4:57 AM Jun 22, 1994

INTERNALIZING ENVIRONMENTAL COSTS, NICE THEORY BUT...

Minnesota 22 Jun (TWN/Kristine Dawkins) -- The use of economic instruments to internalize costs is a nice theory in trade and environment, but in practice it is impossible to implement fully or fairly.

The European Union has tried for many years to implement a carbon tax, but for reasons of competitiveness it has not been found feasible until and unless the United States does so as well.

US President Bill Clinton, when he first took office, announced that he would impose a broad-based tax on British Thermal Units or BTUs, the unit that measures the heat content of fuels. But during the course of the federal budget process, that tax proposal was cut down to a mere four cents per gallon gasoline tax -- an amount which does nothing to internalize costs although it does raise some revenue for the federal budget.

At the national level, for implementing the concept of internalization of costs, there are four general questions to be resolved -- all of them involving political choices.

First, how can environmental and social costs be monetized; that is, how can they be valued in money terms? The best work in this area has been done with energy costs: identifying the relative social and environmental costs of coal, gas, oil, the renewables and nuclear power.

A German, Olav Hohmeyer, produced what is probably the best such study in 1988. More recently, researchers at Pace University in New York produced a comprehensive survey and analysis of full cost energy studies. And what you see when you read these reports is that each one has a major section in which the researchers list those costs that were not included in their consideration.

The second and third questions relate to how the costs, once identified, are to be collected and distributed. Taxes accrue to the government treasury, but the revenues are rarely if ever reinvested in projects that correct the problem. Gasoline taxes, for example, in theory should be reinvested in public transportation but by the time the tax policy is enacted, the public transportation components tend to be whittled away during the political process.

Likewise, if the costs are internalized through prices in the private sector, they may be collected by the firms but rarely if ever are they reinvested in altering production patterns. Unless the price increase is so severe as to alter consumption patterns, little is actually changed. And the political will to do so is missing.

Finally, if there is sufficient political will, there is a question about a transition process. If implemented so as to truly change producer and consumer behaviour, then marginal consumers and marginal producers are going to fall out of the system.

Even in the United States, we have very many poor people who simply cannot afford to absorb cost increases of any kind. And very many small and medium-sized entrepreneurs will find that, without some kind of transitional assistance, they will be unable to survive. The result will be increased poverty and unemployment, unless safety nets are devised and financed, and increased corporate concentration in production sectors are tackled.

Otherwise, it will actually add to the problem of monopolistic pricing, by which huge companies with significant shares of a given market are able to set price levels on their own for that market and, in fact, externalize ever more costs: the exact opposite of what we are trying to accomplish.

All of this is problematic enough at the national level. Each of these questions becomes even more complex internationally. The world price for many traded goods is determined by market shares, whether national or corporate. Many commodities are priced by producer cartels via the commodity agreements.

The Agriculture Agreement of the Uruguay Round locks in subsidies and dumping in traded products, not the cost of production.

The Institute of Agricultural Trade Policy in Minnesota, USA, recently produced a preliminary assessment of the costs of spring wheat grown in the Northern Plains of the United States, based entirely on official figures drawn from a variety of government sources.

What we found is that the market price for a bushel of spring wheat is about $2.50 while the U.S. Department of Agriculture estimates farmers' costs to be more than $6.00 a bushel. Adding in environmental costs related to water subsidies, cleaning up chemical run-off, soil erosion and other land degradation, the cost rises to $111 (rtp $111) per bushel.

It is easy to imagine how the internalization of these costs would create massive disruption in the world's food supply.

At a time when the terms of trade for developing countries producing raw commodities are already spiralling downward, it is obvious that the internalization of costs in degrees sufficient to alter production and consumption behaviour will cause shifts in comparative advantage and market shares.

In GATT jargon, these shifts could be considered "nullification and impairment of benefits" that call for some form of multilateral compensatory instrument to assist in the adjustment process.

We all know that the establishment of this type of instrument is absolutely not politically feasible at this time. And so the transition would add to the already painful terms of adjustment occurring throughout the world.

I've already discussed the way in which the adjustments resulting from cost internalization will tend to increase monopolies and monopolistic pricing. And we know how over-supply and export subsidies add to the problem of below-cost prices in the global marketplace.

Then we must consider how fluctuating exchange rates, currency devaluation and debt negotiations influence prices in different countries. Clearly, a major devaluation will more than offset whatever producer and consumer signals were intended by tinkering with politically acceptable cost internalization.

And the privatization of major state enterprises adds to the monopolistic structure of many industries, with a resulting tendency to externalize rather than internalize costs in those sectors.

Finally, we must consider the fact that some 40% of global trade occurs between subsidiaries of single firms. Forty percent of the world's traded goods, then, are subject to price manipulation and other distorting restrictive business practices, especially transfer pricing in which the cost to the firms at either end of a transaction are altered so as to maximize corporate earnings and avoid tariffs, taxes or other nationally or perhaps internationally established economic instruments designed to internalize costs. Thus, the implementation of the theory of cost internalization is exceedingly complex -- both technically and politically.

If the World Trade Organization is serious about studying the potential for cost internalization as an environmental trade measure, it should look closely at one or at most two items of major export interest -- perhaps one of great value to the North such as the automobile and one of great value to the South such as coffee.

This kind of study would be very helpful in assessing the practical implications of the theory of using economic instruments to internalize costs at the international level.

(The above, written for the SUNS, is based on an oral presentation by the author in the final session at the recent GATT Symposium on Trade and Environment. Ms Dawkins works at the Minnesota-based Institute for Agricultural Policy)