-Income 0.14 0.14 0.07 0.17

* — Indicates policy regime that represents a best response for all non-coalition countries

for a given carbon tariff regime.

31 / 37

% Welfare Loss by Region andPolicy Regime: No Annex-I Crowding Effect

Tariff No TariffCHN,RUS=C All D-N All D-N* All C

Others=R*(1) (2) (3) (4)

All 0.32 0.32 0.31 0.36Coalition 0.23 0.19 0.25 0.20Non-Coalition 0.70 0.83 0.55 0.96

CoalitionEurope 0.29 0.23 0.32 0.26United States 0.14 0.11 0.15 0.12Other Annex-I 0.32 0.27 0.33 0.28

Non-CoalitionChina 0.22 0.32 0.19 0.33Russia 3.37 4.42 2.88 4.37

India -0.26 -0.24 -0.32 -0.32Other Energy-Exporting 2.50 2.61 2.01 3.12Other Middle-Income 0.08 0.16 0.05 0.22Other Low-Income 0.48 0.45 0.27 0.86

* — Indicates policy regime that represents a best response for all non-coalition countries

for a given carbon tariff regime.

32 / 37