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Addressing Competitiveness Concerns in the Context of a Mandatory Policy for Reducing U.S. Greenhouse Gas Emissions
Richard D. Morgenstern

Summary A variety of mandatory policies to reduce U.S. greenhouse gas (GHG) emissions - principally cap-and-trade systems, occasionally carbon taxes, and sometimes standards - are now being seriously debated at the federal level. A frequent concern raised in these debates is the potential for adverse impacts on the competitiveness of U.S. industries, particularly on firms or in sectors that face high energy costs and significant international competition. This issue brief examines the advantages and disadvantages of five strategies or options for addressing competitiveness concerns in the context of federal climate legislation. The first of these options would involve the design of the policy as a whole; all of the remaining options attempt to target industries or sectors that would be particularly vulnerable to adverse impacts under a mandatory program to reduce GHG emissions:

Addressing Competitiveness Concerns in the Context of a Mandatory Policy for Reducing U.S. Greenhouse Gas Emissions

• Weaker overall program targets
• Partial or full exemptions from the carbon policy
• Standards instead of market-based policies for some sectors
• Free allowance allocation under a cap-and-trade system
• Trade-related policies, including some form of border adjustment for energy- or carbon-intensive goods

We arrive at the following observations:

• Cost-effective policies that allow access to inexpensive mitigation opportunities throughout the United States and potentially around the world will generally minimize the economic costs of achieving any given emission target and could be viewed as a first response to competitiveness concerns.
  
  
• A weaker overall policy - less stringent emissions caps and/or lower emissions prices - represents the least focused approach available for addressing competitiveness impacts. This approach has the advantage that it does not require policymakers to identify vulnerable sectors or firms and thus avoids the potential for a "gold rush" of industries seeking relief. The disadvantage, obviously, is that less ambitious emission-reduction targets will produce smaller environmental benefits and weaker incentives for technology innovation.
  
  
• Simply exempting certain sectors or types of firms provides a direct response to competitiveness concerns and the most relief to potentially affected industries, but it is also the most costly option in terms of reducing the economic efficiency of the policy.
  
  
• More traditional (non-market-based) forms of regulation - such as emissions standards or intensity-based regulations - can be used to avoid direct energy price increases and deliver some emissions reductions. Regulated industries will still face compliance costs, however. Meanwhile, the overall cost to society of achieving a given environmental objective using these forms of regulation will tend to be higher than under a single pricing policy.
  
  
• Free allowances can be used to compensate adversely affected industries (even if those industries are not directly regulated under the policy) without necessarily losing the efficiency of a broad, market-based approach. Different forms of free allocation - for example, an allocation based on historic emissions or energy use ("grandfathering") versus an updating allocation tied to current output - will have very different incentive properties and may respond more or less effectively to concerns about retaining production capacity and jobs in the United States. The consequences of different allocation methodologies and their relative advantages and disadvantages in relation to competitiveness concerns and other policy objectives must therefore be carefully considered.¹
  
  
• Trade-related policies (such as border adjustments for energy- or carbon-intensive goods) can both protect vulnerable domestic firms and industries and create incentives for nations without similar GHG policies to participate in emissions-reduction efforts. However, such policies also risk providing political cover for unwarranted and costly protectionism and may provoke trade disputes with other nations.
  
  
• In general, the more targeted policies (that is, all options noted above except an overall weaker policy) will be difficult to police and many industries will have strong incentives to seek special protection by taking advantage of these various mechanisms without necessarily being at significant competitive risk.

1. Issue Brief #6 provides more detail concerning specific issues related to allocation.