Trade and the environment

By Gal Hochman (Energy and Bioscience Institute) and David Zilberman (Professor, Department for Agriculture and Resource Economics; Energy and Bioscience Institute), UC Berkeley.



The Earth’s natural environment offers local benefits in the form of open space and recreational opportunities. It also offers global benefits in the form of existence and option values associated with biodiversity. These gains, however, depend on the level of greenhouse gases in the atmosphere, a global public good.

Greenhouse gases in the atmosphere affect the surface temperature of the Earth and are crucial in keeping our planet warm. Too much greenhouse gases in the atmosphere, however, can lead to global warming with adverse effects upon the Earth’s natural environment and human well being. There is growing evidence that climate change is affected by anthropogenic emissions of greenhouse gases, which can lead to a warmer planet and more volatile weather patterns, as well as rising sea levels. These changes in our climate may lead to reduction in productivity as well as physical destruction, resulting in forced human migration and causing immense economic losses and severe political instability, globally.

The greenhouse gas emissions are what economists term stock pollution problem that accumulate through the process of ongoing industrialization. Human related greenhouse gas emissions is a product of our modern way of life, and is affected by globalization and capital flows, which leads to new demand for energy and higher energy prices. Globalization and capital flows also increase demand for land, leading to a loss of environmental amenities and land allocated to food production — resulting in higher food prices. These effects are observed in China, for instance, where FDI and government investment have lifted overall investment in China and contributed to its growth. This growth produced sharp increases in demand for energy, and led China to become a major importer of oil. China also halted some biofuel production because the loss of land for food crops has produced record high food prices.

The major challenge is to slow or even reverse the accumulation of greenhouse gases to a level that is tolerable and that would not lead to negative consequences. This would require policies that drastically reduce human made greenhouse gases, and lead to carbon sequestration and storage. The policy is especially challenging given population and economic growth in developing economies. Some policy scenarios in developed countries aim at an 80% reduction in greenhouse gases emissions, toward the end of the current century.

The reduction in greenhouse gases may require modification in behavior, as well as drastic changes in technology. The main contributors to greenhouse gas emissions include energy sources from fossil such as oil and coal, deforestation in tropical forests, and land use management practices. Thus, the reduction in greenhouse gases can be achieved by reducing energy consumption, increasing energy use efficiency, using cleaner energy sources, adopting improved agricultural and forestry practices, and introducing carbon sequestration and storage technologies. Existing technologies can meet some of these challenges, but the set of technological tools needs to be augmented by successful outcomes of new research and development efforts. These successful outcomes that result in technological change may be associated with large changes in investment and in the capital composition, as well as changes in behavior.

The need to reduce anthropogenic emissions such as carbon emissions can be obtained through a mix of policies, which include incentives to modify behavior and investment in research and development of cleaner technologies. The efficient policy is a uniform global price for carbon, as well as uniform prices for other environmental amenities such as land. The efficient policy can be implemented using carbon tax, and subsidizing carbon sequestration and storage. Alternatively, under certain conditions an efficient outcome can be achieved using tradable permits. Yet another option might be to levy a tax on fuel consumption, introduce land use management practices, and price other observable activities based on the calculation of their greenhouse gas emissions. This system should be complemented with increase spending on research and development for clean technologies, as well as research and monitoring activities to better assess the evolution of greenhouse gases and their implications.

However, the difficulty of estimating the marginal cost of the pollution externality usually prevents the application of an efficient solution, and regulators resort to a second best alternative to pursue cost-effective policies whereby a country or a global community aims to achieve a predetermined pollution reduction target at the lowest cost. Cost effective polices impose a uniform tax on greenhouse gases, that may be implemented through carbon taxation or a cap and trade schemes. However, policy instruments are chosen to meet multiple objectives (not only efficiency), and their selection is affected by political economic considerations. Thus, the objective of environmental regulation of climate change may simply be to limit the increase in average temperature or the amount of carbon emitted to the air.

Pollution problems usually are contained within countries, and governments establish policies such as taxes, property rights, and standards to regulate them. When, however, externalities are transnational or global, as is the case of greenhouse gases, a governess structure to establish and enforce policies is needed. That is the reason for international agreements or international conventions that establish mechanisms for sharing responsibilities for pollution reduction and coordinating policy among countries. Although a ton of carbon is a ton of carbon and so the price of carbon should not vary widely among emitter, one cannot simply disregard any distributional effects that may prevent countries from joining an international agreement on the environment and adhering to their commitment in the future. Differences in GDP, energy sector infrastructure, and growth prospective among nations affect their perspective and preferences on greenhouse gas management, resulting in further difficulties in reaching an international agreement on the environment.

Differences among countries, in terms of endowments and technologies, can be addressed by employing a compensating mechanism. With respect to tradable permits, a compensation mechanism may include grandfathering rights and allocation of permits. Another compensation mechanism that should be further considered, especially with regards to land management and land pricing practices, are payment for environmental services. This is a mechanism to improve provision of indirect environmental services, in which those who provide the environmental service get paid (landowners are paid not to cut down the tropical forest and produce soybeans), while those who benefit from environmental services pay for their provision. Payment for environmental services can be used to prevent deforestation in tropical forests, and induce carbon sequestration in developing countries. Compensation can also be obtained by linking environmental agreement with trade agreements, although the cost will probably be less trade.

In addition to international differences, there are intersectoral differences, making the design of effective polices to consistently address greenhouse gas emissions in the urban agricultural sector, as well as the industrial sector, very challenging. The design of climate change polices require integration of scientific and economic data and knowledge, and calls for interdisciplinary collaboration. One of the major topics of research on climate change should aim to address issues of irreversibility and uncertainty.

The evolution of the biofuel sector and the policies that guided it, illustrates some of the challenges of establishing policy to reduce greenhouse gas emissions. Although many expected that the introduction of biofuels to result in less dependence on foreign oil and less greenhouse gas emissions from fuel consumption, the actual effect of biofuels on greenhouse gases depend on the feedstock used and the technology used to convert the feedstock to biofuels. If not appropriately produced and processed, biofuels may actually result in an increase in greenhouse gases. The introduction of biofuels also had unintended consequences on world food prices. Even though biofuels were not the main contributor to the food price inflation of 2007/08, and the crisis was a product of years of growing demand for food resulting from industrialization and economic growth in Asia and elsewhere that was not matched by an increase in agricultural productivity, the diversion of some food commodities to biofuels made the situation more acute. Agricultural biotechnology unambiguously reduces the land constraint and attenuates the impacts of biofuel adoption on food supply and land allocations. Investment in agricultural biotechnology has slowed, however, in part because of regulation and bans in Europe and elsewhere. These results suggest a new commitment to agricultural biotechnology, as well as second-generation biofuels, may be needed to address the new energy paradigm. Such policies would be consistent with heightened environmental concern in the developed world.

Transnational cooperation among countries aimed at reducing greenhouse gases is needed now. The much-needed environmental agreement should lead to international institutions that result in emissions reductions, but limit the damage to output and welfare. It should make reasonable demands so nations can join them and abide by their commitment in the future, and develop an appropriate compensation mechanism that will help bring as many countries on board as possible. The cost of delaying an agreement goes beyond excess emissions in the interim, and so we need to act now.