A New (Emissions) Trade Deal Environment

September, 2016

Ban Ki-moon, Secretary-General of the United Nations, delivers his opening remarks at the Paris Agreement signing ceremony on climate change at the United Nations Headquarters in Manhattan, New York, U.S., April 22, 2016. REUTERS/Mike Segar

Ban Ki-moon, Secretary-General of the United Nations, delivers his opening remarks at the Paris Agreement signing ceremony on climate change at the United Nations Headquarters in Manhattan, New York, U.S., April 22, 2016. REUTERS/Mike Segar

In the 1980s, I was involved in the first flush of free trade enthusiasm. Ronald Reagan had mused about having a free-trade zone from Alaska to Cape Horn and Macdonald Commission in Canada, under Pierre Trudeau’s government, proposed a free trade agreement with the United States. The CUSTA, as it was called, was signed in 1988, followed up by the inclusion of Mexico in NAFTA in 1993. All kinds of other initiatives were taken elsewhere, notably in the creation of the EU. I never lost my interest in the subject, as freer trade brought millions, maybe billions, of people out of terrible poverty.

Now these arrangements are under threat. The UK wants out of the EU, Candidate Trump wants to renegotiate NAFTA and almost everyone except President Obama wants to turn down the Trans-Pacific Partnership. Trade is ‘out’. Global warming is ‘in’.

But wait a minute. This month, the Canadian province of Quebec, along with the Western Climate Initiative, made up of the State governments of California, Oregon and Washington, announced an agreement with Mexico to have it join their trading club. This trade zone will deal in what is called a cap-and-trade (C&T) system. As well, the EU has a similar system, the EUETS, which presumably will lose a member with Brexit, though I’d bet this bit, amongst others, will stay in place.

As a trade deal, presumably, Quebec could sell surplus emission rights to California, for instance—or Mexico. We could call this NAETA, the North American Emissions Trading Agreement, to distinguish it from NAFTA. It is fascinating to see these new international trading agreements go on without the large national profile players at the negotiating table.

What seems to be going on is a concerted effort to link all kinds of jurisdictions around the world in C&T systems, a kind of global trade zone for controlling greenhouse gas emissions. And this kind of trade seems to be on the side of the angels, where buying and selling stuff is not. Weird.

The logic behind a C&T system is that the jurisdictions set an emissions cap for the territory under their control. Generally, this would be based on statistics about the emissions levels for some past years. Then, different emitters would have their shares identified and capped. Over time, violators would be fined, unless they bought emission rights from others who under-emitted that year. An alternative way to distribute permits would be for the jurisdiction simply to auction them off, like some places do with the electromagnetic spectrum.

Excess rights could also be traded amongst those jurisdictions that are parties to a given agreement. Then, over time, the overall cap levels in each jurisdiction would be reduced and eventually we’d get to lower levels of global warming. Keep in mind the world has been warming slowly since the Ice Age ended. All we’ve been doing is to speed up a natural process.

You may have noticed that the C&T system is based on a kind of regulatory control that just might be prone to lobbyists and voter pressure. Can’t meet your cap? Then maybe you’ll have to close down your company or move elsewhere; this being a rough equivalent in free trade lingo to moving to a low-wage country. Then, Voila!, there is a miscalculation discovered in the capping numbers and problem solved.

The alternate popular approach to controlling emissions is a carbon tax. This is a straight tax on the production of materials that have varying degrees of emissions by final users. It is usually expressed in terms of a tax on tons of potential emission-producing materials mined, pumped or otherwise made available, if the focus is on the raw materials, or on the tons of gases produced by final users. Normally, the first is preferred because there are fewer raw material producers than there are consumers and so collection is easier.

The expectation is that such a tax would make everyone less prone to use greenhouse gas producing products and for producers to move to more efficient production processes. The tax is easier than a C&T system to administer—add it to the GST in varying amounts, for instance—but it is prone to tax competition between jurisdictions. Move your plant here; our carbon tax is lower than yours.

The anti-trade people are dismissive of the economists who use their models and data to show that there are gains from trade and that technological change accounts for more disruption than foreign competition. Yet these same people can justify ‘carbon pricing’ mechanisms by using the same general logic as is used in goods trade.

That is, if you raise the price of emissions high enough, the rational consumer will look to alternatives. You can ‘starve the beast’ by making it too difficult for people to feed it with their purchases. Countries benefit from carbon pricing. The opposite is found in free trade; the beast gets fatter if you lower the price for feeding it. Countries benefit from free trade. Both logics share the same base.

The problem is that we live in a democracy, where people are unlikely to behave in accord with the rational model. There is a whole area of behavioral economics devoted to this. All the ‘fast thinking/slow thinking’ research also points up how different people really are from those models we commonly rely upon.

Applying carbon pricing models to human behavior may be appealing at the start, as was free trade in the 1990s, but as people think they are being hurt by these public policies in the short run or in an economic slowdown, and react at the ballot box, there will come a backlash and entrepreneurial politicians will take advantage of this.

By and large, I guess that carbon pricing has, on the outside, a generation to spread and run before someone declares the problem ‘solved’ or C&T drops off in popularity, or corporate exemptions and carbon taxes get hit in some party’s low-tax platform.

Having said that and sounding like a cynic, my practical suggestion is that we all get on with one or both of these, in order to get as much technological and behavioral benefit as possible from them before the reaction sets in.

There is a lot of material on this subject, though a good starting point that is clear and succinct is Canada’s Ecofiscal Commission: https://ecofiscal.ca*

 Copyright Jim McNiven 2016

*Jim McNiven has no connection with the Ecofiscal group.

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Jim McNiven

James McNiven has a PhD from the University of Michigan. He has written widely on public policy and economic development issues and is the co-author of three books. His most recent research has been about the relationship of demographic changes to Canadian regional economic development. He also has an interest in American business history and continues to teach at Dalhousie on a part-time basis.






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