Category: Trade

U.S. Carbon Dioxide Emissions in a Global Context

Photo from the New York Times.

As we discuss in Microeconomics and Economics, Chapter 5, Section 5.3, carbon dioxide (CO2) emissions contribute to climate change, including the increases in temperatures that have been experienced worldwide. We’ve found that students are interested in seeing U.S. CO2 emissions in a global context.  

The first of the following figures shows for the years 1960 to 2020, the total amount of CO2 emissions by the United States, China, India, the 28 countries in the European Union, lower-middle-income countries (including India, Nigeria, and Vietnam), and upper-middle-income countries (including China, Brazil, and Argentina). The second of the figures shows the percentage of total world CO2 accounted for by each of the three individual countries and by the indicated groups of countries. in the United States and in the countries of the European Union both total emissions and the percentage of total world emissions have been declining over the past 15 years. Emissions have been increasing in China, India, and in middle-income countries. The figures are from the Our World in Data website (ourworldindata.org). (Note that the reductions in emissions during 2020 largely reflect the effects of the slowdown in economic activity as a result of the Covid-19 pandemic rather than long-term trends in emissions.)

Governments in many countries have attempted to slow the pace of climate change by enacting policies to reduce CO2emissions. (According to estimates by the U.S. Environmental Protection Agency, CO2 accounts for about 76 percent of all emissions worldwide of greenhouse gases that contribute to climate change. Methane and nitrous oxide, mainly from agricultural activity, make up most of the rest of greenhouse gas emissions.) In August 2022, Congress and President Biden enacted additional measures aimed at slowing climate change. Included among these measures were government subsidies to firms and households to use renewable energy such as rooftop solar panels, tax rebates for some buyers of certain electric vehicles, and funds for utilities to develop power sources such as wind and solar that don’t emit CO2. The measures have been estimated to reduce U.S. greenhouse gas emissions by somewhere between 6 percent and 15 percent. Because the United States is responsible for only about 14 percent of annual global greenhouse gas emissions, the measures would likely reduce global emissions by only about 2 percent.

The figures shown above make this result unsurprising. Because the United States is the source of only a relatively small percentage of global greenhouse emissions, reductions in U.S. emissions can result in only small reductions in global emissions. Although many policymakers and economists believe that the marginal benefit from these reductions in U.S. emissions exceed their marginal cost, the reductions can’t by themselves do more than slow the rate of climate change. A key reason that India, China, and other middle income countries have accounted for increasing quantities of greenhouse gases is that they rely much more heavily on burning coal than do the United States, the countries in the European Union, and other high-income countries. Utilities switching to generating electricity by burning coal rather than by burning natural gas has been a key source of reductions in greenhouse gas emissions in the United States.

The two figures above measure a country’s contribution to CO2 emissions by looking at the quantity of emissions generated by production within the country. But suppose instead that we look at the quantity of CO2 emitted during the production of the goods consumed within the country? In that case, we would allocate to the United States CO2 emitted during the product of a good, such as a television or a shirt, that was produced in China or another foreign country but consumed in the United States.

For the United States, as the following figure shows it makes only a small difference whether we measure CO2emissions on the basis of production of goods and services or on the basis of consumption of goods and services.  U.S. emissions of CO2 are about 7 percent higher when measured on a consumption basis rather than on a production basis. By both measures, U.S. emissions of CO2 have been generally declining since about 2007. (1990 is the first year that these two measures are available.)

Sources: Hannah Ritchie, Max Roser and Pablo Rosado, “CO₂ and Greenhouse Gas Emissions,” OurWorldInData.org, https://ourworldindata.org/co2-and-other-greenhouse-gas-emissions; Greg Ip, “Inflation Reduction Act’s Real Climate Impact Is a Decade Away,” Wall Street Journal, August 24, 2022; Lisa Friedman, “Democrats Designed the Climate Law to Be a Game Changer. Here’s How,” New York Times, August 22, 2022; Hannah Ritchie, “How Do CO2 Emissions Compare When We Adjust for Trade?” ourworldindata.org, October 7, 2019; and United States Environmental Protection Agency, “Global Greenhouse Gas Emissions Data,” epa.gov, February 22, 2022.

