Krugman's good point on Cap'n Trade

Krugman writeth:

I think the president has this wrong:

President Obama on Sunday praised the energy bill passed by the House late last week as an “extraordinary first step,” but he spoke out against a provision that would impose trade penalties on countries that do not accept limits on global warming pollution.

The truth is that there’s perfectly sound economics behind border adjustments related to cap-and-trade...The essential idea is that...you should choose policy instruments to align incentives with [your policy] objective; in normal circumstances this...rarely [leads] to tariffs.

But in this case the...objective is to reduce greenhouse gas emissions, never mind their source. If you only impose restrictions on greenhouse gas emissions from domestic sources, you give consumers no incentive to avoid purchasing products that cause emissions in other countries; as a result, you have an inefficient outcome even from a world point of view. So border adjustments here are entirely legitimate in terms of basic economics.

And they’re also probably OK under trade law. The WTO has looked at the issue, and suggests that carbon tariffs may be [OK]. Because it’s essentially a tax on consumers, it’s legal, and also economically efficient, to collect [a carbon tax] on imported goods as well as domestic production; it’s a matter of leveling the playing field, not protectionism...

What’s happening here, I think, is that people are relying on what Paul Samuelson called an economic “shibboleth” — they’re relying on some slogan rather than thinking through the underlying economics. In this case the shibboleth is “free trade good, protection bad”, when what the economics really says is that incentives should reflect the marginal cost of greenhouse gases in all goods, wherever produced — which in this case happens to imply border adjustments.

Basically, if we impose a carbon tax (or a cap-and-trade system) only on U.S.-made goods, then people will shift toward buying goods made in places that allow factories to cheaply emit carbon (mainly China). That will increase the amount of carbon-emitting economic activity in China, which will drastically reduce the overall anti-global-warming effect of our own carbon tax.

In fact, I'll do Krugman one better. Transporting goods from far away takes fuel; burning fuel emits carbon. If we're going to put a carbon tax on foreign goods, we should include the carbon that was emitted in shipping the stuff here.

Basically, a carbon tax or cap-and-trade system that doesn't include China (and India) will be of limited effectiveness in combating global warming. But a carbon tax or cap-and-trade system that just shifts U.S. carbon emissions to China will be of no effectiveness whatsoever.