Kyoto and the carbon content of trade

Scientists and politicians agree that we must limit global warming to less than 2°C above long-time averages. But getting there involves the tragedy of the commons on a global scale – carbon dioxide emissions have worldwide costs but local benefits.

Coordinated international policymaking is needed, but there is no legally binding agreement yet that would involve all relevant emitting countries. The Kyoto Protocol, signed in 1997 and ratified by 37 countries plus the EU between 2001-2007, exempts emerging and developing countries.

With international trade in goods, this protocol can give rise to so-called “carbon leakage”, where firms relocate production to countries without carbon taxes (or similar policies), thus offsetting emission reductions in “green” countries by higher emissions in “brown” countries. The associated competitiveness concern lies at the heart of the US resistance against the Kyoto Protocol.

But just how important is carbon leakage?

Recent literature argues that trade of carbon – as embodied in international trade in goods – matters. Grether and Mathys (2009) have shown that the world’s centre of gravity of CO2 emissions has shifted faster eastwards than the centre of economic activity. Similar evidence is presented by Wang and Watson (2007) who find that about a quarter of China’s CO2 emissions result from production for exports, mainly to OECD countries. Hence, trade in carbon brought about by the geographical separation of production and consumption seems a non-trivial phenomenon. But these papers are silent about the determinants of those trading patterns. Climate policy is a candidate explanation, but surely not the only one; classical comparative advantage arguments may well be sufficient to make sense of this evidence.

In a recent study, Mattoo et al. (2009) use a computable general equilibrium model to quantify the importance of carbon leakage due to unilateral emission cuts by industrial countries. The authors argue that – relative to a business as usual scenario – carbon taxes in OECD countries (including non-Kyoto partners such as the US) would have sizeable effects on their exports of carbon-intensive goods and also on their imports. Carbon leakage, i.e., the share of emission savings in OECD countries offset by higher emissions in trade partners, is about 6.5%.

We compute a 17% decrease in OECD emissions and a 1% increase in non-OECD countries, relative to year 2005. Using data from the IEA (2008), OECD emissions would fall by 2,197 Million metric tons of CO2 (MtC), while non-OECD emissions would increase by 142 MtC. Other models have found much higher effects, e.g. Babiker (2005). But it is well known that computable general equilibrium models are sensitive to assumptions about the model structure and parameters.