More trade, rather than carbon tariffs

Paul Krugman suggests an interesting solution to the problem of China’s carbon emissions. Since their exporting sector is the main driving force behind their growth, it is crucial for China to have access to Western consumer markets. The suggestion is now to use this dependence and imposing a carbon tariff on imports from China. Paul reckons that this will encourage China to cut its emissions, thus lowering the tariff and staying competitive. Sounds good but I’m not so sure whether such a scheme will be effective, let alone efficient.

It basically boils down to the elasticity of import substitution. Is it high, then Western customers will shun the tariff-expensive Chinese goods and look for alternatives. If the elasticity is low, China will just shrug and Westerners will pay the price for just another failed environmental policy.

There is probably also at least two kinds of imports from China: true monopolies and not-so-true monopolies. Thinking of commodities, especially things like rare earths, the import elasticity is probably very low, simply because China controls about two thirds of the world’s deposit. I would consider this a true monopoly. Then there are quasi-monopolies such as manufacturing of electronic devices (think Foxconn). Here of course, other countries can step in, but given the huge amount of capital that China has in place to be the world’s workbench, it would probably be quite an investment for, say, Brazil to take China’s place. I am not quite sure that international companies will invest heavily to leave China for some other place – given further, that is not the companies who will shoulder the costs of the tariff in the end. Those will be imposed on consumers.

Granted, one could argue that imports from China are suboptimally cheap given the external costs of China’s emission on everybody on this planet. This is likely a reasonable assumption, but it is very hard to measure the external costs and hence to choose the optimal tariff, that balances costs of pollution and higher import prices at the margin.

So we already know that it is not the companies that pay for the tariff, but the consumers. At least in the short to medium run, until (hopefully) production has moved to a cleaner place – I find this a very long shot. Even more, given that quite a number of economists – Paul among them – argue for higher domestic spending. At least for Germany, that is probably right, but paying for tariffs is not really efficient, since it leaves less money to be spent on domestic production – which would inter alia robusten the economy and help getting Europe out of the woods.

Still, Paul’s idea is charming because it does not depend on China and its policies. The thing is, it is precisely because of that, that consumers in the West are also paying the price for China’s emission. From a distributional point of view I can think of fairer arrangements. Let me propose one:

The West helps China to clean its energy industry by providing state of the art technology, such as wind power but also nuclear power, modern grids, energy saving schemes and the like. This is the true spirit of international trade where everybody is better off. China becomes cleaner and reduces its health problems due to smog and pollution while still being able to supply the world with manufactured goods and commodities. The West benefits from the business of outfitting China with modern energy technology, thus creating jobs and income. Further our consumers do not need to pay for a likely ineffective and inefficient tariff.

However, there’s a catch. It depends on China’s willingness to cooperate and on the ability of western firms to deliver the needed technology. Both is manageable, but it requires a bit of effort. Maybe Paul’s carbon tariff is, let’s put it delicately, a kind of incentive device to nudge the Chinese into agreeing to the cooperative, efficient and welfare-maximising solution.

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I write about economics and politics. I take Ordnungspolitik seriously. While not blogging, I study monetary unions for my doctorate.