Trade sanctions and Climate Policy

As Kyoto has come into force, it seems that trade sanctions to combat potential negative impacts on EU­competiveness are "WTO­proof". The opposing views from empirical research and simulation studies leave room to the fear of deteriorating competitiveness, substantial sectoral adjustments and carbon leakage. Simulations with WorldScan, a global general equilibrium model, focus on climate policies and provide alternative answers to the question how to alleviate the problems associated with this policy. Import tariffs and export subsidies that compensate the effect of the energy tax on production cost, restore the competitiveness of European industries, at home and abroad. Both compensating import tariffs and export subsidies thus help to alleviate the problem of carbon leakage. Simulations show that trade policy has favorable consequences, both economic and environmental. However its role is limited. Trade in energy­intensive goods plays a limited role in the economy as a whole. Within the context of Kyoto, relocation and loss of competitiveness is rather small. In a more stringent climate policy, like unilateral action by EU25 to reduce CO2 emission 20% below 1990 levels, there may be some room for trade policy. Imposing tariffs and granting subsidies can restore import and export of energy­intensive goods to baseline levels. These sanctions mitigate the negative effects on income in abating countries and decrease carbon leakage. They accomplish that the reduction of European CO2 emissions is achieved by improving energy efficiency rather than by relocation of industries. Abating countries, relying relative strongly on energy­intensive trade, like the Netherlands, benefit most. However, trade sanctions are not a credible threat to non­abating countries. They may reduce the positive effects of non­abating, but effects on income and production in energy­intensive sectors will not turn negative.