Kate Mackenzie Chichilnisky on how to solve ‘carbon leakage’ with carbon trading

One of the difficult issues facing countries negotiating at Copenhagen is ‘carbon leakage’. Developed countries agree — in principle — that they should sign up for more stringent emissions reduction targets, allowing developing countries to continue increasing their emissions for a while in order for their populations’ living standards to improve.

But big developed countries, particularly the US, face massive political backlash against the idea of signing up to commitments that would increase costs to their own carbon-intensive industries. Even worse is the prospect of ‘carbon leakage’ – or, work going offshore to developing countries who were allowed more generous limits. The US has floated the idea of a border tax to offset this, which is only inflaming developing countries ahead of Copenhagen.

Angel Gurria, secretary-general of the OECD, wrote in the FT last week that border taxes issue divert attention from the real issue: reducing greenhouse gas emissions. Incidentally, he also says the OECD has found that ‘carbon leakage’ would be minimal; even if only EU countries agreed to strict limits, only 12 per cent of their reductions would leak over to developing countries. If all developed countries signed up, that number would be just 2 per cent.

Professor Graciela Chichilnisky, a key designer of the Kyoto Protocol carbon trading system, says the carbon leakage problem could be addressed in a way that saves face for both the US and China, and means emissions will be reduced. She writes:

The carbon market makes free trade the friend of the environment. Border taxes are no longer necessary and may not work either.

This is how it works. A feature of the carbon market of the Kyoto Protocol – its Clean Development Mechanism or CDM – incorporates all the developing nations. They stand to gain by exporting cleaner products rather than products that emit carbon.So no border taxes are needed.

This works because clean investment in developing nations is now rewarded by carbon credits that are traded in the carbon market. The CDM has led to over $25 billion in clean investment in developing nations so far. Much more can be expected in the future.

Here is one proposal: using ”negative carbon” technologies, poor nations can reduce more carbon in the atmosphere than they emit. For example, poor nations could build power plants that ‘suck’ carbon from air – all funded by the Clean Development Mechanism of the Kyoto Protocol.

There are other possibilities as well. For example, the EU and the US can offer export credits for these technologies, gaining export revenues and increasing employment generation at home. This is a win win solution for the world economy, made possible by the carbon market.

A second proposal is to use the carbon market to diffuse the diplomatic standoff between US and China. Each wants the other nation to reduce emissions first – and both are the largest emitters in the world.

A solution that has been overlooked is that a modest modification of the carbon market allows China and the US to resolve their differences and both get what they want. I have proposed that the US buys from China a forward right to limits its emissions – while China buys from the US price insurance on the cost. All of this is based on the carbon prices arising from the carbon market. Little or no money needs to be exchanged and both nations get what they want from each other. This works within existing law — and will helps obtain endorsement from the US Congress – who wants emissions commitments on the part of China.

Prof Chichilnisky is architect of the carbon market of the Kyoto Protocol, Director of Columbia Consortium for Risk Management, professor of economics statistics at Columbia University, and co-author of Saving Kyoto.

A longer piece on this solution (reprinted from Time magazine) is available at Chichilnisky’s website in PDF format.