The Impact of Climate Change Rules on the World Economy

From: English Edition of Qiushi Journal Updated: 2011-09-20 12:57
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 Global climate change rules are the various institutional arrangements instituted around the world to reduce greenhouse gas emissions. The core issues in disputes over these rules concern how the economic benefits are distributed and how costs are to be shared. Future rules on climate change will not only reshape the pattern and distribution of global industry but also create an institutional environment that encourages development of clean energy and low-carbon economies. This will determine to a certain degree the future position of countries in the international division of labor. In general, developed countries stand to gain more than they lose from global rules on climate change.

 Global climate change rules are gradually developed through multilateral agreements.

 Because developed countries have reversed their position on limiting emissions and compensating developing countries for reducing emissions, the Copenhagen climate conference did not reach a binding agreement, but it nevertheless marked the beginning of efforts to establish global climate change rules. In the future the UN will lay down regulations on limiting emissions, allocation of emission limits and compensation. These three areas comprise the core of global climate change rules. The vast differences in the stands of different countries at the Copenhagen conference were concentrated in those areas. Once a consensus in those areas is reached, the focus of the next phase will shift to the mechanisms for implementation. At the national level, options for institutional arrangements for cutting emissions include a carbon tax and a carbon trading mechanism. Considering that not all countries have the same ability to pay for emissions reduction, the UN Framework Convention on Climate Change calls for the implementation of a principle of “common but differentiated responsibilities.” Accordingly, carbon prices for developed countries should be higher than those for developing countries. However, once the carbon trading mechanism is set up, developed countries may adopt new measures to promote a unified international carbon price, such as the establishment of regional carbon markets.

 Developed countries may also create new bilateral and multilateral rules to implement global emissions rules. At a bilateral level, the United States’ proposal to impose carbon tariffs (border tax adjustments or BTA) has attracted wide attention from the international community. This proposal is based on the so-called "carbon leakage" mechanism. A simulation study by the Organization for Economic Cooperation and Development (OECD) shows that the "carbon leakage" effect is actually very small. If the European Union takes unilateral emissions reduction measures, the carbon leakage ratio would be only 12%, and if all developed countries were to take actions to reduce emissions, the ratio would be less than 2%. However, such carbon tariffs could exert a huge negative impact on the trade of both sides. Besides, existing testing methods can not accurately measure the carbon content of each product, and imposing carbon tariffs would undoubtedly open the door to trade protectionism. Considering that the implementation of future global rules for emissions reduction would be very complex, some developed countries are likely to unilaterally introduce carbon tariff measures in the name of promoting more effective implementation of emissions reduction rules. In addition to bilateral carbon tariffs, multilateral talks, especially future WTO negotiations on new rules, may also be linked with emissions reduction (or with broader environmental protection issues). 

 Climate change rules will lay the institutional foundation for developing clean energy and a low-carbon economy.

 The need to develop clean energy or a low-carbon economy has become a post-crisis-era general consensus for developed countries. The reason for this is the serious impact the financial crisis had on the finance industry in developed countries, and the finance industry has been the very foundation for supporting their rapid economic growth over the past 20 years. Emerging industries represented by clean energy and a low-carbon economy have thus become the hope for the future for developed countries.

 In contrast to fossil fuels such as petroleum and coal, the biggest obstacle to the development of the clean energy industry is high cost. There are only two ways to alter the price ratio between clean energy and fossil fuels: One is to accelerate the development of clean energy technologies and the other is to establish climate change rules. Changing the price ratio by relying on technological advances would be a very slow process, and without demand in the market, R&D investment would not likely grow very rapidly. The price advantage of fossil fuels over clean energy comes from the fact that the price consumers pay does not include the cost of carbon emissions, so the enactment of global climate change rules is a fundamental way to alter the price ratio. Developed countries believe that the provisions of climate change rules must apply to all developing countries as well to avoid developed countries being forced to use high-cost clean energy while poorer developing countries continue to use low-cost fossil fuels. Developed countries are strongly opposed to the development of such a situation because they worry about the risk of "carbon leakage." In fact, what they are really concerned about is the loss of international demand for the products of the clean energy industry they are working to develop.

 April 25, 2010, people at “The Climate Rally” in Washington D.C., a concert to commemorate World Earth Day. April 22 was the 41st “World Earth Day.” / Photo by Xinhua reporter Zhu Wei

 Clean energy will be a key industry in the next boom cycle, but this does not mean that clean energy will soon replace fossil fuels as the main source of energy in the world. Even if the development of the clean energy industry were to maintain a very, very high speed of growth, fossil fuels would remain the main source of energy for a long time to come. The core issue in the development of clean energy is emissions reduction, so the development of clean energy and reduction of emissions have a cause and effect relationship. The development of the clean energy industry requires emissions reduction rules to promote it, and conversely, development of clean energy will promote the development of emissions reduction. If clean energy is to become a pillar industry in the next boom cycle, it must become part of the trend of developing a low-carbon economy, in which emissions reduction is key.

 Climate change rules will reshape the global industrial structure.

 First, the rising cost of energy consumption will change the ratio of factors of production to a certain extent, thereby affecting the distribution of global industry. The carbon intensity varies greatly among different industries and the carbon intensity of the same industry varies greatly from country to country. The carbon intensity of the energy industry, for example, is about 10 times that of the service industry and the carbon intensity of developing countries is about 4 times higher than that of developed countries. Therefore, rising energy costs due to emissions reduction will put a markedly different amount of pressure on different industries and different countries.

