December 2, 2022 — The most important task in confronting global climate change is the need to enforce serious quantitative limits on Greenhouse Gas emissions, such as the Nationally Defined Contributions which were originally negotiated in the 2015 Paris Agreement. The 27th Conference of Parties to the UNFCCC, which concluded in Sharm-el-Sheikh November 20, did not tackle this task. Carbon border equalization measures, including tariffs against carbon-intensive imports from lax countries, might supply the teeth that have been missing from such agreements. But they also risk advancing protectionism, which would ultimately slow the needed global energy transition. Adjudicating the fairness of carbon tariffs would be a good job for a reinvigorated WTO.
- Too-slow progress on national policies to achieve desired targets
It is a waste of time for negotiators to argue over whether the global aspiration should be to limit warming to 1.5 degrees Celsius versus 2.0 degrees, when individual countries are pursuing emission policies that are too lax to achieve collectively either of those numerical climate goals. Most countries have failed to achieve emission targets that they themselves had set previously. The fact that countries missing their targets have not even been individually called out, let alone subjected to any sort of international penalty, shows that enforcement of the agreements as they stand is toothless.
The biggest increases in carbon emissions are coming from China and other developing countries. But they, understandably, ask why they should cut emissions before the rich countries, who already achieved industrialization while emitting freely. To be sure, the European Union has its Emissions Trading System, which has successfully raised the price of carbon to around € 75 per tonne on that continent. And, at long last, the US this year legislated important steps to fight climate change in its Inflation Reduction Act, which will heavily subsidize electric vehicles and other green technologies. But these do not go far enough to accomplish the environmental goals.
The free-rider problem is exacerbated by the problems of carbon leakage and competitiveness: each country asks why it should impose regulatory costs on its own firms, if production in their respective industries will respond by relocating to countries where such costs have not been imposed, vitiating the global reduction in emissions.
- Carbon Border Adjustment Mechanism
Realistically, there is one way to protect firms in carbon-intensive industries that are regulated by their governments, against imports coming from foreign competitors that are less regulated. There is also, realistically, one way to give free-riding countries a strong incentive to join the set of countries that are making serious commitments and then keeping them. Fortunately, the way to encourage countries to become commitment-abiding members of the club is the same sort of instrument that insulates competitively-disadvantaged firms in member countries against non-member exports: carbon border equalization measures.[i]
The EU is expected to finalize in December plans for its Carbon Border Adjustment Mechanism (CBAM), which will protect certain of its carbon-intensive industries. The proposed list of industries, originally from the EU Commission, started with aluminum, iron and steel, cement, fertilizer, and electric power generation. But the European Parliament wants to expand the list to include various other industries, along with indirect emissions.
Tariffs will be imposed on imports to equalize the weekly price of carbon between domestic producers and their foreign competitors. Currently, among major trading partners, only the United Kingdom has a carbon price close to the EU’s € 75 per tonne.
When the EU’s CBAM arrives, US firms will see it as a threat, perhaps even as a violation of WTO rules, especially if the list of protected industries is expanded to include many where carbon usage is indirect and difficult to quantify or if the EU over-estimates the gap in the effective prices of carbon. The quantification problem is not just a matter of data, but arises even conceptually. Should imports of electric cars be penalized because steel and aluminum are inputs to their production?
- A new role for the WTO?
The EU says that its mechanism will comply with WTO rules for international trade. It may indeed turn out to do so.
There are precedents for the WTO’s environmental exceptions, which one need not be a lawyer to perceive. Articles XX(b) and XX(g), which date back to the WTO’s predecessor, the General Agreement on Tariffs and Trade (GATT), allow exceptions to protect health and natural resources. That they include environmental objectives was made clear in the preamble to the 1995 Marrakesh Agreement that established the WTO and in subsequent rulings, beginning with a 1996 decision on US gasoline imports.
Most notably, the WTO dispute settlement mechanism ultimately upheld environmental exceptions in the famous 1998 shrimp-turtle case, so long as the US did not discriminate unnecessarily against foreign fishermen. By contrast, under the pre-WTO GATT, the US could not apply tariffs against imports of Mexican tuna to stop fishermen from using production methods that ensnared dolphins in the nets.
In 2007, a WTO Appellate Body decision on Brazilian restrictions against imports of retreaded tires also confirmed the applicability of Article XX, finding that the rules accord considerable flexibility to WTO Member governments when they take trade-restrictive measures to protect life or health, and that problems like global warming are included. One aspect that strengthens the applicability of these precedents is that we are not talking about targeting practices in other countries that harm solely their local environment, where the country could make the case that this is nobody else’s business. Further, it probably helps legally that CBAMs are enacted in pursuit of the goal of multilateral agreements, that is, the goal of climate change mitigation.
Who is to be the judge in the CBAM case of what is the effective price of carbon in countries like the United States, where climate policies are now largely pursued without the price mechanism? Can the EU be trusted to make such judgments, unbiased by the economic interests of the protected industries? Rather, it seems like a natural job for a revived WTO, if its members were to give the organization such a mandate. Even the US might rediscover the usefulness of the WTO.
An environmentally-driven reinvigoration of the WTO would benefit developing countries too. US and EU trade barriers against imports of solar panels and other renewable energy equipment, from Cambodia, China, Malaysia, Thailand, and Vietnam might give these exporting countries cause to bring cases before a resuscitated WTO. And the “buy American” aspect of subsidies in the US Inflation Reduction Act might give its trading partners a case to take to the WTO. The winners would include not just producers in the plaintiff countries, but also those buyers in the US who want to continue lowering the costs of wind turbines, solar panels, batteries, and electric cars.
In place of an environmental trade war, a revived WTO could foster new norms for beneficial CO2 border measures and generate a wave of trade in green goods and services. WTO Director-General Ngozi Okonjo-Iweala would like to revive lapsed negotiations among a willing subset of members to facilitate free trade in environmental products. This would cut through the web of measures and counter-measures, and benefit all countries. The big winner in all these examples would be planet Earth.
[A shorter version appeared at Project Syndicate. Comments can be posted at Econbrowser.]
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[i] Climate clubs were proposed by Nobel Prize winner Bill Nordhaus.