Solved Problem: How Does the Value of the U.S. Dollar Affect the U.S. and World Economies?

Supports: Macroeconomics, Chapter 18, Economics, Chapter 28, and Essentials of Economics, Chapter 19.

Between June 2021 and September 2022, the exchange rate between the U.S. dollar and an average of the currencies of the major trading partners of the United States increased by 14 percent. (This movement is shown in the figure above.) An article in the New York Times had the headline “The Dollar Is Strong. That Is Good for the U.S. but Bad for the World.”  

  1. Briefly explain what the headline means by a “strong” dollar. 
  2. Do you agree with the assertion in the headline that a stronger dollar is good for the United States but bad for the economies that the United States trades with? Briefly explain. 
  3. During this period the Federal Reserve was taking actions that raised U.S. interest rates. The article noted that “Those interest rate increases are pumping up the value of the dollar ….” Why would increases in U.S. interest rates relative to interest rates in other countries increase the value of the dollar?

Solving the Problem

Step 1:  Review the chapter material. This problem is about the effect of fluctuations in the exchange rate and the relationship between interest rates and exchange rates, so you may want to review Macroeconomics, Chapter 18, Section 8.2, “The Foreign Exchange Market and Exchange Rates,” or the corresponding sections in Economics, Chapter 28 or Essentials of Economics, Chapter 19.

Step 2: Answer part a. by explaining what a “strong” dollar means. A strong dollar is one that exchanges for more units of foreign currencies, such as British pounds or euros. (A “weak” dollar means the opposite: A dollar that exchanges for fewer units of foreign currencies.)

Step 3: Answer part b. by explaining whether you agree with the assertion that a stronger dollar is good for the United States but bad for the economies of other countries. A stronger U.S. dollar produces winners and losers both in the United States and in other countries. U.S. consumers win because a stronger dollar means that fewer dollars are needed to buy the same quantity of a foreign currency, which reduces the dollar price of imports from that country. For example, a stronger dollar reduces the number of dollars U.S. consumers pay to buy a bottle of French wine that has a 40 euro price.  A strong dollar is bad news for foreign consumers because they must pay more units of their currency to buy goods imported from the United States. For example, Japanese consumers will have to pay more yen to buy an imported Hershey’s candy bar with a $1.25 price. 

The situation is reversed for U.S. and foreign firms exporting goods. Because foreign consumers have to pay higher prices in their own currencies for goods imported from the United States, they are likely to buy less of them, buying more domestically produced goods or goods imported from other countries. U.S. firms will either to have accept lower sales, or cut the prices they charge for their exports. In either case, U.S. exporters’ revenue will decline. Foreign firms that export to the United States will be in the opposite situation: The dollar prices of their exports will decline, increasing their sales.

We can conclude that the article’s headline is somewhat misleading because not all groups in the United States are helped by a strong dollar and not all groups in other countries are hurt by a strong dollar.

Step 4: Answer part c. by explaining why higher interest rates in the United States relative to interest rates in other countries will increase the exchange value of the dollar. If interest rates in the United States rise relative to interest rates in other countries—as was true during the period from the spring of 2021 to the fall of 2022—U.S. financial assets, such as U.S. Treasury bills, will be more desirable, causing investors to increase their demand for the dollars they need to buy U.S. financial assets. The resulting shift to the right in the demand curve for dollars will cause the equilibrium exchange rate between the dollar and other currencies to increase. 

Source:  Patricia Cohen, “The Dollar Is Strong. That Is Good for the U.S. but Bad for the World,” New York Times, September 26, 2022.

New 3/01/22 Podcast – Authors Glenn Hubbard & Tony O’Brien discuss Russia’s Invasion of Ukraine.

Authors Glenn Hubbard & Tony O’Brien reflect on the global economic effects of Russia’s invasion of Ukraine last week. They consider the impact on the global commodity market, US monetary policy, and the impact on the financial markets in the US. Impact touches Introductory Economics, Money & Banking, International Economics, and Intermediate Macroeconomics as the effects of Russia’s aggression moves into its second week.