 Second, changes in the ratio of the cost of consuming fossil fuels and clean energy may change the global pattern of energy supply and demand. While climate change rules cannot change the ratio of the cost of production for fossil fuels and clean energy, they can change the ratio of the cost of consumption. Once global climate change rules are instituted, the development of clean energy will no longer be subject to fluctuations in the prices of fossil fuels, because every country or company will be subject to its own emissions reduction quotas. This is bound to impact the existing pattern of fossil fuel supply and demand.

 Third, one area of advances in industrial technology will be in innovations in emissions reduction technology. International rules on climate change will provide drive for development of emissions reduction technology as well as inevitably put pressure on industries and countries to develop such technology. The future development of industries will increasingly be determined by their carbon intensity and a company’s profitability will increasingly depend on how well that company is able to reduce emissions. For this reason, the correlation between advances a company makes in technology and its carbon intensity will become stronger and stronger. Although there may not be substantial improvement in the performance and effectiveness of many products, they are likely to be considered high-tech products because of reduction of the carbon intensity of their production process (the power generation industry applying carbon capture and storage technology, for example) or because of reduction in the carbon intensity of their use (driving electric and hybrid vehicles and using energy-saving building materials, for example). In this sense, there will be a shift in standards for judging the technology content of industries, companies and products.

 Developed countries will gain more than they lose from global climate change rules.

 The emissions reduction measures required by climate change rules will result in increased energy costs for all countries, but this does not mean that the increase will be same for all countries. Similarly, the gains from the implementation of climate change rules will not be distributed equally among all countries. This is at the root of the wide discrepancy in the views of different countries at the climate conference in Copenhagen.

 Cost analysis shows that the cost will be much higher for developing countries than for developed countries. A recent OECD study shows that, assuming the global carbon intensity stabilizes at 550ppm and carbon emissions peak in 2025, by 2050 the proportionate GDP loss of the main developing countries will be 5-8 times higher than that of developed countries. A World Bank study shows that the overall scale and distribution of emissions reduction costs will be closely related to the particulars of global climate change rules. Due to many of the constraints provided in the rules, reduction of benefits in developing countries will be much higher than in developed countries, and within developing countries themselves, reduction of benefits in highly energy-intensive industries will be the largest. How great the gap will be is determined by the particulars of emissions reduction rules and depends on a number of factors. First, it depends on whether or not all emissions are to be reduced at the same time. Simultaneously reducing emissions by all countries will reduce the possibility of "carbon leakage" and shrink the reduction of benefits incurred by developed countries, as well as put pressure on developing countries. Second, it depends on whether or not emissions allowances can be traded. The trading of emissions allowances will result in the formation of a unified global carbon price. This will greatly hurt developing countries because a unified carbon price will in effect chip away at the right to "preferential treatment" now enjoyed by developing countries. Third, whether or not compensation can be made for emissions reduction. In other words, whether or not developed countries can give financial compensation to developing countries for their emissions reduction. From the standpoint of morality and justice, developed countries have the responsibility to help reduce the global imbalance in the contribution to atmospheric carbon accumulation. These are the three areas of dispute between developed and developing countries in formulating global climate change rules.

 Whether developed or developing countries come out the winners from implementation of global climate change rules in terms of gain distribution will also be determined by whether developed or developing countries improve their competitive positions. The restrictions placed by climate change rules will mean that carbon emissions could be either a liability (cost) or an asset (gain) to any one country. Whether emissions constitute a liability or an asset will depend on the competitive position of each country in the global carbon market. Obviously, developed countries will be the net winners from implementation of climate change rules. First of all, the economies of developed countries are mainly based on light industry, so their industrial energy consumption and carbon intensity are far smaller than those of developing countries. This, however, does not mean that developed countries have some kind of moral advantage over developing countries on the issue of emissions reduction. This is due to the fact that developed countries were the first to complete their industrialization (as well as the first to finish emitting large amounts of CO2). Since developing countries are still in early stage of industrialization, it would be very difficult for them to reduce their dependence on heavy industry in the near future. Second, developed countries have an edge in low-carbon technology. This is the result of the global industrial division of labor that has existed for many years. Technology is a special commodity, and it is still an open question as to whether or not developed countries will actually transfer the technology to developing countries they need to reduce emissions as they promised to do. If the technology transfer is only to take place through normal market channels, the promise would be meaningless and the result for developing countries would be increased dependence on developed countries for technology. Third, in addition to developed countries benefiting from developing clean energy and a low carbon economy starting in the areas mandated by climate change rules by the easing of their current financial crisis, there will be an added bonus. They will also become more competitive in the world energy market. One final benefit for developed countries is that the development of clean energy will boost the development of related industries. In the area of bio-energy, developed countries are currently the world's major exporters of grain, and the demand for grain as raw material will create new development opportunities for their agriculture. 

 The formulation of global climate change rules will mark a crossroad for the global economy. Whether or not we can use this opportunity to truly implement the "Bali Roadmap" under a principle of "common but differentiated responsibilities" and create a fair institutional environment for the sustainable development of the world economy in a post-crisis era will depend on the concerted efforts of both developed and developing countries.

(From Qiushi in Chinese, No. 4, 2010)

Note: Author: Director of the Institute for Asian-Pacific Studies of the Chinese Academy of Social Sciences

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