"As OECD countries begin to tax their own economies by charging growing fees on CO2 emissions, their tolerance of the carbon practices of its trading partners will diminish rapidly," says Jeff Rubin, Chief Economist and Chief Strategist, CIBC World Markets. "Particularly when the painful cuts made by North America, Western Europe and a handful of other OECD economies are dwarfed by the emission trail spewing from China and the rest of the developing world.
"Other than moral suasion, which is likely to fall on deaf ears, the OECD's only leverage is through trade access. The response is likely to involve a carbon tariff - an equalizing force that will tax the implicit subsidies on the carbon content of imports that come from carbon non-compliant countries."
The report found that efforts to gradually reduce carbon emissions in the U.S. by just 10 per cent through a cap and trade system will shave an estimated 0.6 percentage points off real GDP growth annually for the next five years - with similar costs expected for other OECD nations.
Mr. Rubin notes that these decarbonization efforts will only be effective in reducing greenhouse gases if done in concert with the developing world. Otherwise it simply adds costs to consumers, makes domestic industry less competitive and will increase overall global emissions as more and more production is shifted to unregulated jurisdictions. CIBC World Markets calculates that China's export-related emissions were approximately 1,700 mmt in 2007. Outside of the entire U.S. Economy, China's export sector is the world's largest carbon emitter.
In the last seven years, China's overall emissions have grown by close to 120 per cent. Its average annual increase is equal to the total greenhouse gas emissions of Canada or the United Kingdom. Its cumulative increase in emissions over the past seven years is equal to the total current level of emissions from the Japanese, Indian, Spanish and Canadian economies combined.
The reasons for this dramatic jump are rooted in the sheer pace of economic growth in the country and the absence of enforceable and meaningful environmental regulations. But the more vital factor has been the emissions intensity of the Chinese economy. "Energy use in the manufacturing-intensive Chinese economy as a share of GDP is four times larger than in the largely services-based U.S. economy," says Mr. Rubin. "To make matters worse, China is not particularly carbon efficient. It produces a third more CO(2) emissions per unit of energy than does the U.S. economy, and double that of Canada. Combine the energy intensity of the Chinese economy with the poor carbon efficiency of its energy use and you have a powerful cocktail for exploding emissions growth."
By slapping a $45 per tonne cost onto CO(2) emissions, a tariff would raise roughly $55 billion a year from Chinese exports to the U.S. "Of course, it's not just Chinese exporters who will have to pay," adds Mr. Rubin. "At least initially, before other carbon compliant sourcing can be found, it will be consumers who will have to bear the bulk of the tariff burden in higher import prices. Based on China's share of U.S. imports, a $45 per tonne tariff would raise U.S. consumer price inflation by more than 0.6 percentage points.
"At some point, however, the inflationary impact might be mitigated as either domestic production replaces some Chinese imports or sourcing is shifted to a less egregious emitter than China."
The report notes that given the overall energy inefficiency of the Chinese economy, a carbon tariff, coupled with triple digit oil prices, suddenly redefines the meaning of Chinese competitiveness. For many industries, what will count is how energy efficient they are, and how carbon efficient they are in their use of energy. On both counts, China and the rest of the developing world are hugely disadvantaged. As a result, China's wage advantage would be lost for many energy-intensive industries who who will then look to return home to the U.S.
"With OECD's carbon tolerance diminishing with every tonne of CO(2) spread into the atmosphere by non-OECD countries, environmentalism will soon become a significant barrier to trade," concludes Mr. Rubin. "A carbon tariff imposed by the U.S. on emissions embodied in Chinese exports would not only abolish the implicit subsidies on the carbon content currently enjoyed by Chinese exports, but it would be large enough to start reversing current trade and offshoring patterns."
