by Simon Tilford

The United Nations Climate Change Conference in Bali produced as much as it was ever likely to do. There was no breakthrough, contrary to the claims of some that attended the conference. Nobody should read too much into reports that the US administration fears its negotiators gave too much away. This is just news management, an attempt to create the impression that the US moved further than it did. The US gave nothing away. The aim of the US negotiating team in Bali was to prevent any international agreement that might demand the US cut its emissions, despite the fact the country could do this at relatively moderate cost according to its own Environmental Protection Agency (EPA). This opposition stems partly from the personal intransigence of President Bush, but also reflects a deep-seated reluctance to allow the country’s freedom of action to be constrained by international agreements. It is another big blow to US soft power in the world.

Of course, on current trends the proposed target of a 25-40 percent cut in developed country emissions by 2020 is nonsense. There is no chance whatsoever of such targets being met unless EU governments get very serious, very quickly about curbing emissions. The construction of new coal-fired power stations would not be compatible with meeting such a target for example, so governments in Germany and the UK would have to scrap plans for a new generation of such plants. Germany would also have to overcome its squeamishness about nuclear power. Energy efficiency standards, for everything from cars to buildings would have to be ratcheted-up very aggressively. Crucially, the EU emissions trading scheme (ETS) would need very tight emissions caps. Only then will businesses be confident that the price of carbon will rise steadily, providing sufficiently strong incentives to invest in low-carbon technologies.

However, notwithstanding question marks over the realism of the 25-40 per cent target, the US position – that targets are meaningless without policies can be put in place at the outset to met those targets – is hugely cynical. It is impossible to agree policies to reduce emissions until governments know which targets their economies have to meet. Similarly, the US knows as well as everyone else that the commitments to curb emissions it wants to see from developing countries will only happen if the developed countries take the lead. It is simply not plausible for the US to turn to China and India and demand they commit to mandatory cuts before it does. Per capita US emissions are at least 4 times Chinese levels and more than 10 times Indian ones. Research from the EPA calculates that the US could cut emissions of greenhouse gases by 60 per cent by 2050 at a cost of just 3.2 per cent of GDP. To put that in perspective, US GDP will rise by nearly 200 per cent over this period (assuming annual real GDP growth of 2.5 per cent.) For the world’s only superpower to rule out such action almost looks like a calculated snub to the rest of the world and will prove a big blow to its moral authority.

However, it is still early days – the timetable for agreeing a replacement for Kyoto stretches into 2009, and hence beyond President Bush’s time in office. Whoever replaces him will have to be more open-minded about international action to challenge climate change, even if only for questions of political expediency. With only 18 months left in office Bush can afford to dismiss the damage being done to the US’s international standing and influence. The next president will not have such a luxury and, regardless of how seriously he/she takes the threat of climate change, will calculate that the costs of refusing to join the EU in its attempt to orchestrate international action to address climate change will outweigh the perceived costs of signing-up.

The EU can do much to ensure that the costs of US inaction are steep. The best way to put pressure on the next administration is for the EU to persevere and impose big unilateral cuts in its own emissions. This will not impair the competitiveness of the EU or cost it export markets. Indeed, the opposite is much more likely. The US is unwilling to take action, but neither does it want to see the EU building on its lead in energy efficient technologies. In an age of mounting energy scarcity, geo-political tension and ever more environmentally conscious consumers and businesses, aggressive emissions targets by the EU will be positive for Europe’s authority in the world and for its long-term economic prospects. The Chinese and Indians might not be ready to sign up to mandatory caps on their emissions, but they are only too aware of the need to make their development more environmentally sustainable. The EU is well placed to supply the technology. The more successful it is at doing this, the quicker the US will come to its senses.

Simon Tilford is chief economist at the Centre for European Reform.

by Philip Whyte

Not long after its launch, the euro was famously dismissed by a disgruntled currency trader as a “toilet currency”. How things have changed. Since 2003, the euro’s external value has soared despite comparatively sluggish rates of economic growth in many of Europe’s largest economies. The strength of the euro has been a boon to European consumers who have been able to buy DVD players from China for less than the price of a meal at a run-of-the-mill restaurant. But not everyone has been celebrating—least of all France’s hyperactive president, Nicolas Sarkozy, who has been fretting about the economic downsides of a strong euro. Mr Sarkozy believes that the euro is now over-valued and that French companies’ trade competitiveness is being damaged as a result. Ever since he entered office in May, therefore, he has thrashed around looking for a culprit.

