Trade and Climate Change

HIR Issue: 
Disease

Trade and Climate Change
A Mutually Supportive Policy

Joshua Meltzer serves as a fellow in Global Economy and Development at the Brookings Institution where he focuses on international trade policy, including the implications of climate change and energy policy for the international trading system. Prior to Brookings Joshua Meltzer was a trade lawyer and trade negotiator at the Australian Department of Foreign Affairs and Trade and a diplomat at the Australian Embassy in Washington DC with responsibility for climate change and energy matters.

Katherine Sierra serves as a senior fellow in Global Economy and Development at the Brookings Institution where she focuses on climate and energy policy.+Katherine Sierra was the former vice president for sustainable development at the World Bank, where she directed its climate change policy and programs.

Introduction

There are several links between trade and climate change, but in most cases these connections have been viewed as being in tension or in conflict. For example, there is concern that domestic climate change policies promoting renewable energy may be inconsistent with the rules prescribed by the World Trade Organization (WTO). There are further concerns that United Nations (UN) climate change discussions on the role of intellectual property may undermine WTO intellectual property rules.

The potential for conflict between trade and climate change policy is real. However, trade policy can also be used to support climate change action. In particular, an international trade negotiation to reduce trade barriers to goods developed using low-carbon processes could support climate change policy and create incentivize businesses to reduce their greenhouse gas (GHG) emissions.

Uncertain costs and its impact on climate change policy

At the UN climate change conference in Cancun in December 2010, countries agreed that by 2050 global average temperature increases should be kept below two degrees Celsius above pre-industrial levels. Yet uncertainties over the costs of reaching this global goal loom large, particularly as this level of emission reductions will require all major economies to make significant transformations in the way they produce and consume energy in their transportation systems, industrial structures, and buildings. Moreover, many of the key climate change technologies, such as carbon capture and storage, smart grids, and storage for renewable energy are not fully developed. Meanwhile, nuclear energy, a key technology, which many countries had included under their low emission scenarios, has been taken off the table in Japan and Germany after the recent Fukushima accident in Japan. A 2007 McKinsey & Company report estimates that by 2030 the annual worldwide costs of reducing emissions could be anywhere between US$750 and US$1,500 billion.

However, the discussion of costs in the UN climate change negotiations has been limited to the obligation of developed countries to fund the incremental costs of mitigating and adapting to climate change in developing countries. While developing countries are expected to be the most significantly affected by climate change, developed countries have contributed the most to current concentrations of GHG emissions and have the resources to combat climate change. At the December 2009 Copenhagen Climate Change conference, developed countries proposed two streams of climate change finance – Fast Start financing of US$30 billion in between 2010 and 2012, and US$100 billion per year to be mobilized by 2020.

In contrast, the costs of meeting GHG mitigation targets have been left to each developed country to address. This is also true for large, developing countries such as China, the world’s largest GHG emitter, which will also have to significantly reduce its GHG emissions over time. However, China’s trade surplus with the US and European Union (EU) member countries, combined with its large holdings of foreign debt (including approximately US$1 trillion in US Treasuries), has made developed country financing of China’s climate change policies politically infeasible.

The costs of reducing GHG emissions in developed countries has also raised carbon leakage and competitiveness concerns. Carbon leakage arises when climate change policies lead to no net reduction in GHG emissions as businesses seek to avoid the costs of climate change policies by relocating to developing countries with less strict climate change regulations. Competitiveness concerns are closely related to this issue and arise when the costs of climate change policies, which are most pronounced for carbon intensive industries such as cement, steel, and aluminium, lead to a loss of market share to imports from countries not facing similar carbon costs.

Any assessment of the costs of climate change policy also needs to account for the economic benefits, the most significant being avoiding the costs of climate change. However, the value of these avoided costs has been plagued by the same uncertainties over the impact and costs of addressing climate change.

A Bottom-Up Approach – International Climate Policy

These uncertainties about costs have stalked global climate change policy. They were key to the recent failure of the US and Australia to pass cap and trade systems in 2009. Uncertainty over the costs of reaching the type of GHG targets discussed at the UN climate change negotiations also contributed to the near-complete failure of the Copenhagen Climate Change Conference in December 2009.

Yet a key outcome from that conference - the Copenhagen Accord - laid the foundations for an alternative international paradigm that was more fully articulated at the following UN climate change meeting in Cancun in December 2010. In contrast to the Kyoto Protocol framework - where countries negotiated a target, apportioned responsibility for meeting this target, and then adopted domestic policies to meet the target – the Accord adopts a so-called bottom-up approach, whereby countries first decide their domestic climate change policies before committing to policies at the international level.

Following this “bottom-up approach”, developed countries have listed their GHG mitigation targets in Annexes to the Copenhagen Accord and formulated policies to meet these targets. For example, the US is seeking to reduce its GHG emissions by regulating emissions from vehicles, fossil fuel plants, and petroleum refineries and by developing sources of clean energy. The EU has a cap and trade system and is also investing heavily in renewable energy. Japan is also considering a cap and trade system and is promoting renewable energy and energy efficiency.

