The assertion implies that we should internalize all negative externalities produced in products, businesses and sectors. Conceptually, the idea is not novel as it just follows the Pigouvian tax of negative externalities. Pigouvian tax has been well-known since 1921, after the British economist Arthur C. Pigou wrote a book titled The Economics of Welfare.

A global trend today sees many countries starting to enforce a Pigouvian tax, which is the so-called carbon tax. For example, the European Commission just planned to apply a mechanism called the Carbon Border Adjustment Mechanism (CBAM). It is aimed at taxing imported products coming to the European Union based on carbon produced in their production process. Similarly, the United States also plans to impose a border carbon adjustment fee for carbon-intensive imported goods. In addition, the Indonesian government also plans to apply a carbon tax to products that result in carbon emissions.

In our opinion, the trend is good news for our future life on Earth. However, we see that some issues arising from this global trend should be highlighted in relation to international trade, specifically that between developed and developing countries. Accordingly, we think the global coordination for the internalization of negative externalities is key to a successful emission reduction program.

In more detail, we see some issues that should be resolved together, meaning that countries need to coordinate with one another in implementing the zero-carbon emission program. The reasons include the following:

First, we see that carbon emissions relate to the economic externalities at the global level affecting people’s lives that could be geographically separated. In other words, carbon produced in one country may affect lives in other countries that could be thousand miles away.

Second, we may find that carbon tax may be charged double. The case may be that one country charges an imported carbon tax on products coming from other countries. Meanwhile, the exporting countries also charge a carbon tax for the products. So, the question is: Who has the right to collect the carbon tax, the importing country or the exporting country?

Third, we may find that a carbon tax could be misused as an instrument to practice unfair trade. A country may impose an imported carbon tariff to protect its domestic market from products of foreign competitors.

Fourth, carbon tax revenue in principle should be allocated to fixing environmental damage, ensuring reforestation, compensating indigenous people and carrying out other activities that support the reduction of carbon emissions. Obviously, we think carbon tax revenue should be spent in places where the carbon is produced, to fix the environmental damage. An alternative is that the revenue is spent in other places able to clean up CO2, such as maintaining tropical forests.  

On top of that, we think the fairness principle should be enforced, mainly in the relation between developed and developing countries. In our opinion, developing countries are always blamed as the primary cause of GHG effects; whereas developed countries are said to be clean. In fact, the data show that the largest polluters in the world are largely advanced countries. More precisely, World Resource Institute data show that the largest GHG emitter is China, which contributes 26.1 percent to to global emissions, followed by the US (12.67 percent), and the EU-27 (7.52 percent).

Correspondingly, the largest thermal coal consumers are also not too different from the largest polluters in the world. The largest is China with a thermal coal consumption of 3.81 billion tons in 2019, followed by India with 1.03 billion tons and the US with 628 million tons.

Therefore, we propose some actions to accomplish the carbon reduction program.

First, all countries should coordinate at the global level to implement carbon reduction policies, carbon tax and tariffs, and fund allocation of carbon tax revenues. A global institution, principally the United Nations, should take the initiative to coordinate the implementation of an emission reduction program.

Second, we should design the allocation of carbon tax revenues collected from imported products. In our opinion, the funds should be spent in countries that produce those products to fix the environmental damage in those areas.

Third, we may consider developing a global trust fund tasked with managing carbon tax revenues, and to act as a clearing house to determine who should pay carbon taxes and receive the compensation.

Fourth, developing countries such as Indonesia should implement initiatives to enforce the fairness principle. The data described above clearly show that the biggest polluters are advanced countries. So, developing countries should ask them to pay compensation in order to internalize the negative externalities they cause. The compensation should be allocated mainly to countries that have been maintaining tropical forests, coral and mangrove.

To sum up, we think the emission reduction program absolutely needs closed coordination and cooperation from all countries and stakeholders from global institutions, corporations, investors, nongovernmental organizations and ordinary people. Furthermore, we also should impose the fairness principle to ensure the relevant countries provide compensation for the negative externalities.

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Economist at Bank Mandiri