At first, he blamed the European Central Bank (ECB) for neglecting the euro’s external value and for pursuing its inflation target at the expense of economic growth. This struck many observers as odd, for at least two reasons. First, a central bank cannot target the inflation rate and the exchange rate simultaneously: was Mr Sarkozy suggesting that the ECB jettison its inflation target? Second, it seemed perverse to accuse the ECB of pursuing an excessively restrictive monetary policy. Real interest rates remain low by historical standards, and were even negative for much of the period between 2003 and 2004. More recent indicators—notably buoyant rates of broad money growth and lending to the private sector—hardly point to a central bank that has sacrificed economic growth on the altar of low inflation. Mr Sarkozy’s broadsides were in any case widely seen as an attack on the ECB’s institutional independence—so no-one was surprised when they were given short shrift.

Mr Sarkozy then shifted his attention across the Atlantic. Authorities in the US, he argued, needed to act to stem the US dollar’s decline against the euro. Again, however, it was not clear what Mr Sarkozy was proposing the US authorities should do. Raise short-term interest rates? You must be joking! The US Federal Reserve is trying to contain the fall-out from the crisis in sub-prime lending which is threatening to push the world’s largest economy into recession. This is why it cut short-term interest rates in September. In any case, it is hard to see what the US Federal Reserve could possibly do to support the US dollar. The dollar is weakening because the US is struggling to attract the capital inflows needed to fund its current-account deficit. As the world’s largest debtor, the US has to attract three-quarters of the world’s capital flows to service its external deficit. This is unsustainable—and not just because US assets have offered investors absolutely terrible returns in recent years. A weak US dollar is imperative if the US’s external deficit is to narrow.

Slowly, it dawned on Mr Sarkozy that the problem might lie to the east rather than the west. In the run-up to the G7 meeting in late October, the French government spoke rather less about the US dollar and rather more about the Chinese yuan. It had taken its time, but at last it had stumbled on the heart of the problem: namely, that parts of the world—mainly China, Japan and oil exporters in the Middle East and elsewhere—are saving vastly more than they are investing. This excess of savings over investment has resulted in colossal outflows of capital which have supported the spending habits of governments and households in the US and, to a lesser extent, Europe. That’s right, you read correctly. Developing economies such as China are now large net creditors to the developed world. This is totally at odds with what one might normally expect. Capital usually flows in the other direction, from the developed to the developing world. So what happened?

The short answer is that China and a number of other Asian economies have spent the best part of the last decade pursuing unashamedly mercantilist policies. There are two reasons for this. One is the abiding attraction of an egregious fallacy: that a country’s primary objective in trade is to export more than it imports. The other is the experience of the Asian crisis in the late 1990s, when countries with large external deficits were unable to defend their currencies in the face of huge capital outflows. Stung by this experience, many Asian countries did not choose to abandon fixed exchange rates. Instead, they decided that they should continue to maintain a peg of sorts against the US dollar—but by actively intervening to keep their currencies artificially weak. Since that date, many Asian countries have turned trade deficits into vast surpluses by accumulating foreign exchange reserves. And the world has been stuck with an asymmetric monetary system in which the euro and the US dollar have floated freely against each other, but not against Asian currencies.

The apparently insatiable appetite of China and other Asian countries for piles of depreciating US dollars has had undoubted benefits for the EU. The most important is the boost to domestic demand that the resulting strength of the euro has provided. This has worked in at least two ways. First, by bearing down on import prices, the strength of the euro has contained inflation—allowing the ECB to keep official interest rates lower than they would otherwise have been. Second, it has boosted consumers’ purchasing power. The Chinese government, in other words, has indirectly given European consumers and mortgage holders something looking like a free ride. The downside is that the yuan’s exchange rate is generating protectionist demands from beleaguered European firms labouring under the weight of a currency that has borne the brunt of global adjustments since 2002. The EU trade commissioner, Peter Mandelson, has been muttering darkly about the speed at which the EU’s trade deficit with China is growing; and hinted that the EU cannot maintain an open market for Chinese goods if the Chinese government does not change policy direction.

In the mid-nineteenth century, the UK famously used gunboats to open Chinese markets to opium. Times have changed and few would now advocate similar methods to persuade the Chinese government to let the yuan appreciate. In fact, there is not much the EU can do, other than to raise the rhetorical volume and wait for the domestic tensions generated by China’s policy to play themselves out. No-one knows how long this process will last. The Chinese people’s capacity for pain is legendary. But the point will surely come when the Chinese government succumbs to internal pressure and refocuses economic policy on raising the living standards of the wretched Chinese people rather than relentlessly acquiring assets in a depreciating foreign currency. When this happens, Mr Sarkozy should pay particularly close attention. For the mercantilism that China has practised looks suspiciously like that which he would be tempted to pursue if ever he were let loose on the ECB!

