Although nothing will be signed, the US-China climate understanding, however it turns out, will determine the course of global climate policy. Not only are Chinese emissions greater than our own, they are growing five times faster. The strength of US-Chinese cooperation will be reflected in Copenhagen’s outcome.

Up until this June, the hope was to coax China into accepting a binding limit on emissions—a carbon cap. But as chief US climate negotiator Todd Stern has now concluded “We're not talking a national cap for China. We're talking a national cap for industrialized countries. We don't expect China to take a national cap at this stage.” As the US-China Strategic Dialogue got underway, Secretary of State Clinton explained “any agreement must include meaningful participation” by China. But she mentioned no cap, so where does that leave us?

Two paths deserve attention: the one that the world will likely follow and the one it should take instead. Quite probably, nations will undertake individual “nationally appropriate mitigation actions” (NAMAs). Instead, we should preserve the concept behind the Kyoto Protocol—the idea of a uniform global carbon price with differentiated responsibilities. Even with many caps discarded, global carbon pricing is still possible, but it requires a more flexible approach.

Flexible global carbon pricing (described here) would allow countries to adopt either a carbon cap or a carbon tax. Carbon pricing is strongly favored by most economists because it addresses the market failure at the root of the climate problem by applying the appropriate market-based correction. Economists show a general preference for a carbon tax, and some, including Stigitz (left), Nordhaus (center), and Mankiw (right), think a tax is essential. So, to most economists, China’s rejection of a cap is not much of a problem. And a tax addresses both of China’s objections to a cap—that it limits growth and discriminates against them.

Instead of carbon pricing, “Our vision for future cooperation on climate change,” in the recent Declaration of the Major Economies Forum, describes our likely but unfortunate path. It begins “Our countries will undertake transparent nationally appropriate mitigation actions.” This is a dressed-up version of George Bush’s voluntary approach. But where will it lead?

Developing countries must make a “meaningful deviation from business as usual.” Also, “Climate financing should … promote development in accordance with national priorities.” Combine these with the Waxman-Markey bill and we gain a fairly clear idea of what China was thinking when it signed onto the Declaration.

As the NY Times explains, “Calling renewable energy a strategic industry, China is trying hard to make sure that its companies dominate globally.” So the Major Economies declaration tells us financing should complement this “national priority.” And when the Waxman bill goes into effect, the EPA tells us its foreign offsets will start financing projects in developing countries to the tune of $13 billion a year—not to mention EU offsets.

Now China will almost surely get over half of that money, so perhaps $5 billion a year will go to financing large-scale production of wind and solar—China’s national priority. That will give China the scale economies to dominate the world market, and at the same time, it will fulfill China’s obligation to make a “meaningful deviation from business as usual.” China’s main NAMA will be US-subsidized domination of the global renewables market.

Offsets also help explain the failure of caps and the recent push by developing countries for severe emission cuts by industrial nations. There’s no chance we would actually make such cuts. But if we committed to make them, we would end up buying far more offsets from developing nations. And they would end up with far larger profits.

Once we start down this road of paying poor countries to stop specific acts of harm to the environment—HFC-23 comes to mind—it will be very hard to turn back. The only private markets that pay people not to do harm are protection rackets, and that’s exactly what we will have created. The less developing countries do on their own, the more room they have for profitable offset projects.

The is not a new idea. As Stanford researchers Michael W. Wara and David G. Victor found over a year ago, Europe’s offset purchases have not drawn developing countries into “substantial limits on emissions,” but have, “by contrast, rewarded them for avoiding exactly those commitments.” As a result of this perverse incentive, Europe’s cap-and-trade market is considering rules to ban the purchase of UN offset credits from major developing countries.

We should help poor countries, who have emitted almost nothing, develop along a clean energy path. But such transfers should reward cooperation rather than encourage its rejection. For the present, this must wait. Preferences for subsidies and offsets still block any hope of cost-effective climate policy. And blocking that, they block success as well.

America’s policy on climate change must begin with the recognition that this is a global issue requiring a global solution. A unilateral U.S. response with no participation by China will not resolve the environmental concern, but will cost us thousands of jobs and millions of dollars in economic activity as production moves to China. China’s argument that the burden should fall only on the U.S. and other developed countries is thus incorrect both from an economic and an environmental standpoint. Moreover, the claim America has not taken the lead on climate change is not factually accurate, at least not in the environmental sense. The steel industry in the U.S. has reduced energy intensity 33% since 1990 and many other manufacturers in our country have done as well. Taking action to curtail GHGs and using less energy is real climate leadership, and it's been going on in our manufacturing sector for 20 years.

The issue of China's behavior on climate change is not a difficult concept. Setting aside concerns over mercantilism and currency manipulation for the sake of argument, let's call the current global "playing field" level on cost of climate policy, meaning there are no mandatory climate measures in either country at present. Now consider the case where the U.S. and China adopt comparable policies to reduce GHG emissions. In the steel industry, comparable policies will impose comparable costs of compliance in both places. That would also be a level playing field – both environmentally and economically.– both to prevent the loss of jobs and to protect the environment as well. How China chooses to participate in a rational climate policy is ultimately up to China. But the environmental necessity to prevent carbon leakage requires that China bear its fair share of the cost one way or another.

If the U.S. enacts climate policies that impose a greater cost of compliance on its businesses than China imposes on its, then the present competitive balance (level playing field) will have been altered, and the environmental goal will be undermined, as production will shift to the dirtier, but cheaper industrial platform. Rational climate policy in the United States must include measures to offset this incentive toward carbon leakage that is created by an uneven playing field. The most effective way to do this is for China to make comparable reduction commitments at Copenhagen. But if it does not, it will be incumbent on the United States to maintain a level playing field