In the runup to a new round of negotiations on a global climate agreement, China is calling for a “consumer pays” principle: those who import goods from China should pay for their embedded carbon emissions. According to this Reuters Report, Gao Li, the top Chinese official for climate change policy says, “About 15 percent to 25 percent of China's emissions come from the products which we make for the world....this share of emission should be taken by the consumers, not the producers.”
This is not only correct, it is the natural outcome of a rational climate policy regime.
Suppose China requires anyone introducing a carbon fuel into its economy, such as an oil, gas or coal company, to have a permit, and that it caps these permits to curb emissions. Prices of the fuels rise, and these prices are passed along to direct consumers including manufacturers who use these fuels as inputs. This in turn means that prices rise for the manufactured products, paid by the ultimate consumers—in this case, often US and European importers.
If all the permits are auctioned, their combined value will approximately equal the extra revenues derived from consumers. The government could then rebate this money back to its citizens. Since China is a net exporter (even during the current crisis), the money received by its households will exceed the money they pay in higher prices. This means China could, if it wished, rebate somewhat less than the total auction proceeds, use its cut to finance investments in energy efficiency and non-carbon alternatives, and still protect the real income of its population.
This process, which meets the conditions laid down by Li, can be set in motion by the Chinese themselves, unilaterally. The only need for international coordination concerns the problem of leakage, i.e. how to prevent Chinese domestic and export markets from being captured by producers in countries that don’t require carbon permits. The first-best solution would a global agreement to require permits everywhere with a single, global cap. Such permits would be universally tradeable, which means that artificial barriers to their efficient allocation would be removed. Since there would be a single global price, the leakage problem would be eliminated too.
A second-best approach would be to institute a system of border taxes calibrated to the differences in production costs stemming from different national carbon regimes. Establishing a common set of procedures for calculating and applying this tax should be a high priority for negotiators.
Developing countries with trade surpluses, and particularly China, should be eager to enter a system of carbon emission controls. The rest of the developing world will need other inducements.