Simply put, we will be worse off

Our biggest import suppliers

The Prime Min­is­ter is wrong when she claims that “street mar­ket” log­ic demands her car­bon emis­sions tax. She’s as wrong as she can be. The con­trary is true: mar­kets will ensure her pro­pos­al is both futile and dam­ag­ing.

Her error, in this case, has noth­ing to do with glob­al warm­ing at all. The rea­sons that the car­bon emis­sions tax will be futile (it won’t cut glob­al emis­sions or Aus­tralian con­sump­tion of CO2 inten­sive goods and ser­vices) and will dam­age our econ­o­my (reduc­ing growth and inno­va­tion in our coun­try and else­where) is inter­na­tion­al trade.

Trade guar­an­tees that any price (e.g. on car­bon inten­sive goods) that Aus­tralia sets high­er than prices else­where will be under­cut, leav­ing world-wide demand for car­bon-inten­sive goods unchanged but switch­ing sup­ply from Aus­tralian pro­duc­ers to for­eign pro­duc­ers. This effect has the fan­cy name of “car­bon leak­age” because imports are like a “hole in the dike” (except the PM is not plan­ning to erect any dike around our bor­ders). But it is real­ly just the same as buy­ing from Coles when Wool­worths’ prices are high­er

The tricky thing about inter­na­tion­al trade, how­ev­er, is that it is not like bar­gain­ing in a “street mar­ket”. A tax on the pro­duc­tion, not just the con­sump­tion, of trad­able goods has much worse con­se­quences…

Our top five import suppliers do not tax emisssions

The biggest loss­es are due to the impact of the tax on the mech­a­nisms of our gains from trade (‘com­par­a­tive advan­tage”). If we tax the pro­duc­tion of valu­able goods that are rel­a­tive­ly cheap to pro­duce in Aus­tralia, such as coal-pow­ered ener­gy and its products—implicitly sub­si­dis­ing sub­sti­tutes that are rel­a­tive­ly cost­ly to pro­duce in Aus­tralia such as low-car­bon ener­gy and its products—we will make our­selves and our neigh­bours poor­er for­ev­er while still not achiev­ing any over­all change in the glob­al out­put of car­bon-inten­sive goods. We will be poor­er because we will have hand­i­capped our own eco­nom­ic strengths and sub­sidised our weak­ness­es. We’ll spend way too much on doing things the hard way, rob­bing our­selves of the oppor­tu­ni­ty to acquire things we need now and in the future at low prices.

The Prime Min­is­ter wants us to believe that she can “com­pen­sate” the loss­es. It’s easy to show why com­pen­sa­tion prob­a­bly won’t off­set the first impact of the tax (on prices). For exam­ple, Wool­worths’ might offer to “com­pen­sate” for high­er prices on one prod­uct by cut­ting prices on anoth­er; but you know that if the high­er price is on milk and the low­er price on onions, your food bill will still go up. Com­pen­sa­tion could work, in the­o­ry, but in fact Wool­worths wants high­er mar­gins over­all, so it’s unlike­ly to be real com­pen­sa­tion. The same is true of the car­bon tax: the gov­ern­ment wants the tax to hurt enough to change behav­iour, so it can­not be ful­ly off­set.

It’s more dif­fi­cult to show why you can’t “com­pen­sate” a loss of com­par­a­tive advan­tage. But the result is even more cer­tain. We don’t have the resources to com­pen­sate either our­selves or our trad­ing parters for the loss of eco­nom­ic effi­cien­cy (“spe­cial­i­sa­tion” in pro­duc­tion) the tax will bring. It’s a bit like the com­pen­sa­tion offered to a car acci­dent vic­tim for para­ple­gia; the mon­ey (nev­er enough, any­way) is just not the point. Mon­ey is not walk­ing; the loss of func­tion is non-com­pen­si­ble.

David Ricardo’s con­cept of “com­par­a­tive advan­tage” has an inescapable log­ic that not even the Prime Min­is­ter can evade or with­stand. She can only imag­ine she may do so because she hasn’t real­ly under­stood it.

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