Bridges Trade BioRes Review • Volume 3 • Number 3 • December 2009

Competitiveness and climate policies: Is there a case for unilateral trade measures?

by Ingrid Jegou

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Unless the world moves ahead on a global track to address climate change, countries acting to address the problem may opt to take measures to protect the competitiveness of their energy-intensive industries through unilateral trade measures. How such border carbon measures might work in practice - and especially, what their impacts would be on poorer countries - is not yet known.

The world is facing a situation in which temperatures are rising as a result of human activities involving unprecedented levels of emissions of greenhouse gases. Climate change is already causing and will continue to cause a rise in sea levels, a decrease in snow and ice, more frequent droughts, more intense tropical cyclones and other extreme phenomena. This in turn is affecting, and will affect, living conditions all over the world. Poor countries, which have contributed the least to climate change and are the least equipped to deal with the consequences, are being hit the hardest.

The key to success: A global solution

Further climate change seems inevitable. However, the damages can be limited if concrete and substantive action is taken to significantly reduce carbon and other green house gas (GHG) emissions. This response has to be global. If the industrial countries alone were to severely restrain from emitting greenhouse gases it would not be enough. This is a big challenge. The last attempt to curb emissions through a global deal among nations, the Kyoto Protocol, failed to include the United States of America, the world’s biggest emitter of carbon dioxide at the time. Under the Kyoto Protocol, developing countries were exempt from making binding reduction commitments based on the principle of “common but differentiated responsibility.” Moreover, although marking an important first step, reductions resulting from the Protocol have so far been very modest. Hence, the international community has embarked on a quest for a global arrangement that will entail considerably larger reduction commitments and much broader participation, while respecting historical responsibility and the differences in capabilities among nations.

Although the optimal solution, a global deal resulting in the necessary cuts in global emissions, is well understood, it is by no means certain that world leaders will be able to achieve it. Views differ on who bears the responsibility and who should pay.

Risks inherent to a partial solution

If only some countries take action, this may result in distortions to competitiveness particularly for energy- and emission-intensive industries, as producers in mitigating countries would face costs for reducing emissions and compete against firms without or with less such costs. The efforts of mitigating countries risk being rendered futile as some emissions could simply move to countries with less strict climate-change regulations, thereby resulting in so-called carbon leakage. In response to these considerations and in order to leverage participation of developing countries in an eventual global deal, legislators, industry leaders and lobbyists have come up with the idea of using measures at the border, so-called border carbon adjustments (BCAs). Such measures appeal to politicians as they allegedly protect both the environment and domestic jobs. At the same time, they are hard to accept by countries whose trade is likely to be affected. In the US, there are concrete proposals for border measures in the American Clean Energy and Security Act of 2009 (based on the “Waxman-Markey bill”) and in the Boxer-Kerry bill, currently being debated by the US Senate. In France, president Sarkozy recently proposed a carbon tax, which should be accompanied by border measures. Other OECD countries are to an increasing extent discussing along similar lines.

How do border carbon adjustments work?

BCAs could either take the form of a tax at the border, or, as discussed more frequently, a requirement for importers to purchase allowances in the cap-and-trade system of the importing country. The tax or emission allowance would be calculated based on the quantities of carbon that have been emitted during the production process.

Multiple objections have been raised against such measures. These objections are based on questions of effectiveness as well as economic and legal concerns.

Theory and economic modelling give some support to the effectiveness of BCA in addressing carbon leakage and competitiveness concerns. High administrative costs risk marginalizing the benefits, however. In order for BCAs to be effective, a number of criteria regarding their design would need to be fulfilled. For example, product coverage would need to be broad to avoid firms trying to bypass the BCAs by further transforming the goods. Calculating the emissions related to the production of highly processed goods would - as one can easily imagine - be a daunting task, and associated with considerable administrative costs.

Moreover, in order to fully address competitiveness issues, exports would need to be rebated as competition takes place not only at home but also to a high degree in export markets. This criterion is not fulfilled in any existing proposal on BCAs. In other words, as most existing proposals do not fulfil the criteria, border carbon measures would probably not be fit to do the job they are intended to do.

Looking at the compatibility of border measures with the obligations of the WTO, the situation is unclear. The legal option that seems to have the most support as a ground for border carbon measures would be to show that they are necessary deviations from the general principles of the WTO in order to protect exhaustible natural resources. However, the discussions related to the existing proposals on BCAs have focused mainly on the protection of domestic jobs and economies. Therefore, it may be difficult to persuade a WTO panel that the environment is the real reason for restricting trade.

The high political price of border measures

More worrying is that there seem to be important political risks associated with BCAs. In particular, BCAs risk creating bad will both in the climate change negotiations and in the multilateral trading system. Indeed, many countries that have done little historically to contribute to the problem of climate change and now risk facing taxes at the border, claim they are being unfairly pushed in the climate change negotiations. Additionally, some have indicated that they are reluctant to further open their economies through trade liberalization if industrial economies plan on raising new barriers to trade. Moreover, BCAs could risk opening a Pandora’s box of protectionist measures, which could lead to a veritable trade war.

Should BCAs be the last straw in causing climate change negotiations - and maybe even the trade negotiations in the WTO - to collapse or to seriously lower the ambitions and fall back on second or third best alternatives, the real consequences would be considerable both for climate change and for the world economy.

Development implications of BCAs - the big unknown

The effects of BCAs on developing countries would need to be studied in great detail by countries imposing such measures. The debate today focuses mainly on China and India as likely targets for BCAs. However, preliminary analysis of the Waxman-Markey bill indicates that as many as some 25 countries could be targeted. What would that mean to the trade and development of those countries? Would other developing countries also be affected, through changed world market prices of energy-intensive goods or through altered trade patterns following the new trade restrictions? These questions should be studied in order to avoid adverse effects on the trade and development of poor. Indeed, the world is committed through the Agenda 21, the Millennium Development Goals as well as through the UNFCCC and the WTO to strive for sustainable development. Policies that protect the environment at the expense of welfare and opportunities for the poor and poor countries cannot be sustainable.

Today, we lack knowledge of the consequences of BCAs. We simply have no experience to fall back on. Dealing with carbon and greenhouse gas emissions, economy-wide, has never been done before and lacks precedents. Therefore, we must rely on simulations and prognostics. However, as long as we do not know what the final design of the measures will look like, and how much trade is likely to be affected, all simulations and prognostics must be based on a great number of assumptions.

Understanding the possible merits and impacts of the eventual use of BCAs is particularly relevant in the current context of uncertainty with respect to the outcome of the Copenhagen Climate Conference in 2009. If a full-fledged global deal cannot be secured, national policies and measures, eventually including BCAs, may end up acting as the primary instruments in curbing global carbon emissions.

The full paper is available at http://www.ictsd.org

Ingrid Jegou is Global Platform Research Fellow at ICTSD