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May 20, 2009

How Will Climate Change Legislation Affect US Competitiveness?
    by Robert Kropp

Report from the Pew Center on Global Climate Change finds that a flexible cap-and-trade program can reduce emissions while protecting vulnerable industries from foreign competition. First of a two-part series. -- What will happen if the United States implements a cap-and-trade program for greenhouse gas (GHG) emissions, and developing economies in countries like China and India do not? Will the competitiveness of the US economy suffer as a result, with an increase in competitive pressures from abroad and a decline in employment? A new report from the Pew Center on Global Climate Change, authored by economists Joseph Aldy and William Pizer of Resources for the Future (RFF), addresses theses questions and provides some answers via much-needed quantitative analysis.

The report, entitled The Competitiveness Impacts of Climate Change Mitigation Policies, draws on 20 years of data to analyze the historical relationships between energy prices and shipments, trade, and employment within energy-intensive manufacturing industries.

"Thus far, the debate over competitiveness has occurred in the absence of good, hard data," said Eileen Claussen, President of the Pew Center. "This report suggests that the effect of climate change policies can be modest and manageable."

According to the report, "By pricing carbon dioxide (CO2) emissions associated with fossil energy, domestic production costs rise, eventually raising prices to customers and causing a decline in domestic sales. This production decline may reflect, in part, a shift of economic activity, jobs, and emissions overseas to key trading partners, if they do not face comparable regulation."

Expectations are that the Obama administration will encourage passage of cap-and-trade legislation, under which GHG emissions are controlled and eventually reversed by means of financial incentives to invest in energy-efficient technologies and to switch to lower-carbon fuels. The proposed American Clean Energy and Security Act would establish "a market-based program for reducing global warming pollution from electric utilities, oil companies, large industrial sources, and other entities that collectively are responsible for 85% of US global warming emissions."

Already in place is the Regional Greenhouse Gas Initiative (RGGI), a cooperative effort by ten Northeast and Mid-Atlantic states. The initiative caps CO2 emissions from the power sector, and requires a 10% reduction in emissions by 2018.

Other states, including California—which produces 6.2% of GHG emissions in the US—are expected to follow suit, through such initiatives as the Western Climate Initiative (WCI), a collaboration of seven US governors and four Canadian Premiers.

Concerns over the impact of such legislation include the loss of domestic market share to foreign companies located in countries in which they are not subject to such regulation, and the relocation of manufacturing activities to unregulated countries. Such effects could lead to "emissions leakage," in which GHG emissions reductions in the US are offset by increased emissions elsewhere.

The report focuses on such potential adverse impacts on competitiveness under a US cap-and-trade program. Its analysis reveals that energy-intensive industries in the US are better positioned to withstand adverse impacts today, because by 2006 their use of fossil fuels had declined to 80% of peak levels of usage recorded in 1979. As a result, the industrial sector now comprises 28% of US CO2 emissions, compared to 39% in 1979.

In addressing the question of whether manufacturing in the US is likely to lose market share as a result of climate change legislation, the report finds a number of mitigating factors that should reduce such an impact. First, "the availability of relevant factors of production, such as appropriately skilled labor, natural resources, and capital, can play a more significant role than pollution control costs." High transportation costs are also likely to discourage relocation.

Allowing for an estimated price of $15 per ton of CO2 in 2012, the report projects an increase in the cost of electricity in the industrial sector by about 8%. As a result, the average effect on manufacturing in the US of the price of CO2 is expected to decrease production by about 2%. The energy-intensive industries are likely to bear a more substantial decline in production, of about 4%.

"These declines in production could reflect increasing market share by foreign competitors and/or lower domestic consumption of these manufactured goods," according to the report. The report projects declines in consumption in energy-intensive sectors of up to 3%, which "clearly shows that the bulk of the estimated change in production is arising from changes in consumption, and not from net imports or presumed competitiveness effects."

The results of the analysis suggests that consumers of energy-intensive goods do not respond to higher energy prices by consuming more imports, but by economizing on their usage. According to Elliot Diringer, Vice President for International Strategies at the Pew Center, "This analysis projects a competitiveness effect of less than 1% in most energy-intensive sectors, which are modest impacts that can be readily managed by good policy practices."

The report concludes that climate change legislation in the US will not have a significant economic impact on manufacturing as a whole, or even on most energy-intensive industries. However, there does remain the possibility of more significant impacts on narrowly defined industries. In response to such potential impacts, the report considers three possible regulatory solutions.

The US could condition climate change legislation on a broad-based agreement among all nations, which would mitigate the potential effect on domestic manufacturing. Vulnerable industries could be excluded from a cap-and-trade program. Finally, efforts to mitigate effects on vulnerable industries could be accomplished within a cap-and-trade program by such practices as allocating emission allowances in a manner that subsidizes production.

Because only the third approach addresses both the necessity of effective climate change legislation and the potential competitiveness impact, it is the approach strongly favored by the authors of the report.

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