1 Topic 4.a: Trade and the Environment There are two main sets of international environmental linkages: –trade and investment –transboundary environmental impacts We will talk about trade and investment first Arguments over whether trade is “good” or “bad” for the environment are typically overly simplistic

2 Topic 4.a: Trade and the Environment There is a two-way linkage between trade and the environment: –the production and consumption patterns associated with global trade have substantial environmental impacts (trade to environment impact) –the policies designed to manage those impacts have important implications for competitiveness and the pattern of trade (environment to trade impact)

3 Topic 4.a: Trade and the Environment The Trade to Environment Linkage Trade affects the volume and composition of resource flows and these changes in turn impact on environmental quality. Three key channels: –a scale effect –a technology effect –a composition effect

4 Topic 4.a: Trade and the Environment The Trade to Environment Linkage The Scale Effect of Trade Trade leads to an increase in the volume of production and consumption due to: –specialization according to comparative advantage –the exploitation of scale economies This trade-induced increase in the scale of economic activity causes an increase in the scale of environmental impact.

5 Topic 4.a: Trade and the Environment The Trade to Environment Linkage The Technology Effect of Trade Trade leads to an increase in wealth. This leads to an increase in demand for environmental quality, and pressure for the adoption of cleaner technologies (remember environmental quality is a a normal good) That is, a substitution of knowledge capital (technology) for natural capital The strength of the technology effect of trade relies on effective market and political pressure in response to demands for higher environmental quality: –increased market pressure on industry –increased political pressure on government.

6 Topic 4.a: Trade and the Environment The Trade to Environment Linkage The Composition Effect of Trade The composition effect reflects the change in relative natural capital intensity across countries in response to specialization. The environmental impact of the composition effect is: –positive for countries with a comparative advantage in non-natural capital intensive production –negative for countries with a comparative advantage in natural capital intensive production

7 Topic 4.a: Trade and the Environment The Trade to Environment Linkage Note that an increase in relatively polluting industries in a developing country does not necessarily imply an increase in the absolute level of pollution in that country The technology effect can mean an absolute reduction in pollution even for countries that specialize in relatively polluting production Scale effect is negative; technology effect is positive; composition effect is positive for some countries, and negative for others What is the likely net effect? The answer depends critically on the type of policies implemented The key to sustainable growth through trade is the technology effect

8 Topic 4.a: Trade and the Environment The Environment to Trade Linkage Economies of scale and scope can cause imperfect global competition in global markets and the existence of economic rent Rent captured by a domestic firm means higher returns to its shareholders, higher wages to its workers and higher taxes to government However: –higher environmental standards put upward pressure on domestic production costs –cost increases cause a loss of global market share for domestic firms –a smaller share of global economic rents for the domestic country

9 Topic 4.a: Trade and the Environment The Environment to Trade Linkage National governments may have an incentive to distort environmental policy in an attempt to capture a greater share of global economic rent for their citizens This can lead to downward pressure on environmental standards It is in the self-interest of each country to find a balance between environmental quality and capturing a share of global rents All countries acting unilaterally in their own self-interest can potentially precipitate a destructive “race to the bottom” in setting environmental standards

10 Topic 4.a: Trade and the Environment The Environment to Trade Linkage Three important factors can weaken the negative relationship between environmental standards and competitiveness: –the productivity costs of poor environmental quality –the promotion of technological change –environmental protectionism

11 Topic 4.a: Trade and the Environment The Environment to Trade Linkage International cooperation, and the integration of environmental agreements with trade liberalization agreements is crucial The solution lies in comprehensive regional and international policy cooperation This does not necessarily mean uniformity of policies across countries: policies should be tailored to individual circumstances but set cooperatively

12 Topic 4.b: Transboundary Environmental Impacts Now we are going back to the second environmental linkage the transboundary pollution problem Transboundary environmental impacts (TEIs) are impacts of actions taken in one country on environment-related welfare in another country The prime example of a TEI is global climate change caused by greenhouse gas emissions Many TEIs involve the physical transportation of air-borne pollutants for example: greenhouse gases (GHGs) and sulphur dioxide

13 Topic 4.b: Transboundary Environmental Impacts In other instances there is no physical transmission of pollution but there are nonetheless important welfare effects for example: the loss of biodiversity and deforestation TEIs are international externalities: a cost imposed on other countries for which the source country does not have to pay Consequence: unilateral action leads to standards that are too low from the perspective of maximizing global welfare The only resolution to international externalities is through international agreements like the Kyoto Protocol on GHGs

14 Topic 4.c: The Economics of Global Warming We will begin with a little (very little) background info on the problem of global warming. Global warming is linked to greenhouse gas (GHG) emissions –increased concentration of GHGs in atmosphere trap heat - hence “greenhouse effect.” Most common GHGs: Carbon Dioxide, Methane (CH 4 ), Nitrous Oxide (N 2 O), Clorophluorocarbons (CFCs). GHG emissions arise from a variety of sources, some anthropogenic (human-made), some “natural.” –First three GHGs are both anthropogenic and natural. –Last four are anthropogenic only. Note that the distinction between “natural” and anthropogenic emissions can be a little tricky to draw.

