Climate Change Trade Measures: Estimating Industry Effects
Published: 2009-07-08T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Countries can take varying approaches to reducing greenhouse gas emissions. Since energy use is a significant source of greenhouse gas emissions, policies designed to increase energy efficiency or induce a switch to less greenhouse-gas-intensive fuels, such as from coal to natural gas, can reduce emissions in the short term. In the long term, however, major technology changes will be needed to establish a less carbon-intensive energy infrastructure. To that end, a U.S. policy to mitigate climate change may require facilities to achieve specified reductions or employ a market-based mechanism, such as establishing a price on emissions. Several bills to implement emissions pricing in the United States have been introduced in the 110th and 111th Congresses. These bills have included both cap-and-trade and carbon tax proposals. Some of the proposed legislation also include measures intended to limit potentially adverse impacts on the international competitiveness of domestic firms.
section_title: What GAO Found
paragraphs: Estimating the potential effects of domestic emissions pricing for industries in the United States is complex. If the United States were to regulate greenhouse gas emissions, production costs could rise for certain industries and could cause output, profits, or employment to fall. Within these industries, some of these adverse effects could arise through an increase in imports, a decrease in exports, or both. However, the magnitude of these potential effects is likely to depend on the greenhouse gas intensity of industry output and on the domestic emissions price, which is not yet known, among other factors. Estimates of adverse competitiveness effects are generally larger for industries that are both relatively energy- and trade-intensive. In 2007, these industries accounted for about 4.5 percent of domestic output. Estimates of the effects vary because of key assumptions required by economic models. For example, models generally assume a price for U.S. carbon emissions, but do not assume a similar price by other nations. In addition, the models generally do not incorporate all policy provisions, such as legislative proposals related to trade measures and rebates that are based on levels of production. Proposed legislation suggests that industries vulnerable to competitiveness effects should be considered differently. Industries for which competitiveness measures would apply are identified on the basis of their energy and trade intensity. Most of the industries that meet these criteria are in primary metals, nonmetallic minerals, paper, and chemicals, although significant variation exists for product groups (sub-industries) within each industry. Additional variation arises on the basis of the type of energy used and the extent to which foreign competitors' greenhouse gas emissions are regulated. To illustrate variability in characteristics that make industries vulnerable to competitiveness effects, we include illustrations of sub-industries within primary metals that meet both the energy and trade intensity criteria; examples that met only one criterion; and examples that met neither, but had significant imports from countries without greenhouse gas pricing.

section_title: Letter
paragraphs: Thank you for the opportunity to appear again before the Committee to  provide insights from GAO’s work on issues related to important  international issues. Changes in the earth’s climate attributable to  increased concentrations of greenhouse gases may have significant  environmental and economic impacts in the United States and  internationally. To mitigate climate change effects, countries are taking or  considering varying approaches to reducing greenhouse gas emissions,  such as carbon dioxide, which is the most important greenhouse gas due  to its significant volume. Between 2007 and 2009, Congress introduced a  number of climate change bills, many of which contained proposals for a  domestic emissions pricing system, such as a cap-and-trade system or a  carbon tax. However, imposing costs on energy-intensive industries in the  United States could potentially place them at a disadvantage to foreign  competitors. In addition, emissions pricing could have negative  environmental consequences, such as “carbon leakage,” whereby  emissions reductions in the United States are replaced by increases in  production and emissions in less-regulated countries. As Congress  considers the design of a domestic emissions pricing system, a key  challenge will be balancing the need to reduce greenhouse gas emissions  with the need to address the competitiveness of U.S. industries.
In my testimony today, my comments are based on a report that we are  issuing today to the Senate Committee on Finance. In particular, I will  briefly describe some of the key challenges associated with estimating the  industry effects from climate change measures, and provide illustrations of  key characteristics for potentially vulnerable industries.
To address these objectives, we interviewed officials and reviewed climate  change literature and documents from U.S. agencies, international  organizations, policy institutes, and professional organizations; reviewed  and analyzed a selection of climate change legislation introduced between  2007 and 2009 and congressional hearing records; analyzed data from the  Census Bureau and the Departments of Energy and Commerce, among  others; and reviewed and presented summary results for studies  attempting to quantify the potential international competitiveness effects  on domestic industries from emissions pricing. We conducted our work  from October 2008 to July 2009 in accordance with all sections of GAO’s  Quality Assurance Framework that were relevant to our objectives. We  believe that the information and data obtained, and the analysis  conducted, provide a reasonable basis for any findings and conclusions in  this product.
