I’ve always been a big proponent of free trade and open markets; however looking at the mounting problems facing the US I can’t help but think that perhaps some level of protectionism may find its way into the nascent US carbon market. Indeed, the current global fears about potential protectionist policies in the US have resulted in a high degree of anxiety, but could a healthy level of protectionism be the key that accelerates a functional carbon market in the US – in spite of it’s detriments to broader trade?

Wholesale protectionism in free markets rarely works. During the Great Depression this was a favored strategy however today most economists agree that it was an ineffective – and damaging – position.  However now that we are descending into a deep economic hole the U.S. is again flirting with protectionism. The “Buy American” clause in the recent U.S. stimulus bill has generated much debate, and we may very well see similar restrictions on the burgeoning U.S. carbon market.

We are sitting at a time in history where the confluence of market developments may force the hand of the US into such policies. With its economic system in ruin and an unemployment rate approaching 8%, it’s fair to say times are desperate in the US. At the same time we are facing what I would call the most serious environmental challenge in human history. Unfortunately, we need to find a way in which all challenges can be met.

At the center of this issue is the allocations and projects that make up most functional markets.  Depending on the regulatory framework carbon reduction projects can make up 5-25% of some markets. But with internal pressures facing the new US administration we may see a drastic increase in this percentage in an effort to create jobs and stimulate the economy. Other markets restrict the percentage of foreign investment via CDM but the US may further increase restrictions on such investments and provide incentives to build reduction projects in America. This will surely upset China and India (who have the lion’s share of current global CDM projects) as much of the world’s CDM developers are waiting for (and banking on) the immense demand to be generated from U.S. cap and trade.

Of course this all remains to be seen, nobody has a carbon crystal ball.  But when it comes to carbon markets it’s difficult to see how the U.S. will be able to make good on its assurances to the global community that international trade will flow freely. When it comes to carbon markets, I certainly hope it does.