Philip Whyte is a senior research fellow at the Centre for European Reform.

The EU, the US and Taiwan

by Charles Grant

Taiwanese domestic politics is nasty and messy. The two main political forces – the KMT, which believes in ‘one China’, and the DPP, which leans towards an independent Taiwan – hate each other with venom that is unmatched in most other functioning democracies. But the country is pluralistic, with a free press and fair elections. Since Taiwan’s politics are so much more ‘western’ than those of the People’s Republic of China (PRC), it ought to have many friends in the western democratic world.

But it has few close friends. Both the Americans and the Europeans know that they must be on good terms with China. It is simply too important, economically and strategically, to have as an enemy. Therefore ministers in most western governments are careful not to meet their Taiwanese counterparts on an official basis, lest China get annoyed. And they tolerate the fact that China excludes Taiwan from many international bodies, such as the World Health Organisation. Of course, there are some policy-makers in the West who think that democracies should stand by other democracies. The much-maligned neo-cons, for example, give moral support to Taiwan, as do some idealists of a more liberal persuasion.

American policy on Taiwan is both realist and idealist. The US supports the status quo, meaning that it opposes Taiwanese independence. But the US also promises to defend Taiwan in the event of a Chinese attack. That promise is deliberately couched in ambiguous terms, to discourage the Taiwanese from provoking China, and to dissuade China from taking military action.

Having made no commitment to defend Taiwan, EU policy is much simpler. The EU does not see China as a strategic competitor, since – unlike the US – it is not an Asian power. So it has a clear policy of engagement with China, of supporting the status quo across the Taiwan Straits, and of being friendly towards Taiwan – but not so friendly that China would become annoyed.

The EU and the US agree on the goals of stability and the non-use of force across the Taiwan Straits. But Americans care much more about Taiwan, for the understandable reason that American blood and treasure could be shed in its defence Such emotions explain why the US over-reacted over the EU’s tentative moves towards lifting its arms embargo on China two years ago (there were good reasons why the EU should not have lifted the embargo at that time, but it was hard to have a rational discussion with some Americans over the matter, such was the strength of their feelings; they talked of the Chinese firing French missiles at American troops fighting on the beaches of Taiwan).

European views have shifted somewhat over the past two years, to be slightly more sympathetic to Taiwan. The fact that China passed the Taiwan secession law, which promises the use of force if Taiwan moves towards independence, was good PR for the Taiwanese. And the replacement of Gerhard Schröder by Angela Merkel has made a difference. She is a little more critical than her predecessor of large countries that abuse human rights, and opposes lifting the arms embargo. The departure of Jacques Chirac is also likely to affect EU’s China policy: he has been the leading proponent of lifting the embargo.

In some ways, the status quo is not so bad for Taiwan. The country is rich, successful and free, and many of its people enjoy a good quality of life. The problems for Taiwan are, firstly, its status – it is not allowed to do many of the things that normal countries do; and, secondly, its insecurity – almost a thousand Chinese missiles are pointing at it.

So the US and the EU are right to tell the Taiwanese not to rock the boat. This, along with a sensible US China policy balancing engagement with a promise of a military response to an attack on Taiwan helps safeguard the status quo, probably the best option available to Taiwan at the moment. In time, burgeoning economic ties between Taiwan and the mainland should make each side very wary of taking provocative actions that could threaten the prosperity of both – whatever the nature of the political relationship between the two. Ties between businessmen and politicians in Taiwan and the PRC are growing all the time. China is also democratising, slowly but surely, which increases the odds of peaceful reunification. Perhaps in the long run Taiwan can offer China an example of how prosperity, order and stability can co-exist with liberal democracy.

Charles Grant is director of the Centre for European Reform.

Climate change:
Western business can help China and India
by Katinka Barysch


We Europeans are proud pioneers in combating climate change. But what we do at home is almost irrelevant unless we persuade and help China and India to limit emissions.

European countries are doing more than most to reduce emissions at home, according to report presented to the UN’s climate change conference in Nairobi this week: 15 of the world’s ‘greenest’ countries are in Europe. And the EU wants to go further. The European Commission has just published a plan to extend the EU’s pioneering emissions rights trading (ETS) scheme to cover more sectors and pollutants.

European climate policies matter – as examples for the rest of the world and as a testing ground for new technologies and policies. But to stop global warming we need a global approach.

In the US – the single biggest source of greenhouse gas emissions – the consensus is slowly shifting in favour of tougher policies. While the Bush administration has ruled out ratifying the Kyoto Protocol, a large number of State governments have adopted emission reduction targets or joined regional ‘cap and trade’ schemes.