subsections: section_title: Background
paragraphs: Countries can take varying approaches to reducing greenhouse gas  emissions. Since energy use is a significant source of greenhouse gas  emissions, policies designed to increase energy efficiency or induce a  switch to less greenhouse-gas-intensive fuels, such as from coal to natural  gas, can reduce emissions in the short term. In the long term, however,  major technology changes will be needed to establish a less carbon- intensive energy infrastructure. To that end, a U.S. policy to mitigate  climate change may require facilities to achieve specified reductions or  employ a market-based mechanism, such as establishing a price on  emissions. Several bills to implement emissions pricing in the United  States have been introduced in the 110th and 111th Congresses. These bills  have included both cap-and-trade and carbon tax proposals. Some of the  proposed legislation also include measures intended to limit potentially  adverse impacts on the international competitiveness of domestic firms.
section_title: Estimating Competitiveness Effects
paragraphs: Estimating the effects of domestic emissions pricing for industries in the  United States is complex. For example, if the United States were to  regulate greenhouse gas emissions, production costs could rise for many  industries and could cause output, profits, or employment to fall.  However, the magnitude of these potential effects is likely to depend on  the greenhouse gas intensity of industry output and on the domestic  emissions price, which is not yet known, among other factors.  Additionally, if U.S. climate policy was more stringent than in other  countries, some domestic industries could experience a loss in  international competitiveness. Within these industries, adverse  competitiveness effects could arise through an increase in imports, a  decrease in exports, or both.
For regulated sources, greenhouse gas emissions pricing would increase  the cost of releasing greenhouse gases. As a result, it would encourage  some of these sources to reduce their emissions, compared with business- as-usual. Under domestic emissions pricing, production costs for regulated  sources could rise as they either take action to reduce their emissions or  pay for the greenhouse gases they release. Cost increases are likely to be  larger for production that is relatively greenhouse gas-intensive, where  greenhouse gas intensity refers to emissions per unit of output. Cost  increases may reduce industry profits, or they may be passed on to  consumers in the form of higher prices. To the extent that cost increases  are passed on to consumers, they could demand fewer goods, and industry  output could fall.
While emissions pricing would likely cause production costs to rise for  certain industries, the extent of this rise and the resulting impact on  industry output are less certain due to a number of factors. For example,  the U.S. emissions price and the emissions price in other countries are key  variables that will help to determine the impact of emissions pricing on  domestic industries. However, future emission prices are currently  unknown. Additionally, to the extent that emissions pricing encourages  technological change that reduces greenhouse gas intensity, potential  adverse effects of emissions pricing on profits or output could be  mitigated for U.S. industries.
Several studies by U.S. agencies and experts have used models of the  economy to simulate the effects of emissions pricing policy on output and  related economic outcomes. These models generally find that emissions  pricing will cause output, profits, or employment to decline in sectors that  are described as energy intensive, compared with business-as-usual. In  general, these studies conclude that these declines are likely to be greater  for these industries, as compared with other sectors in the economy.  However, some research suggests that not every industry is likely to suffer  adverse effects from emissions pricing. For example, a long-run model  estimated by Ho, Morgenstern, and Shih (2008) predicts that some U.S.  sectors, such as services, may experience growth in the long run as a  result of domestic emissions pricing. This growth would likely be due to  changes in consumption patterns in favor of goods and services that are  relatively less greenhouse gas-intensive.
Potential international competitiveness effects depend in part on the  stringency of U.S. climate policy relative to other countries. For example,  if domestic greenhouse gas emissions pricing were to make emissions  more expensive in the United States than in other countries, production  costs for domestic industries would likely increase relative to their  international competitors, potentially disadvantaging industries in the  United States. As a result, some domestic production could shift abroad,  through changes in consumption or investment patterns, to countries  where greenhouse gas emissions are less stringently regulated. For  example, consumers may substitute some goods made in other countries  for some goods made domestically. Similarly, investment patterns could  shift more strongly in favor of new capacity in countries where  greenhouse gas emissions are regulated less stringently than in the United  States.
Stakeholders and experts have identified two criteria, among others, that  are important in determining potential vulnerability to adverse  competitiveness effects: trade intensity and energy intensity. Trade  intensity is important because international competitiveness effects arise  from changes in trade patterns. For example, if climate policy in the  United States were more stringent than in other countries, international  competition could limit the ability of domestic firms to pass increases in  costs through to consumers. Energy intensity is important because the  combustion of fossil fuels for energy is a significant source of greenhouse  gas emissions, which may increase production costs under emissions  pricing.
Legislation passed in June 2009 by the House of Representatives, H.R.  2454, 111th Cong. (2009), uses the criteria of trade intensity and energy  intensity or greenhouse gas intensity, among others, to determine  eligibility for the Emission Allowance Rebate Program, which is part of the  legislation. H.R. 2454 specifies how to calculate the two criteria. Trade  intensity is defined as the ratio of the sum of the value of imports and  exports within an industry to the sum of the value of shipments and  imports within the industry. Energy intensity is defined as the industry’s  cost of purchased electricity and fuel costs, or energy expenditures,  divided by the value of shipments of the industry.
