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Trade and Climate Change: Handle with Care

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Over the past several decades international trade has expanded dramatically. Today, the volume of world trade is nearly 32 times greater than its level in 1950, and the ratio of merchandise trade to global GDP has increased to more than 50 percent, up from less than 20 percent just half a century earlier. This dramatic increase in global trade flows was brought about, in part, by a reduction in average world tariffs at major export destinations, with rates dropping to an average of just 4% in North Atlantic countries by the turn of the millennium.

During the same period, however, world trade was not the only thing growing to unprecedented levels. According to the World Bank, there has also been a large increase in the concentration of carbon dioxide--one of several greenhouse gasses that contribute to growing temperatures--from about 310 parts per million in the 1950s to about 390 at the end of the century.

Does increased trade tend to cause increased emissions of greenhouse gasses? The most recent Economic Premise, written by my World Bank colleague Harun Onder, highlights three ways through which country and global emissions levels may be affected by higher trade intensity. First, as increased trade is generally conducive to economic prosperity, emissions may rise as a result of increased levels of economic activity. Second, as trade leads to greater specialization, levels of emissions may rise--or fall--depending on whether a country's comparative advantages are in sectors that are "dirtier" or "cleaner" in terms of emissions. Third, trade facilitates technology transfers and thus makes easier the adoption of "cleaner" methods of production available worldwide.

While the last channel can be expected to help reduce of emissions, the second is neutral from the standpoint of global emissions of greenhouse gasses, as specialization only redistributes geographically "clean" and "dirty" industries. The greenhouse gas effects associated with higher scales of economic activity dominate the other channels. However, the problem then of emissions is not derived from trade as such, but rather from a broader issue regarding how to prosper economically with a lower intensity of emissions. Furthermore, consumer preferences and political processes may evolve in favor of environmental quality as income grows.

The picture becomes more complex in the case of a question related to a reverse in direction, also addressed in "Trade and Climate Change: An Analytical Review of the Key Issues": Can efforts to mitigate emissions at the individual country level be countervailed--or boosted--by international trade? Think of a country or a group of countries that decide to curb national emissions by imposing carbon taxes or quotas on certain "dirty" local activities. These policies may be negated if they have the unintended side effect of reducing the international competitiveness of local production in certain sectors and industries--particularly those that are energy-intensive and trade-exposed--in favor of competitors outside the bloc. Facing the increased costs of compliance with domestic climate provisions, some firms may choose to relocate, leading to a so-called "leakage" problem where increased greenhouse-gas emissions begin to occur in non-participating countries.

This has been the rationale alluded to by some who argue in favor of "border tax measures" to be levied on non-participant countries, as a supposed instrument to address leakage and competitiveness concerns and "level the playing field". In my view, however, inner difficulties to calibrate such border taxes, as well as risks of their capture by protectionist interests should make policy makers wary of going down that route. Trade wars sparked by retaliatory measures may additionally lead to harmful trade distortions that go far beyond the playing field intended to be leveled.

On the other hand, trade can boost the efforts of countries taking the lead in reducing emissions if they adopt schemes like "cap-and-trade", in which emission allowances are made tradable and economic agents can search for emissions abatements wherever they can find them least costly. The costs of reducing greenhouse gas emissions in a same sector vary among countries, and thus the abatement of global emissions intended by leading countries may be maximized for a same amount of resources.

There are many other arguments in favor of cap-and-trade schemes as opposed to carbon-and-border taxes (e.g. see here). Our point here is that trade may help mitigate climate change, as long as the temptation to resort to inappropriate trade policies is avoided.

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