Why Countries Must Cooperate on Carbon Prices

An international floor price for carbon could speed the world’s transition to green energy without compromising countries’ competitiveness.

Recent surges in food and fuel costs are hurting households everywhere. The global spike in energy prices since Russia’s invasion of Ukraine underscores the need to transition away from dependence on energy sources that are subject to recurrent disruptions. The war has also impacted food security, which is already under pressure from crop failures and extreme weather events due to higher temperatures. These developments make clear the importance of accelerating a green transition that would limit further temperature rises, while protecting vulnerable groups who are most dependent on high-carbon fuels and jobs.

While carbon pricing is among the most effective policy tools to direct spending and investment out of dirty energy and into green alternatives, many countries are reluctant to use this policy lever. They fear a loss of international competitiveness, especially in high-emission sectors such as steel or chemicals.

One way to square this circle is through an international carbon price floor (ICPF) agreement. This was proposed by IMF staff in a paper last year that called for the world’s largest emitters to pay a floor price of $25-$75 per ton of carbon depending on their level of economic development. The proposal recognizes that some countries may use alternative policies to carbon pricing—regulations, for example—but these alternatives should achieve at least the same emissions reductions as the carbon price floor.

We develop this proposal in a recent staff paper which shows that an ICPF introduced by all countries simultaneously—and with the same tiered price floors based on income level—would combine several important advantages over alternative schemes. First, it would reduce emissions sufficiently to accomplish the 2-degree target. In fact, it is the only feasible option out of all those we considered in the paper to prevent the planet from heating to dangerously high temperatures.

A price worth paying

Second, it would have only a small impact on global economic growth—provided countries also invest in low-carbon energy. According to our estimates, the ICPF would reduce global gross domestic product by 1.5 percent by 2030 relative to what it would have been in the absence of the price floor, with the world’s poorest countries seeing a much smaller slowdown (just 0.6 percent). This is a price worth paying to prevent the far larger costs of failing to curb carbon emissions—many trillions of dollars—as spelled out in a recent report by the United Nations Intergovernmental Panel on Climate Change.

And third, it would ensure that the costs of transition are allocated according to differentiated responsibilities between countries of different income levels through differentiated carbon price floors. The ICPF proposal sets price floors per ton of carbon at $25 for low-income countries, $50 for middle-income countries, and $75 for high-income countries. This would be fairer than a uniform global carbon price and there would be less need for additional transfer payments between countries which have proven politically problematic in the past.

These are only floor prices. Many countries (especially high-income ones) have committed to ambitious climate policy in their nationally determined contributions (NDCs). These countries might have to set a higher price to achieve these goals. For many middle- and low-income countries, meanwhile, our analysis shows that the floors are higher than those implied by their NDCs which do not go far enough to limit the increase in temperature. Strengthening the contributions of middle- and low-income countries—which account for a fast-growing share of global emissions—is indeed key to keep global temperatures in check.

Competitiveness preserved

In the absence of a global agreement, high-income countries that have proposed ambitious climate policy have considered imposing a tariff on carbon emissions of imported products (a so-called border carbon adjustment or BCA). The intention is to protect domestic industry from foreign competitors that face less stringent climate policies. Our study confirms previous work showing that while BCAs can protect energy-intensive and trade-exposed industries they do not incentivize enough emissions reductions to achieve global temperature goals. This is because they only tax exported goods from countries that do not have a domestic carbon tax.

A fourth advantage of a simultaneous and differentiated ICPF is that there would be no need for high-income countries to impose a BCA tariff. All country groups would be acting together, and high-income countries would suffer no major losses to competitiveness. This would hold true even with differentiated carbon price floors: goods from middle- and low-income countries are typically more carbon-intensive, so the lower carbon price and the higher carbon intensity offset one another. A given good would thus require similar carbon payments in all income groups.

Geopolitical tensions have increased since Russia’s invasion and the prospects for international cooperation may seem slim as countries signal retreat into rival camps. Yet climate change is a global challenge that can—and must—concentrate minds as more frequent floods, droughts and weather disasters exacerbate the food crisis and impose other economic and human costs. Our proposal for an international carbon price floor phased in by 2030 would be a big step towards limiting global warming to below 2 degrees Celsius.