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17 Trends in atmospheric concentrations and human-generated emissions of GHGs

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21 Global warming will be a problem for a LONG time….

22 Topic 4.c: The Economics of Global Warming Effects on the natural system are likely to be wide-ranging and cannot be known with certainty.  But effects will not be uniform across the world. Likely to be worse impacts in poorer nations. Some estimates from climate scientists:  Sea levels rising, from both melting of polar ice caps and expansion of ocean volume as it warms. IPCC estimates: sea level rises of between 7 and 23 inches by 2100 (compares to 6-9 inches last century). One estimate: rising sea levels “likely” to  land area of Bangladesh by 15%, displacing million people.

23 Topic 4.c: The Economics of Global Warming – Heat waves and heavier precipitation in some parts of the world (like here). – Droughts or cooling in other parts of the world. – Some species threatened (polar bears), others will thrive (ants!). – Events arising from climate change disproportionately affect women and children.

24 Topic 4.c: The Economics of Global Warming Majority of scientists agree that anthropogenic emissions of GHGs are driving (at least in part) climate change. Alternative view: anthropogenic emissions of GHGs constitute just 5% of overall emissions. –Our emissions are too small to be causing global warming. –This is a minority view. –Effects of global warming are uncertain. –To reverse effects we need to incur costs now in order to receive benefits far off in the future. –So what, if anything, should be done to halt/reverse/slow climate change? –We will look at what policies have been proposed, and what economists have to say about them.

25 Topic 4.c: The Economics of Global Warming First: some info on the Kyoto Protocol. Goals of Kyoto: –Reduce aggregate emissions to 5% below 1990 levels by –Annex I countries (essentially industrialized countries) given various emissions reduction goals. e.g. Canada to reduce to 6% below 1990 levels. –Developing countries emissions not restricted (yet). Mechanisms under Kyoto: –Emissions trading system (ETS) among Annex I countries. –Clean Development Mechanism (CDM) to incorporate developing countries. –Details of implementation are still unclear, though CDM projects and some emissions trading are going ahead..

26 Topic 4.c: The Economics of Global Warming Where is Kyoto at? For Kyoto to be binding, treaty had to be ratified by at least 55 governments from countries responsible for 55% of Annex I country emissions. Five years ago, it looked like Kyoto was dead: neither Russia nor US would ratify, making 55/55 target impossible. –Late 2004, Russian changed course and ratified, meaning that the 55/55 target was achieved. –US & Australia are only Annex I countries not to have ratified. Kyoto came into effect on February –Europe has begun carbon permit trading. –Some CDM projects are taking place. –Most countries are a long way off meeting Kyoto targets. We want to try to get a sense of the economic impacts of Kyoto targets, relative to alternative policy targets.

27 Topic 4.c: The Economics of Global Warming EU Emissions Trading Scheme (EU ETS) –Phase I launched in January 2005, scheduled to run to end of 07. –Phase II: EU ETS targets specific large industrial sectors. –Energy, metal production, cement, bricks, pulp & paper. –Covers about 40% of EU GHG emissions. Each of 27 member states sets National Action Plan (NAP) to decides their own national-level quota as well as the initial distribution of permits among firms. –Most permits given away; only 0.2% of total permits were auctioned during Phase I. NAPs are subject to EU approval. –NAP must show progress towards meeting Kyoto target. –But…. very little actual abatement to date (<1.0%).

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29 Topic 4.c: The Economics of Global Warming Other carbon trading schemes? Norway: cap and trade for heavy industry and major energy generation introduced in Japan and South Korea: small pilot programs currently underway. Australia (non-Kyoto signatory): a form of state-level (NSW) emissions trading for electricity retailers. US (non-Kyoto signatory): –Some companies have volunteered to reduce emissions by certain amounts and “comply” via carbon trading on the Chicago Climate Exchange. CCX emitting Members make a voluntary but legally binding commitment to meet annual GHG emission reduction targets.

30 Topic 4.c: The Economics of Global Warming The Western Climate Initiative began in February 2007 when the Governors of Arizona, California, New Mexico, Oregon, and Washington signed an agreement directing their respective states to develop a regional target for reducing greenhouse gas emissions, participate in a multi- state registry to track and manage greenhouse gas emissions in the region, and develop a market-based program to reach the target. The Premiers of British Columbia, Manitoba, Ontario, and Quebec, and the Governors of Montana and Utah have since joined the original five states in committing to tackle climate change at a regional level. Regional targets are to be set in 2009.