Climate policy by trade war?

23rd October 2009 By: Harald Winkler

Will climate policy in future be conducted through trade measures? A worrying scenario is that the current approach – negotiating climate change multilaterally, through the United Nations (UN) – could be replaced by domestic action and border adjustments.

Border adjustments are under consideration as US legislation. They would impose additional tariffs or border taxes on goods imported from countries that did not have caps on greenhouse-gas (GHG) emissions.
The Obama administration has re-engaged on climate negotiations in a much more positive spirit than was the case during the last eight years. But, substantively, the focus is strongly on domestic legislation aimed at establishing a domestic cap-and-trade system. The Waxman- Markey Bill (formally, the American Clean Energy and Security Act of 2009), sailed through the House of Representatives, albeit by a narrow margin. Companion legislation is now being lined up for the Senate. Most analyses of Waxman-Markey have focused on the GHG emission reduction targets. But a key provision are the border measures.

The rationale is that US manufacturers should not be put at a disadvantage compared with competitors overseas, who may not face a constraint on carbon emissions and the accom- panying costs incurred. The concern, politically, is mostly about China. The first step is that trade-exposed sectors receive ‘rebates’ to compensate them for additional costs in meeting the US domestic targets. In the US, rebates look likely to be linked to production volumes. In Europe, the free allowance allocation is linked to activity levels.

In the US, another layer can be added at the discretion of the President. An explanatory memorandum to Waxman Market put it thus: “If the President finds that the rebate provisions do not sufficiently correct competitive imbalan- ces, the President is directed to establish a ‘border adjustment’ programme. Under that programme, foreign manufacturers and import- ers would be required to pay for and hold special allowances to ‘cover’ the carbon contained in US-bound products.”

In plain language, if the US President was per- suaded that the rebates to US industry still made them uncompetitive against Chinese imports, a programme could be established for manufacturers in China (or any other country without a cap) which would have to buy ‘allowances’ related to the carbon content of their exports to the US. Effectively, the US would be imposing its standards on other countries.

The scenario is a cause for deep concern. The sequence, in simple terms, is domestic legis- lation and then the negotiation of a climate deal in the United Nations Framework Convention on Climate Change; in anticipation that deve- loping-country competitors do not take on strong enough targets, give some free allowances to industries that are likely to lobby government; and, if no deal is reached, effectively regulate imports from those countries – impose border adjustments.

Industrialised countries have used similar measures to protect their industries in other contexts. Unless they are very carefully designed, border adjustments will seem like more protectionism – just called climate policy.
Not surprisingly, the reaction from developing countries has been negative. China’s legislature recently adopted a resolution on climate change, and commented that China, “as a deve- loping country”, will firmly “maintain the right to development” and opposes “any form of trade protectionism disguised as tackling climate change”. The resolution, aimed at “actively dealing with climate change”, was endorsed by lawmakers at the closing meeting of a four-day session of the Standing Commit- tee of the eleventh National People’s Congress. China is signalling that it is willing to act on climate change, but not through trade measures. India expressed its protest to US Secretary of State Hillary Clinton about the proposed legislation.

Given such a reaction, unilaterally imposed border adjustments may invite gaming – Chinese exports could be sent to Japan, and Japanese production then exported to the US. If so, they would hardly be effective. More fundamentally, conducting climate policy through imposing constraints on trade seems a highly precarious means of achieving GHG emission reductions. Predictably, trade partners react negatively. The trust that is an essential element for international cooperation would be broken down, rather than built.

Serious discussion of border taxes risks waking a sleeping beast, the World Trade Organisaiton (WTO). Formally, such measures would run some risk of clashing with WTO provisions, unless they can be shown to be ‘warranted’ in order to achieve one of the aims embodied in the general exceptions of General Agreement on Tariffs and Trade (GATT) Article XX – (b) and (g). While these exceptions could be interpreted to allow protection or regulatory measures to be taken pursuant to environmental protection, they do not explicitly mention the environment.

WTO head Pascal Lamy recently said: “[We hope that agreement] will happen in Copenhagen; if it doesn’t happen, our job at the WTO will become more difficult. Go-it-alone measures will not achieve the desired results. Relying on trade measures to fix global environmental problems will not work.”

Can border adjustment measures comply with WTO rules, even if the domestic final product is only indirectly subject to national environmental charges? This might be the case with carbon dioxide taxes, but a fraught issue – and may differ for exports and national input taxes. It will have to be established whether border adjustments are compatible with the GATT.

Karsten Neuhoff, of Cambridge University, has suggested that very careful design might still make it possible. Border adjustment would have to be “restricted to a narrow set of carbon- intensive commodities”.

“They should be limited to the early stages of the value chain (for example, not steel in cars), and to a scale that does not exceed carbon intensity of best available technology. To avoid unfair subsidies, they also have to be limited to sectors that do not receive free allowances.”

Even with careful design – limited, targeted border tax adjusments based on output – there may still be contraventions of founding GATT/WTO norms of nondiscrimination, as a potential barrier to market access. However, this issue would arise only if some country declared a dispute with, say, US border adjustments (which are not taxes, strictly speaking).

But, overall, it would seem better not to conduct climate policy through the trade measures, but through the climate negotiations.

To a significant extent, the concern about competitiveness is being overplayed. Neuhoff studied the extent of the impacts of a higher carbon price and found that “. . . only a few industrial sectors of the economy, accounting for 1% to 2% of total gross domestic product (in the European Union) would face signi- ficant cost increases through the higher carbon price”’ and “for 98% to 99% of econo- mic activities, the cost increase from carbon pricing is trivial relative to other cost components”.