A map of Europe with Ukraine in the middle right below Belarus and to the east of Poland.

The U.S. Dollar in the World Economy

The U.S. dollar is the most important currency in the world economy. The funds that governments and central banks hold to carry out international transactions are called their official foreign exchange reserves. (See Macroeconomics, Chapter 18, Section 18.1 and Economics, Chapter 28, Section 28.1.) There are 180 national currencies in the world and foreign exchange reserves can be held in any of them. In practice, international transactions are conducted in only a few currencies. Because the U.S. dollar is used most frequently in international transactions, the majority of foreign exchange reserves are held in U.S. dollars. The following figure shows the composition of official foreign exchange reserves by currency as of mid-2021.

Over time, the percentage of foreign exchange reserves in U.S. dollars has been gradually declining, although the dollar seems likely to remain the dominant foreign reserve currency for a considerable period. Does the United States gain an advantage from being the most important foreign reserve currency? Economists and policymakers are divided in their views. At the most basic level, dollars are claims on U.S. goods and services and U.S. financial assets. When foreign governments, banks, corporations, and investors hold U.S. dollars rather than spending them, they are, in effect, providing the United States with interest-free loans. U.S. households and firms also benefit from often being able to use U.S. currency around the world when buying and selling goods and services and when borrowing, rather than first having to exchange dollars for other currencies.

But there are also disadvantages to the dollar being the dominant reserve currency. Because the dollar plays this role, the demand for the dollar is higher than it would otherwise be, which increases the exchange rate between the dollar and other currencies. If the dollar lost its status as the key foreign reserve currency, the exchange rate might decline by as much as 30 percent. A decline in the value of the dollar by that much would substantially increase exports of U.S. goods. Barry Eichengreen of the University of California, Berkeley, has noted that the result might be “a shift in the composition of what America exports from Treasury [bonds and other financial securities] … toward John Deere earthmoving equipment, Boeing Dreamliners, and—who knows—maybe even motor vehicles and parts.”

As shown in the following figure, the importance of the U.S. dollar in the world economy is also indicated by the sharp increase in the demand for dollars and, therefore, in the exchange rate during the financial crisis in the fall of 2008 and during the spread of Covid-19 in the spring of 2020. (The exchange rate in the figure is a weighted average of the exchange rates between the dollar and the currencies of the major trading partners of the United States.) As an article in the Economist put it: “Last March, when suddenly the priority was to have cash, the cash that people wanted was dollars.”

Sources: International Monetary Fund, “Currency Composition of Official Foreign Exchange Reserves,” data.imf.org; Alina Iancu, Neil Meads, Martin Mühleisen, and Yiqun Wu, “Glaciers of Global Finance: The Currency Composition of Central Banks’ Reserve Holdings,” blogs.imf.org, December 16, 2020; Barry Eichengreen, Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System, New York: Oxford University Press, 2001, p. 173; “How America’s Blockbuster Stimulus Affects the Dollar,” economist.com, March 13, 2021; and Federal Reserve Bank of St. Louis. 

Should Tariffs Be Used to Slow Climate Change?

Why do countries impose tariffs on imported goods? As we discuss in Economics Chapter 9 and MacroeconomicsChapter 7 (particularly in Section 5 of these chapters) countries primarily use tariffs to protect domestic industries from foreign competition. Protectionism appeared to be the main motivation when the Trump administration imposed tariffs on imports of steel, aluminum, and some other products from China, Canada, and countries in the European Union. It was also the main reason that the Biden administration decided in 2021 to retain many of those tariffs.

The other main justification for imposing tariffs is for reasons of national security. For instance, as we note in the textbook, the United States would not want to import its jet fighter engines from China. In fact, the Trump administration relied on Section 232 of the Trade Expansion Act of 1962 when it imposed tariffs, particularly tariffs on steel and aluminum. The Biden administration also cited this section of the law when continuing the tariffs. (In October 2021, the Biden administration negotiated with the European Union a partial reduction of these tariffs.) Under that section of the law, if the president decides that imports of a good threaten nationals security, “he shall take such action, and for such time, as he deems necessary to adjust the imports of such article and its derivatives so that such imports will not so threaten to impair the national security.” In other words, presidents have the power to impose tariffs on imports of a good if they assert that doing so protects the national security of the United States.