Whether the US supports a post-Kyoto regime will critically depend on whether China and India come on board. China is already the second biggest emitter of greenhouse gases, mainly because it relies on coal – the dirtiest of fuels – for two-thirds of its power generation. Coal in China is cheap and plentiful. The country still has reserves to last it about 200 years, and the price of producing energy with coal is a fraction of any alternatives. India is a similar story: it relies on coal for more than half of its energy needs and is the fourth biggest source of CO2 emissions in the world. The International Energy Agency assumes that 70 per cent of additional coal demand until 2030 will come from India and China.

The Kyoto protocol almost pales into insignificance in comparison. In 2004, the Christian Science Monitor reported that China was on course to build 562 additional coal-fired power plants by 2012, more than half of the world’s total. Together with planned new plants in India (213) and the US (70 or so), these will emit 2.7 billion additional tons of carbon dioxide. Compare that with the (maximum) 480 million tons that Kyoto countries have promised to cut from their CO2 emissions by 2012.

Coal is not the only problem. China is already the second biggest oil consumer in the world, after the US. It used up 5.5 million barrels of oil a day in 2005, and India an additional 2 million. Both countries’ needs will continue to grow fast as people get wealthier and more mobile. More than three million new passenger cars were registered in China last year. But still only 11 out of 1,000 people have their own vehicle. In a developed country like the UK, more than half of all people have a car.

Improving the EU’s ETS is important. But our priority must be to persuade and help China and India to limit greenhouse gas emissions.

The Chinese and Indian authorities say they take climate change seriously. But they insist that economic growth has priority and only rich countries can afford to combat climate change. China and India account for only 10 per cent of the fossil fuel CO2 accumulated in 1850-2004. The EU, the US and Russia together account for 70 per cent. Getting Beijing and Delhi to sign up to a tough post-Kyoto regime will be as difficult as it will be essential. In the meantime, are there other things we in Europe can do?

At a workshop on India, China and climate change – which the CER ran together with the German-British Forum on November 14th – we explored how the private sector could help China and India to become greener.

The transfer of Western technology is helping to make these countries more energy efficient. But change is slow: 15 years ago, Chinese power plants typically operated at a level of efficiency that was 35-50 per cent of that of German plants. Since then that share has crept up to 50-60 per cent. A step change is needed.

Many people put their hopes into clean coal technologies. These capture the CO2 produced by coal burning and bury it under ground. So far there are only a few pilot plants in places such as Norway and the UK. But even if the West managed to make the technology commercially viable, it would remain too expensive for China to roll it out on a grand scale.

Western governments and the EU give China some money to encourage the adoption of clean technologies. But it is not enough to make a difference. Perhaps market mechanisms are more promising. Business is certainly interested. There are now 80 environmental companies listed in London’s AIM (alternative investment market) alone. Mainstream companies from Goldman Sachs to Virgin have earmarked billions of dollars for green investment schemes. There are now more than 100 funds that solely invest in clean energy and other environmental technologies.

Under Kyoto’s ‘clean development mechanism’, rich-world polluters can keep within their target by investing in environmental projects in those developing countries that have no targets themselves. In theory, therefore, Western businesses have an incentive to invest in energy savings technologies, clean coal plants and renewables in China. In practice, however, the clean development mechanism is clunky and complicated. Its effectiveness also suffers from Kyoto’s limited lifespan. Most green investments, such as new power station or windfarms, have long lifespans. So investors have to make an assumption about long-term trends in carbon prices. At the moment, they don’t even know whether there will be a carbon market after Kyoto runs out in 2012.

China itself is not exactly making it easy for Western companies. Widespread disregard for intellectual property rights makes investors reluctant to transfer the cutting edge technologies that are often needed in environmental projects. Moreover, regulatory frameworks are uncertain or badly enforced. Take renewables as an example. Both India and China have ambitious targets but since burning coal is cheaper than building dams or erecting wind turbines, regulation is needed to encourage investment. In 2004, the Chinese authorities announced that 30 Giga-watts should come from wind power by 2020 (a modest target: experts assume that China’s potential for wind-powered energy is at least ten times that). However, when the government finally released the relevant regulation in 2006, potential investors withdrew in frustration: local content requirements of 70 per cent and an overly competitive market framework would make it almost impossible for western companies to turn a profit. The big winners would be incumbent Chinese energy giants.

Western investment can help China and India to limit their greenhouse gas emissions. But these countries also need to help themselves by building an attractive regulatory and business environment for green investments.