Under the Copenhagen Accord, developing countries have agreed to list the actions they are taking to reduce their GHG emissions. For example, China has adopted a CO2 emission intensity target of 40 to 45 percent by 2020 (compared to 2005 levels), a renewable energy target of 15 percent by 2020, and has increased funding for renewable energy, mass transit, and electric vehicles. India is developing renewable energy, improving energy efficiency, and investing in its forestry and agriculture sectors. Brazil has pledged to reduce its emissions through reducing deforestation and increasing the use of bio-fuels and renewable energy.

Uncertainty over costs has also led countries to frame climate change policies as in their country’s national interests by tapping into their supplementary benefits, such as energy security, the environmental benefits from reduced deforestation to cleaner air. For instance, China’s commitment to increasing renewable energy and reducing the carbon intensity of its economy can be understood as being about improving its energy security and the health of its environment. In the US, the focus has also been on energy security and promoting green industry to create jobs.

There are, however, costs to the bottom-up approach. There is now less environmental certainty regarding whether countries are doing enough collectively to reduce global GHG emissions. Indeed, according to the International Energy Agency (IEA) the climate change targets and actions that countries have listed so far in the Copenhagen Accord would still leave the world 60 percent above the level required to keep global temperatures at two degrees Celcius above pre-industrial levels.

Trade and Climate

To date, the relationship between trade and climate change has been characterized as one of tension and conflict. For instance, the shift to a bottom-up approach has highlighted the range of climate policies being adopted and their implications for the international trading system. For example, WTO rules place limits on the ways that countries are able to subsidize their renewable energy industry. In fact, Japan has commenced WTO litigation accusing Canada’s feed-in tariff for renewable energy of being inconsistent with its WTO commitments.

Another way that trade has appeared in tension with climate change goals has been as a driver of economic growth and increased GHG emissions. However, as countries develop, their economic growth tends to be driven increasingly by the services sector, which generates fewer GHG emissions. Moreover, the Kuznets curve predicts that as countries grow wealthier their citizens will demand greener clean growth, reinforcing the link between higher levels of economic development and lower GHG emissions.

Trade measures have also been proposed under cap and trade systems as a means of addressing the carbon leakage and competitiveness concerns that arise when one country prices carbon and others do not. For example, the proposed US cap and trade legislation required importers of goods from countries taking different climate change approaches to purchase allowances which reflect the costs to domestic producers of the cap and trade system. The EU has periodically considered similar trade barriers to ameliorate some of the costs of its cap and trade system.

Trade issues have also been raised in the UN climate change negotiations. For example, some countries in the UN climate change negotiations have sought to reduce international intellectual property rules in order to prevent the transfer of the climate change technologies to developing countries – a commitment made by developed countries in the United Nations Framework Convention on Climate Change (UNFCCC).

These links between trade and climate change policy have not been adequately reflected in bureaucratic structures. In most countries, responsibility for trade negotiations is with the trade or foreign affairs ministries, and environment ministries have responsibility for climate change policy. Giving environment ministries responsibility for climate change policy has required them to become advocates for policies that have significant impacts on economics and trade effects. This has been met with resistance from the trade and economic ministries skeptical of the capacity of environment ministries to understand the economic and trade ramifications of reducing GHG emissions.

The World Trade Organization and Climate Change Policy

Given the international trade dimensions of climate change policy, conceiving of a more positive relationship between the two seems crucial. The role of the WTO, as the key multilateral institution responsible for governing world trade, is our focus in developing a trade agenda that could support climate change action. Yet the trade and climate change relationship could also be useful as part of negotiations for free trade agreements or within the Major Economies Forum or the G20. Furthermore, developing a role for the WTO in the climate change space would not be an alternative to the UN climate change negotiations. As will be discussed, liberalizing trade in low-carbon goods only makes sense as part of individual and global efforts to reduce GHG emissions.

Despite these links between trade and climate change policy, so far there has been only limited discussion of climate change issues at the WTO Climate change has indirectly become part of the WTO Doha Round with WTO members trying to eliminate tariff and non-tariff barriers to trade in environmental goods and services. The expectation has been that reducing barriers to trade in these goods could reduce the costs of climate change technologies and thereby leads to greater climate change mitigation and adaptation.

As part of these WTO negotiations, the WTO Committee on Trade and Environment in Special Session (CTESS) – comprised of developed and developing country member states – has been tasked with identifying a list of environmental goods. The CTESS has identified six categories of environmental goods, including in the climate change related areas of renewable energy, energy efficiency as well as carbon capture and storage. However, reducing these categories to a specific list of goods has proven difficult.

One of the key questions raised by this negotiation has been whether an environmental good is determined by reference to its use or to the environmental impact of its lifecycle, which involves production and disposal. The United Nations Conference on Trade And Development (UNCTAD) has defined an environmental good broadly, as one which causes significantly less environmental harm at some stage of its life cycle (production, processing, consumption, or waste disposal) than alternative products that serve the same purpose.