When they invoked this section of the law, both the Trump and Biden administrations were criticized for stretching its application beyond what Congress had intended. Critics argue that using this section of the law to impose tariffs on such close allies of the United States as the countries of the European Union was a violation of Congress’s intent because it was unlikely that imports of steel or aluminum from Europe threaten the national security of the United States.

If used as intended, Section 232 is a rare example of imposing tariffs for reasons other than protecting domestic industries. (It’s worth noting that during the 1800s and early 1900s, before there was a federal income tax, Congress relied on revenues from tariffs as the main source of funds to the federal government. In recent years tariff revenues have been very small compared with income taxes and the federal government’s other sources of revenue.) In 2021, some policymakers were proposing using tariffs for another purpose unrelated to protecting domestic industries: Slowing climate change.

In November 2021, the United States and the European Union announced that they would explore imposing tariffs on imports of steel from countries that impose few regulations on carbon emissions from steel mills. (These climate tariffs are sometimes referred to as border carbon adjustments (BCAs).) The tariffs might be extended to include imports of aluminum, chemicals, and cement. The rationale for these tariffs is that in the United States and Europe, steel producers must install expensive equipment to reduce carbon emissions or must pay a tax on those emissions.

These regulations raise the cost of producing steel and, therefore, the price of steel produced in Europe and the United States. As a result, U.S. and European firms that use steel, such as automobile companies, have an incentive to import lower-priced steel from countries that have few regulations on carbon emissions. According to one estimate, the production of steel being imported into the United States generates 50 percent to 100 percent more carbon dioxide emissions than does the production of domestic steel.  An article in the Wall Street Journal noted that a report from a consulting firm argued that “the emissions that many developed countries claim to have eliminated were ‘outsourced to developing countries,’ which generally have fewer resources to invest in cleaner and more advanced technology.”

Critics of using tariffs as a means of slowing climate change note that there are other measures that countries can use to reduce their own CO2 emissions and that attempts to use economic coercion to prod countries into changing policies have not generally been successful. They also note that Section 232 of the Trade Expansion Act of 1962 was intended to be used only for reasons of national security but has been used by the Trump and Biden administration more broadly to protect domestic industries. They fear that the same thing may happen if climate tariffs are allowed under international agreements: The tariffs may be used to protect domestic industries for reasons that have nothing to do with reducing climate change. In fact, an article on barrons.com noted that the agreement between the United States and the European Union to impose climate tariffs on steel imports was “aimed, according to administration officials, at countering the flood of cheap steel from China, which accounts for roughly 60% of production worldwide.”

In addition, some economists and policymakers fear that imposing climate tariffs may undermine the rules of the World Trade Organization (WTO), which do not authorize countries to impose tariffs for this reason. This outcome is particularly likely if some countries see the tariffs as aimed more at protecting domestic industries than at slowing climate change. As we discuss in Section 5 of Chapter 9 in Economics (Macroeconomics Chapter 7), the WTO and its predecessor, the General Agreement on Tariffs and Trade (GATT) resulted in decades of multilateral negotiations that greatly reduced tariffs. The tariff reductions spurred a tremendous expansion in world trade, which significantly increased incomes in the United States and most other countries—although it also disrupted some domestic industries in those countries. If the WTO were to cease to be effective, the world might return to the situation of the 1930s and earlier when countries used tariffs for a variety of policy reasons. The trade war of the 1930s, during which most countries raised tariff rates, led to a collapse in world trade and helped to worsen the Great Depression. 

If climate tariffs become common, the effect on both the climate and on the international trading system may be significant. 

