Can Canada afford to break with the U.S. on climate change policy?

An interview with economist Chris Ragan on how to avoid hurting Canadian industry while still tackling climate change

Canada's Environment Minister Catherine McKenna takes part in a news conference during the First Ministersí meeting in Ottawa, Ontario, Canada, December 9, 2016. REUTERS/Chris Wattie - RTSVGP4

Canada’s Environment Minister Catherine McKenna (REUTERS/Chris Wattie)

Speaking after a key meeting of G7 environment ministers in Italy, Environment Minister Catherine McKenna declared again today that the federal government will not let U.S. President Donald Trump alter Canada’s course on climate-change policy.

“Let’s be clear, the U.S. is bigger than one administration,” McKenna told reporters in a telephone news conference. “And we’re going to be moving forward, as is the rest of the world, with the states, cities and businesses in the United States that are committed to climate action and committed to the Paris agreement.”

Canadians who view Trump’s exit from the 2015 Paris climate accord as just one more bad move in his bizarre presidency will no doubt applaud. Still, is it really possible for Ottawa, along with the provinces, to forge ahead with imposing a national price on carbon emissions, without putting Canadian companies at a punishing disadvantage compared to their U.S. competitors?

I recently spoke about this growing concern with McGill University economics professor Chris Ragan, who also chairs Canada’s Ecofiscal Commission, a group of economists who are trying to promote solutions to environmental challenges that make economic sense.

Q: If someone says, “We’re in trouble, Trump isn’t going ahead with Paris, we’re going to be at this terrible competitive disadvantage,” how would you answer that?

A: There’s a couple of ways. Competitiveness is a really important issue and it was a really important issue last Nov. 7 [the day before Trump was elected president]. The United States was nowhere near a nation-wide carbon price. And on Nov. 8, they were nowhere near a nation-wide carbon price.

So competitiveness was always going to be an issue for any Canadian jurisdiction that was going to put on a carbon price. How are you going to deal with your cement firms, your steel firms, your fertilizer manufacturers, because you’re going to raise their costs and nobody’s going to raise the costs of the [U.S.] rivals against which they compete? But, to me, that was that was an issue pre-Trump and it’s an issue post-Trump.

Q: Even if Trump didn’t change the fundamental problem, it’s still a big problem, isn’t it?

A: It’s funny to me that people say, “It’s crazy for Canada to do this policy unless the U.S. is doing it too.” Well, hold on. We’ve got a completely different health care system that is funded largely from taxes, and that doesn’t seem to be a competitive disadvantage for Canada. It’s actually a very good policy that some people would argue is a competitive advantage for some Canadian firms. We have a different public pension system that’s fully funded, unlike the train wreck that is U.S. social security, and that doesn’t create a competitive disadvantage.

Q: So you’re arguing that climate change is another policy area where Canada can go its own way.

A: We can design our policy to reduce greenhouse gas emissions, we can have carbon prices that are differently designed in different provinces. We do have to think about the competitiveness issue. But the current policies in place are thinking about this; they’re taking it seriously. Alberta has a system of output-based allocations; Ontario and Quebec have a system of giving back some fraction of the permits for free to the emissions-intensive sector. This is all about dealing with the competitiveness issue.

Q: How will the Alberta system work?

A: The Alberta system will be in place, I believe, by the beginning of 2018. But basically what it says is if you are a large final emitter—an oil sands producer, or a cement producer, or a steel producer—you will face a carbon price. But you will also get a credit based on your output—not your output of emissions, but your output of steel.

So you pay the carbon price, and therefore have an incentive to reduce your emissions. But we’re going to give you a credit, which is a function of your output. Think of this as a cash rebate that goes straight to the firm’s bottom line.

It says, “Oh, you were worried about your profitability falling because of this carbon price. Well, we’re going to make you pay the carbon price, but we’re going to give you this credit back, so your profitability isn’t going to be hurt so much.” Depending on how you compute this, maybe your profitability won’t be hurt at all.

Q: So you’d still have an incentive to cut your emissions, because there’s a price put on them. But at the end of the day, if it turns out you can’t do that and remain competitive, you’re getting a little kickback to help your bottom line. Is that how it works?

A: That’s right. And you have an incentive to reduce emissions because that’s where the price is. So if you could maintain your output unchanged, but reduce your emissions, you would save the carbon tax. If you could maintain your emissions constant, but increase your final output, you’d get more of a credit. It’s a carbon price combined with an output subsidy.

Q: What about companies in Ontario and Quebec, where there’s a cap-and-trade system?

A: Those firms are facing a carbon price, but they’re being given free permits. A free permit has cash value equal to the carbon price. So in a world of a carbon price of $17 per tonne, if I give you a free permit, it’s like giving you $17, because you could turn around and sell it in the market for $17. But I’m going to give you those permits for free based on your output.

Q: And that doesn’t undermine the purpose of the carbon price to begin with?

A: What it does is it says, “We want you to reduce emissions, not by getting smaller, but by getting cleaner.” What we don’t want is to reduce emissions in Canada, or Ontario, let’s say, because we closed down the steel sector, and just start importing steel from Pennsylvania. That’s crazy. Globally it would do nothing to emissions. What you’re trying to do to reduce emissions in Canada because we start producing things differently, not because we produce less stuff.

Q: It takes some thinking to grasp how it will work.

A: This two-part policy is confusing. People think, “What are we doing, making them pay money on one side and giving the money on the other?” But we’re giving them money and taking their money in completely different ways. There’s two incentives that firms are facing. One incentive is to reduce emissions, the other incentive is to maintain or increase production.

This interview has been edited for clarity and condensed.