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Energy Trade Wars

Are we now trying to kill coal by banning trade?

This has been an eventful week on and off the court (Go Warriors!). The executive branch of the government is attempting to shake up global trade arrangements though a series of tweets and press conferences. What is being proposed has serious consequences for US producers and consumers of energy resources. So what’s the issue?

Free(ish) trade to the average economist is like chocolate to the average 9 years old. The vast majority of us think it is a really good idea. The basic argument is pretty simple. If place A can make an identical good at a lower cost than place B, place A should make it and sell it to place B. There are many reasons why one place might be able to produce a good at a relatively lower cost, but the two main ones are as follows. Wages in place A might be lower, since it may have a large supply of “cheap” labor. This is the reason why iPhones are assembled in China and not Palo Alto.

The second reason is that certain places have large endowments of physical inputs to production, which other places don’t. In the undergraduate classroom we usually describe “capital” used in the production of “widgets” as an example, which is why so many grownups tell me they feel about their undergraduate economics class the way they feel about Kale in their smoothie (only the weird ones like it). Better, highly policy-relevant examples are easy if you are an energy economist.

No matter whether you’re into coal, wind, solar, oil, gas or bioenergy – these important inputs into producing heat, which you can turn into electricity, are not distributed equally across the globe. China has a lot of low quality coal, Saudi Arabia has massive reserves of oil, the Midwest has incredible wind resources, Canada has ample hydropower resources.

Is there trade in these resources? You bet. California imports a third of its electricity from other states. Some of those electrons are generated by coal in Nevada and Arizona. Others are generated on the pristine streams of British Columbia. The gasoline in that 3 series Beamer in downtown Beijing probably found its origin in the Middle East. That liquefied natural gas feeding a power plant outside of Tokyo probably had its origin in Malaysia.

The beauty of markets is that resources produced at least cost find their way to the highest bidder. This way the global basket of electrons and therms is produced at the least cost and generates the most value. This is the invisible hand of the marketplace gently allocating scarce energy resources in an efficient way.

So what about the haters? There are of course issues with free trade. As my colleague Dara O’Rourke would point out, in locations where legal institutions are lacking, those new Lebron sneakers might be stitched together by 12-year-old workers in atrocious conditions. In areas where environmental regulations are weak or nonexistent, energy resources are extracted and refined in ways that are disastrous for local communities and ecosystems. Also, the transport of resources across oceans leads to significant environmental damage as ships and planes produce emissions of greenhouse gases and local pollutants just to get resources from place A to place B. Much work has been and continues to be done to address these failures of the market allocation mechanism and we clearly have a long way to go.

What makes trade maybe most interesting is the intersection between politics and economics, which we gently refer to as the “Political Economy” of trade. When nations argue over pretty much anything, there is no global supreme court or a global sheriff to enforce violations of agreements between countries. The only way to retaliate if country A does something country B does not like is to impose trade sanctions. For example, the United States could impose tariffs on goods from its Northern neighbor or in the extreme ban all imports. Or, it could disallow all trade – both exports and imports. In my undergraduate class I explain the consequences of bans, tariffs and quotas to a room full of 20-year-olds and they get it in the span of three hours.

The consequences of limiting imports of a good, in whatever way, is that domestic consumers of the good lose and domestic producers of it gain. And the domestic consumers include companies that use the good as an input in their own production. In almost all scenarios domestic consumers lose more than domestic producers (and the government) gain – something called dead weight loss (which is maybe the coolest term in economics and should be a band name).  That is, it makes the total economic pie smaller.

Which is why I was doubly surprised that the current administration’s chief economic advisor is supportive of the current strategy of increased tariffs. But if you think about it for a minute, it is consistent with “Making America Great Again” – if by America you mean U.S. producers of iron and steel for example. This policy would make American consumers lose, but those specific producers would win. If that is your goal, fine.

What I do not understand is a recent statement by the executive branch that the US would possibly “ban all trade” with certain countries (which would presumably include trade in energy resources). What this would mean (I think) is that we would neither import nor export commodities. This immediately made me think about the prospects for coal. The coal industry is dying a slow and painful death, as we have discussed here and here at the hand of cheap natural gas and renewables. In the short to medium run the only hope for US coal is to increase exports to markets which still have demand for it while they build bridges to a clean and renewable future. While U.S. coal exports were dropping for an extended period, they showed signs of recovery in the past two quarters mostly due to increased demand from Asia. A hypothesized limit on coal exports would threaten this important outlet for US producers, which they are spending significant resources on expanding. Further, other producers would gladly step in and supply those other countries with their, possibly lower quality coal.

Of course, this whole set of statements should be interpreted in the light of strategic posturing in a complex game to maximize the welfare of some in the United States. But in my view, limiting coal exports might be the only good outcome for the environment. Tariffs on foreign cars (which tend to be more fuel efficient), energy resources (lots of hydro up north), foreign steel and iron, will result in worse environmental outcomes domestically and higher prices for consumers.

Maximilian Auffhammer View All

Maximilian Auffhammer is the George Pardee Professor of International Sustainable Development at the University of California Berkeley. His fields of expertise are environmental and energy economics, with a specific focus on the impacts and regulation of climate change and air pollution.

5 thoughts on “Energy Trade Wars Leave a comment

  1. Yes, the impact of transportation plays a role in any of the goods production and distribution and Here the Commodity is the “Energy”. But the major thing is that the Politicians and Trade people should have a meeting to get a clarity of what is going on, then the problem might be reduced. Thanks for the information quoted above. Check this: http://www.opendem.com/

  2. I doubt that Trump listens to any of his economic advisors (Kudlow, Navarro, Hassett, Ross). They are meant to be salesmen. Since Trumpism doesn’t go deep, there is an opportunity for them to articulate a version of “Principled Populism” that actually has economic foundations. Said theory would note that the win-win foundations of trade economics rest on Nashian bargaining assumptions positing that you can keep the status quo as an alternative to a negotiated agreement and that countries are more or less playing by the rules. In the alternative theory, you threaten the status quo and punish violations with what are meant to be temporary penalties such as tariffs. I am personally skeptical about the likely effectiveness of this strategy, but we should probably acknowledge the risks of accepting the conventional wisdom as well.

  3. I think the tariff issues is a red herring. The bigger issue is the problem of permitting for shipping coal from West Coast ports to ASIA.
    Stiil since you are at berkely I guess you have to bash Trump.
    Past US and Canadian History show periods of high tarifs which were quite good economically.
    Economists dont think as much interms of robustness. If the US is tied into International trade it will want to intervene in intl issues and other countries will want to intervene here. The Arab oil embargo is one example. More subtle is the russian backing of antifracking groups here and, with more success, in Europe.

    • First, the current tariffs really don’t fit with any real purpose other than as political theater aimed at specific constituencies. Many of these have been shown to likely backfire, even on the intended beneficiaries.

      Second, are you arguing that the U.S. should withdraw from international trade because there are risks of relatively small retaliatory actions on non-trade issues? That’s extreme risk aversion that has bigger costs than any potential benefits.

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