Sources:  Josh Zumbrun, “U.S.-EU Steel Tariffs Deal Is Onerous for Smaller Importers,” wsj.com, November 5, 2021; Yuka Hayashi and Jacob M. Schlesinger, “Tariffs to Tackle Climate Change Gain Momentum. The Idea Could Reshape Industries,” wsj.com, November 2, 2021; By Reshma Kapadia, “The EU Tariff Deal Doesn’t Mean the Trade War With China Is Over,” barrons.com, November 2, 2021; Jennifer A. Dlouhy and Ari Natter, “Democrats Propose Tax on Carbon-Intensive Imports in Budget,” bloomberg.com, July 14, 2021; and Billy Pizer, “The Trade Tool that Could Unlock Climate Ambitions,” barrons.com, November 5, 2021.

Economies of Scale in Ocean Shipping and U.S. Retailers’ Response to Pandemic Supply Chain Problems

Beginning in the 1950s, several companies pioneered in developing modern shipping containers that once arrived at docks can be lifted by cranes and directly attached to trucks or loaded on to trains for overland shipping. As economist Marc Levinson was the first to discuss in detail in his 2004 book, The Box, container shipping, by greatly reducing transportation costs, helped to make the modern global economy possible. (We discuss globalization in Economics, Chapter 9, Section 9.1 and Chapter 21, Section 21.4, and in Macroeconomics, Chapter 7, Section 7.1 and Chapter 11, Section 11.4.) 

Lower transportation costs meant that small manufacturing firms and other small businesses that depended on selling in local markets faced much greater competition, including from firms located thousands of miles away. The number of dockworkers declined dramatically as the loading and unloading of cargo ships became automated. Ports such as New York City, San Francisco, and Liverpool that were not well suited for handling containers because they lacked sufficient space for the automated equipment and the warehouses, lost most of their shipping business to other ports, such as Los Angeles, Seattle, and London. Consumers in all countries benefited because lower transportation costs meant they were able to buy cheaper imported goods and had a much greater variety of goods to choose from.

In the decades since the 1950s, shipping firms have continued to exploit economies of scale in container ships. (We discuss the concept of economies of scale in Econimics and Microeconomics, Chapter 11, Section 11.6.) Today, shipping containers have been standardized at either 20 feet or 40 feet long and the largest ships can haul thousands of containers. Levinson explains why economies of scale are important in this industry:

“A vessel to carry 3,000 containers did not require twice as much steel or twice as large an engine as a vessel to carry 1,500. [Because of automation, a] larger ship did not require a larger crew, so crew wages per container were much lower. Fuel consumption did not increase proportionally with the vessel’s size.”

To take advantage of these economies of scale, the ships needed to sail fully loaded. The largest ships can sail fully loaded only on routes where shipping volumes are highest, such as between Asia and the United States or between the United States and Europe. As a result, as Levinson notes, the largest ships are “uneconomic to run on most of the world’s shipping lanes” because on most routes the costs per container are higher for the largest ships for smaller ships. (Note that even these “smaller ships” are still very large in absolute size, being able to haul 1,000 containers.) 

Large U.S. retail firms, such as Walmart, Home Depot, and Target rely on imported goods from Asian countries, including China, Japan, and Vietnam. Ordinarily, they are importing goods in sufficient quantities that the goods are shipped on the largest vessels, which today have the capacity to haul 20,000 containers. But during the pandemic, a surge in demand for imported goods combined with disruptions caused by Covid outbreaks in some Asian ports and a shortage of truck drivers and some other workers in the United States, resulted in a backlog of ships waiting to disembark their cargoes at U.S. ports. The ports of Los Angeles and Long Beach in southern California were particularly affected. By October 2021, it was taking an average of 80 days for goods to be shipped across the Pacific, compared with an average of 40 days before the pandemic.

Some large U.S. firms responded to the shipping problems by chartering smaller ships that ordinarily would only make shorter voyages. According to an article in the Wall Street Journal, “the charters provide the big retailers with a way to work around bottlenecks at ports such as Los Angeles, by rerouting cargo to less congested docks such as Portland, Ore., Oakland, Calif., or the East Coast.”  Unfortunately, because the smaller ships lacked the economies of scale of the larger ships, the cost the U.S. firms were paying per container were nearly twice as high. (Note that this result is similar to the cost difference between a large and a small automobile factory, which we illustrated in Economics and Microeconomics, Figure 11.6.)