Reducing carbon emissions in the United States could result in carbon  leakage through two potential mechanisms. First, if domestic production  were to shift abroad to countries where greenhouse gas emissions are not  regulated, emissions in these countries could grow faster than expected  otherwise. Through this mechanism, some of the expected benefits of  reducing emissions domestically could be offset by faster growth in  emissions elsewhere, according to Aldy and Pizer (2009).
Second, carbon leakage may also arise from changes in world prices that  are brought about by domestic emissions pricing. For example, U.S.  emissions pricing could cause domestic demand for oil to fall. Because the  United States is a relatively large consumer of oil worldwide, the world  price of oil could fall when the U.S. demand for oil drops. The quantity of  oil consumed by other countries would rise in response, increasing  greenhouse gas emissions from the rest of the world. These price effects  may be a more important source of carbon leakage than the trade effects  previously described.
section_title: Potentially Vulnerable Industries
paragraphs: Two key indicators of potential vulnerability to adverse competitiveness  effects are an industry’s energy intensity and trade intensity. Proposed  U.S. legislation specifies that (1) either an energy intensity or greenhouse  gas intensity of 5 percent or greater; and (2) a trade intensity of 15 percent  or greater be used as criteria to identify industries for which trade  measures or rebates would apply. Since data on greenhouse gas intensity  are less complete, we focused our analysis on industry energy intensity.  Most of the industries that meet these criteria fall under 4 industry  categories: primary metals, nonmetallic minerals, paper, and chemicals.   However, there is significant variation in specified vulnerability  characteristics among different product groups (“sub-industries”).
Although our report examined the four industry categories, figures 1  through 4 or the following pages illustrate the variation among different  sub-industries within the primary metals industry, as well as information  on the type of energy used and location of import and export markets.  The data shown in these figures are for the latest year available.
As shown by sub-industry examples in figure 1, energy and trade  intensities differ within primary metals. For example, primary aluminum  meets the vulnerability criteria with an energy intensity of 24 percent and a  trade intensity of 62 percent. Ferrous metal foundries meets the energy  intensity criteria, but not the trade intensity criteria. Steel  manufacturing—products made from purchased steel—and aluminum  products fall short of both vulnerability criteria. Iron and steel mills has an  energy intensity of 7 percent and a trade intensity of 35 percent and is by  far the largest sub-industry example, with a 2007 value of output of over  $93 billion. The energy and trade intensity for all primary metal products is  denoted by the “x” in figure 1.
Among the primary metals sub-industry examples shown in figure 2, the  types of energy used also vary. Iron and steel mills uses the greatest share  of coal and coke, and steel manufacturing and ferrous metal foundries  uses the greatest proportion of natural gas. Since coal is more carbon- intensive than natural gas, sub-industries that rely more heavily on coal  could also be more vulnerable to competitiveness effects. The carbon  intensity of electricity, used heavily in the production of aluminum, will  also vary on the basis of the source of energy used to generate it and the  market conditions where it is sold. Data shown for “aluminum” include  primary aluminum and aluminum products, and net electricity is the sum  of net transfers plus purchases and generation minus quantities sold.
Industry vulnerability may further vary depending on the share of trade  with countries that do not have carbon pricing. To illustrate this  variability, figure 3 provides data on the share of imports by source, since  imports exceed exports in each of the primary metals examples. As  shown, while primary aluminum is among the most trade-intensive, the  majority of imports are from Canada, an Annex I country with agreed  emission reduction targets. For iron and steel mills, over one-third of  imports are from the European Union and other Annex I countries, not  including Canada (“EU plus”). However, for iron and steel mills, almost 30  percent of imports are also from the non-Annex I countries of China,  Mexico, and Brazil. While less trade-intensive, steel manufacturing and  aluminum products each has greater than one-third of imports from China  alone.
As shown in figure 4, adverse competitiveness effects from emissions  pricing could increase the already growing share of Chinese imports that  exists in some of the sub-industries. Among the examples, iron and steel  mills, steel manufacturing, and aluminum products exhibit a growing trade  reliance on Chinese imports since 2002. This trend has largely been driven  by lower labor and capital costs in China, and, according to  representatives from the steel industry, China has recently been producing  50 percent of the world’s steel.
Mr. Chairman, this concludes my prepared statement. Thank you for the  opportunity to testify before the Committee on some of the issues  addressed in our report on the subject of climate change trade measures. I  would be happy to answer any questions from you or other members of  the Committee.
section_title: Contacts and Acknowlegments
paragraphs: For further information about this statement, please contact Loren Yager  at (202) 512-4347 or yagerl@gao.gov. Contact points for our Offices of  Congressional Relations and Public Affairs may be found on the last page  of this statement. Individuals who made key contributions to this  statement include Christine Broderick (Assistant Director), Etana Finkler,  Kendall Helm, Jeremy Latimer, Maria Mercado, and Ardith Spence.
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