Trade Competitiveness:
Implications of Kyoto Protocol

Udit Mathur            umathur@devalt.org

While the fate of the Kyoto Protocol is still uncertain, European Union has decided to operationalize the EU Emissions Trading Scheme (EU ETS) from January 2005. It will be by far the worlds biggest programme of pollution control, potentially worth billions of Euros. This programme is an important precursor to the implementation of the Kyoto Protocol and can provide valuable insights into the pros and cons of both the developed and the developing countries for doing so, particularly on the trade front. This article examines the estimated impacts of EU-ETS on the competitiveness of traded goods and the likely impact on the Indian economy of these changes. This can provide an analogous situation to the trade scenario when Kyoto Protocol will be in force.

The impact of EU-ETS on the competitiveness of a given sector will depend upon the policy decisions relating to the price and allocation of emission allowances, and also upon the sectors potential exposure. The potential exposure of a sector, in turn, depends upon its energy intensity, and the extent to which international competition may constrain its ability to pass on the increased cost to the consumers.

The power sector, being one of the main emitters of GHGs, will be forced either to switch over to cleaner fuels or purchase emission credits to make up for any shortfall in meeting their reduction targets. This is expected to raise the industrial electricity prices by anything between 10-40%. Thus, all sectors consuming electricity will be indirectly exposed to the impact of EU-ETS. Secondly, sectors in which demand is very price-sensitive will also face a loss in competitiveness vis--vis products from places where emission caps do not have to be dealt with. Chart 1 below classifies various sectors according to the two primary dimensions of competitive exposure - potential value at stake as indicated through energy intensity and the ability to pass cost changes through prices.

The chart shows that while several of the sectors (such as paper, pharmaceuticals etc.) that have low energy intensity but also low ability to pass on increased costs may have a marginal impact on their trade competitiveness, there are several others that have high energy intensities and high demand elasticity that may face the risk of loss of competitiveness in international markets.

What this means for India?

The European Union is Indias largest trading partner, accounting for almost 22% of Indias exports and 18% of total Indian imports in the year 2003. During the year 2003, EUs major items of exports to India consisted of engineering goods, gems and jewellery, chemical and allied products. All these items constitute a share of over 77 per cent in EUs total exports to India. Other items, which have a considerable share is metal and metal products (6.77%) and transport equipment (3.55%).

Chart 1: Classification of industrial sectors according to exposure

 

High

  Pass-through gains?

  At risks?

Value at stake based on potential increase in energy costs

  Electricity  
Ferrous metals*
Cement*
Oil refining
Glass
Aluminium*
Chemicals
 
 
     
 

Unaffected

 
  Marginal impact
Paper (newsprint)*
Pharmaceuticals
Food & drink
Retail
Transport
 
 
 
 

Low

 
      High

Low

    

Source : Carbon Trust  

Ability to pass on costs 
to customers

 

During the same period (2003), EU imported from India textiles and clothing (30.03%), gems and jewellery (10.95%), leather and leather goods (10.42%), engineering goods (11.88%), chemical and allied products (9.20%) and agriculture and allied products (6.66%). It is interesting to note that the items in the high risk category, such as engineering goods and chemicals, form almost a quarter of Indias exports to the EU, while those having a marginal impact on their food and drink (agriculture and allied products) form another 6.66%. While the group of developing countries like India has been fighting battles at the WTO for reduction of subsidies in the EU, the EU-ETS (and implementation of Kyoto Protocol) may help to partially remove this deadlock and negate the impact of these subsidies, thus enabling developing countries to access European markets with goods they have comparative advantages in.

A second source of improvement in trade balances of developing countries is markets in other countries of the world where goods from developing countries compete with those from the European ones. In the present context, when the world prices of metals and alloys like Aluminium and steel are continually rising, such goods from India have become much more competitive, partly due to the increase in the production cost (due to abatement efforts) of European manufacturers.

Trade and Sustainable Development

Conventional economic theory suggests that trade facilitates development and economic efficiency as gains from trade is realized by the countries. The development will, however, be sustainable only if the sectors benefiting from trade have significant backward and forward linkages with other sectors of the economy and initiatives are taken to improve the efficiency of these sectors to make them even more competitive in the international markets. Sectors such as Aluminium and steel have significant impacts on the countrys economy and growth and capital investment in these have considerable impacts on the overall growth of the country. Table 1 shows the multipliers (i.e. % GDP growth with 1% growth in a particular sector) for the relevant sectors:

Sectors Multipliers on the Indian GDP
Aluminum 0.78

Steel

0.8
Agriculture 1.5

Conclusion

The impact of EU-ETS on Indian economy can serve as an example of how the ratification and implementation of Kyoto Protocol can benefit the developing countries through the commodities trade route, besides trade in emission reductions through mechanisms such as CDM. This will of course depend on how the countries structure their emission reduction and the marginal abatement costs of emitters in developed countries. The signing of the Kyoto Protocol in CoP10 would clarify a lot of things and help bring growth and sustainable development in non-Annex I countries. q


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