Unfortunately for U.S. consumers, the higher costs U.S. retailers paid for transporting goods across the Pacific Ocean resulted in higher prices on store shelves. Shopping for presents during the 2021 holiday season turned out to be more expensive than in previous years. 

Sources: Marc Levinson, The Box: How the Shipping Container Made the World Smaller and the World Economy Bigger, Second edition, Princeton, NJ: Princeton University Press, 2016; Sarah Nassauer and Costas Paris, “Biggest U.S. Retailers Charter Private Cargo Ships to Sail Around Port Delays,” wsj.com, October 10, 2021; and Melissa Repko, “How Bad Are Global Shipping Snafus? Home Depot Contracted Its Own Container Ship as a Safeguard,” cnbc.com, June 13, 2021. 

Solved Problem: The Macroeconomic Effects of a Stronger Euro

Supports:  Economics: Chapter 28 – Macroeconomics in an Open Economy (Section 28.2); Macroeconomics: Chapter 12, Section 12.2; and Essentials: Chapter 19 – Comparative Advantage, International Trade, and Exchange Rates (Section 19.6)

Solved Problem: The Macroeconomic Effects of a Stronger Euro

In December 2020, an article in the Wall Street Journal discussed the effects of changes in the value of the euro in exchange for the U.S. dollar. The article noted that: “A stronger euro makes exports from the region less competitive overseas” and that a stronger euro would also “damp inflation” in countries using the euro as their currency.

a. What does the article mean by a “stronger euro”? Why would a stronger euro make European exports less competitive?

b. What does the article mean by “damp inflation”? Why would a stronger euro damp inflation in countries using the euro?

Source: Caitlin Ostroff, “Euro Rally Weighs on Inflation, Sapping Appetite for Stocks,” Wall Street Journal, December 9, 2020.

Solving the Problem

Step 1:   Review the chapter material. This problem is about the effect of changes in the exchange rate on a country’s (or region’s) imports and exports, so you may want to review Chapter 28, Section 28.2 “How Movements in Exchange Rates Affect Imports and Exports.”

Step 2:   Answer part a. by explaining what a “stronger euro” means and why a stronger euro would make European exports less competitive. A stronger euro is one that exchanges for more dollars or, which amounts to the same thing, requires fewer euros to exchange for a dollar. (You may want to review the Apply the Concept “Is a Strong Currency Good for a Country?”) A stronger euro results in U.S. consumers having to pay more dollars to buy goods and services imported from Europe. In other words, the prices of European exports to the United States will rise making the exports less competitive with U.S.-produced goods or with other countries exports to the United States. If the euro is also becoming stronger against currencies such as the British pound, Japanese yen, and Chinese yuan, then European exports will also be less competitive in those countries.

Step 3:   Answer part b. by explaining what “damp inflation” means and why a stronger euro would damp inflation in countries using the euro. To “damp inflation” is to reduce inflation. So the article is stating that a stronger euro will result in lower inflation in Europe. To understand why, remember that while a stronger euro will raise the dollar price of European exports to the United States, it will reduce the euro price of European imports from the United States (and from other countries if the euro is also becoming stronger against currencies such as the British pound, Japanese yen, and Chinese yuan). Inflation in a country is measured using the prices of goods and services that consumers purchase, whether those goods and services are produced domestically or are imported.

The Wall and the Bridge – an article from Glenn Hubbard in National Affairs.

Advances in technology and expanding international trade have disrupted some key U.S. industries. These developments have made new products available, lowered the prices of existing products, and fostered the creation of new companies and new jobs. Yet, there has also been a downside. Some U.S. manufacturing firms have disappeared and some workers have been left unemployed for long periods. How can economists help frame a discussion about policies that will help everyone participate as the economy continues to evolve? Glenn Hubbard discusses a new approach in his article “The Wall and the Bridge”, published in National Affairs in September 2020.