# **5.2 Climate Change**

Just as in the case of fisheries, dealing with rent transfers nationally and internationally will dominate efficiency considerations both because the bulk of the electorate is opposed to a carbon tax and because high GHG emitters are powerful groups in the energy, construction, transportation and manufacturing sectors.<sup>25</sup> The political-economy of implementing a carbon border tax would, however, be extremely difficult, as illustrated by Moore (2010) for the steel industry, a heavy CO2 emitter for which it is difficult to evaluate the carbon footprint in the final product. He shows that none among the possible border adjustments would meet the necessary economic, political, environmental, legal, and administrative constraints needed to gain the necessary support for implementation. These constraints are: (i) domestic firm buy-in; (ii) foreign firm buy-in; (iii) administrative capability; (iv) adherence to WTO rules (articles I on non-discrimination and III on national treatment; and (v) incentives for CO2 reduction by foreign firms. Since several technologies are available to produce steel, it would be necessary for the country wishing to impose a border adjustment to firms in foreign countries to distinguish among foreign firm types. The complicated administrative procedures implied by any choice of border adjustment raises the specter of adopting a system of rules of origin that would attempt, through bureaucratic means, to identify the true source of products whose origin is unclear from their physical characteristics. Such a system would in all likelihood be captured by lobbies as has been the case for rules of origin in the context of preferential market access (see Cadot and de Melo, 2007).

Mathys and de Melo (2011) discuss the exceptional sensitivity of these rent transfers in the political debate in the EU and the US and take the promotion of biofuels as an example of rent capture in action and of a perverse incentive.<sup>26</sup> Getting support for mitigation policies under a cap may then prove to be very costly. Mathys and de Melo conclude that, just as anti-dumping was the price to pay for countries to sign up to the Single Undertaking as part of the Uruguay round grand package, free allowances (or very limited auctioning) may be the political price to pay. As in the case of biofuels, such support would result in large transfers from consumers to producers. In a study of the ETS cap, Demailly and Quirion (2008) estimate that a 15 per cent reduction in CO2 emissions under free allowances would raise the net profit margin of industries under the cap by seven percentage points, an increase coming from a 10 per cent fall in consumer surplus. And of course, aluminium, which is highly tradable (i.e. very substitutable across suppliers), is not covered in the emission cap since, even with free allowances, the possibility to raise prices and pass on the costs to consumers would be very limited. As to total leakage estimates, the authors estimate these to be small at 8%.

> 25Messerlin (2011) draws the parallel between climate and water policies, arguing that both communities face the same foes (protectionist pressures from strong lobby groups, e.g. steel producers and farmers) and friends (exporters of environmentally-friendly products) in their quest to pursue the efficient policies (remove water subsidies and tax carbon).

> 26 Even though estimates suggest that at most half a dozen sectors might be subject to significant carbon leakage, 164 sectors sectors (sub-sectors) have been considered by the EU Commission as exposed to “significant risk of carbon leakage” meaning that they would be up to get 100 percent free allocations. Messerlin (2010) notes that these are the sectors that have succeeded in obtaining contingent-protection measures at the WTO.

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