It looks like we’re about to.

A Provincial Carbon Holdout

This blog has elaborated on carbon pricing before. In short: carbon should be priced at the value where the marginal damage caused by a tonne of carbon is equal to the marginal cost of abating that tonne of emissions. That sounds like hogwash, but reading the aforementioned post should help.

That post is sensible in a world where there is only one government, and the price of carbon is the same everywhere. You can’t escape that tax. No region can outflank the price.

Say we are in a hypothetical world with one government, and with 10 subnational governments who have some control over their environmental policies. It’s in section 92.13 of their hypothetical constitution.

Imagine a hypothetical subnational government called Saskatchewan. They do not want to play ball. Their leader, Bradley, is not interested in levying a tax on carbon. He knows that if everyone else prices carbon, Saskatchewan has an opportunity to specialize in carbon-intensive production.

The Heckscher-Ohlin Model, which models trade between 2 countries, is useful in this analysis. Countries specialize in and export goods that they are abundant in, or those they can produce cheaply. They will import those goods which, in relative terms, other countries are abundant in.

Saskatchewan is abundant in cheap carbon if everyone else taxes themselves. Other provinces will probably become abundant in non-carbon goods. Holding out, thus specializing, gives Saskatchewan an opportunity to develop through export-led growth. Why wouldn’t they do that?

Saskatchewan will increase their carbon emissions as other provinces decrease their own. Other provinces’ abatement will be matched by increases from elsewhere. Perhaps the replacement rate is not 100%, but it is some positive value.

A Provincial Carbon Standout

Say the world has been flipped upside down. In the upside down, our friend Rachel from Alberta is interested in putting a price on carbon. Her province is the only province who would do such a thing. Why put a price on carbon, they say, when folks like Bradley never will? But Alberta thinks itself noble. Decreasing global carbon emissions is probably a good thing.

Albertan carbon emissions will decrease. But that doesn’t mean they’ll disappear from the face of the Earth. Alberta, rather, has altered its specialization to non-carbon goods. And the other provinces have specialized, in relative terms, in carbon-intensive goods because the relative price has changed. Alberta now imports carbon, rather than producing it.

The other provinces will match Alberta’s carbon emissions decrease with increases of their own. The replacement rate may not be 100%, but likely some level higher than in the holdout’s case from earlier.

Unilateral self-imposed carbon pricing may be ineffective and distortionary when other governments do not cooperate. The noble provinces end up importing carbon anyway.

Canada as a Standout

Canada today is much like Alberta in the previous analogy. Some countries and regions, like the European Union, have imposed some form of carbon pricing. But the countries who represent the vast majority of global income have not.

If Canada unilaterally prices carbon, it will probably distort its domestic market, increase prices, and fail to dent global emissions. This is an incredibly inconvenient truth for environmentally friendly economists such as myself.

Canada as a Global Leader

Allow me to stray into the world of Political Economy and International Affairs – a world which I know nothing about. If Canadian unilateral carbon pricing is useless, why do it at all? Is there another angle of environmental policy we could pursue? I am going to write briefly on two possibilities.

We Price Carbon Anyway

Much of the world could eventually do it, and Canada could build international political capital by leading the charge. Canada might gain the level of international recognition the current government is seeking by becoming a global leader on the climate file. But it might be all for naught.

The United States is unlikely to unilaterally adopt a price on carbon. While Democratic control of the Presidency and Senate are likely to last the next 4 years, the House of Representatives is a different story. Republicans are unlikely to cede the House, nor will they cede ground on a carbon tax.

China is unlikely to implement a pricing scheme without the United States buying in. South East Asia is unlikely to buy in without Japanese, South Korean, and Chinese buy-in.

Rather than continue down this train of thought, game theory will do. Carbon pricing is a dominated strategy, especially in the developing world. Unpriced carbon is the Nash Equilibrium outcome.

We Lead the Charge on a Global Price

The world’s 196 countries are unlikely to individually adopt carbon prices. But developed countries were unlikely to individually drop trade tariffs in the 1940s. Then the General Agreement on Tariffs and Trade was signed in 1947. What were the odds of global decreases in tariffs and trade boundaries? Today 164 countries are members of the World Trade Organization.

Global coordination on market-based initiatives is not unprecedented. The climate file will require courage, but so did creating the GATT and WTO. The United Nations has not provided an effective platform for binding global agreements. Perhaps Canada’s best bet is leading the charge on an international binding carbon reductions treaty.

A global price is nonsensical. The marginal damage of the next tonne of carbon varies country-to-country. As does the marginal cost of abating a tonne. However, a global carbon permit trading system is indeed possible, and more practical than a universal price.

Inconvenient Political Economic Truths

It is a shame that a Canadian unilateral carbon tax may do nothing to abate global emissions. China and the United States are beginning to take steps to reduce their emissions. Canada and small countries like ours should probably avoid subsidizing developing countries’ emissions.

Gradual individual uptake of carbon prices is also unlikely. The world’s best chance for decreasing emissions is a global framework. The Trudeau government has good intentions, but a Canadian carbon price will only make Canadians worse off. But it’s not ethical to sit back and do nothing.

Canada should take the lead on a global carbon market before it’s too late.