Discussions in the WTO CTESS have also revealed a range of views. For example, the EU and to some extent Japan have appeared open to defining an environmental good according to how it was made or, in Japan’s case, in terms of its performance such as its energy efficiency. However, countries such as the US and China have opposed extending the definition of environmental good to including how it was produced. The lists of environmental goods that have been developed in the WTO CTESS draw from work done in the Organization for Economic Cooperation and Development (OECD) and Asia Pacific Economic Cooperation (APEC) forum on environmental goods and place an emphasis on end use by largely focusing on goods that could be used to address environmental problems.

One of the main limitations of the WTO CTESS’ focus on a good’s end use is that reducing barriers to trade may not lead to increased reductions in GHG emissions. If cutting tariffs lowered the cost of goods used to mitigate GHG emissions, then in a perfectly competitive market this could be expected to reduce the costs to businesses of complying with domestic climate change regulations. However, this would not lead to businesses reducing their GHG emissions in excess of what was required. In order for trade liberalization to lead to an even greater level of GHG mitigation, governments must adopt more stringent climate change regulations. While developing countries tend to rely on imported goods to address climate change, developed countries have significant domestic capacity to produce the goods and technologies to reduce their GHG emissions. In these countries the liberalization of trade in climate change goods would be unlikely to lead to more stringent climate change policies.

Another approach would be to reduce tariffs and non-tariff barriers on all goods with low -carbon lifecycles. However, such an approach would present its own set of challenges. For one, there is no agreed way of measuring carbon lifecycles. Moreover, given that the disposal of goods usually happens in the country that consumes the good, reducing trade barriers based on a good’s carbon lifecycle raises issues over who controls disposal of the good.

An alternative focus would be on reducing trade barriers on “low - carbon goods” that is, goods produced using low - carbon production processes. Low - carbon goods produced according to an internationally agreed standard would be afforded greater market access than higher carbon alternatives. As an alternative to reducing tariffs, governments could also agree to provide a rebates to importers or consumers of low carbon goods.

One advantage of this approach over the current focus in the WTO CTESS is that it would avoid the need to compile lists of climate change goods because it would be focused on production of goods. Any good that was produced in a low - carbon environment would qualify for a tariff reduction. Furthermore, it would also avoid the difficulties associated with the disposal process of the life cycle approach.

Reducing Trade Barriers to Imports of Low-Carbon Goods

Reducing tariff and non-tariff barriers on goods produced using low-carbon production processes would maximize the ability of the trading system to drive climate change policies.

One of the key climate change benefits from reducing trade barriers in low - carbon goods would be that this reduction could lead to a positive price signal for these goods. In contrast to a cap and trade system or carbon tax, the aim would be to reduce the price of low-carbon goods relative to other higher carbon goods. Creating a positive price effect for low-carbon goods should lead to increased consumption of the lower carbon good and reduced consumption of similar high-carbon goods, leading to reductions in GHG emissions. The extent of the impact of a tariff reduction or rebate on the price of low-carbon goods would depend on a range of factors, including the international standard for the carbon content of production processes, the relative costs of high and low carbon production, and the magnitude of the tariff cuts.

A positive price signal should also create an added incentive for governments to assist businesses in reducing their GHG emissions in order to capture new export markets. Where countries are already supporting low-carbon growth by encouraging renewable energy and improving energy efficiency, lower trade barriers could create political space to maintain government support for these policies, as goods produced from low-carbon energy sources would likely face lower trade barriers overseas.

In cases where the benefits from the liberalization of trade in low-carbon remained with the producer instead of being reflected in lower prices for these goods, the opportunity for a country’s exports to benefit from a tariff reduction should still incentivize business to adopt lower carbon production processes.

Reducing trade barriers to goods using low-carbon production processes could also reduce the carbon leakage and competitiveness concerns from policies that price carbon. This is because lower trade barriers on low-carbon goods would reduce the economic incentive to locate abroad to take advantage of lower costs in countries with less stringent climate change policies; the high-carbon goods produced overseas would not be able to benefit from the lower tariff for goods produced using low carbon production processes, reducing any cost advantage achieved by locating overseas.

Using trade negotiations to incentivize and support climate change policy could also help overcome the divide between the trade and climate change communities. Similar to how international trade negotiations create incentives for exporters to support reducing domestic trade barriers as the quid pro quo for access to new overseas markets, a trade negotiation focused on reducing trade barriers to low-carbon goods could also incentivie stakeholders, particularly businesses, to support reducing domestic trade barriers to low-carbon goods. This should translate into business support for domestic policies to reduce GHG emissions as the ability of goods to receive preferential market access would be conditional upon goods being produced in a low-carbon way.

Furthermore, a trade negotiation would not be significantly challenged by uncertainty over the costs of climate change because the country undertaking trade liberalization would reap most of the economic benefits. By tying reductions in GHG emission to increased market access, such a trade negotiation would clarify the economic benefits countries receive from climate change action, thereby reducing some of the uncertainty over the costs of climate change policy.

Challenges to liberalizing trade barriers to low carbon goods

WTO members have been concerned that distinguishing between goods based on how they were produced as opposed to their environmental impact would allow measures motivated by protectionism to be disguised under environmental concerns. Developing countries with lower environmental standards have opined that they should not be penalized for current standards, which are appropriate and commensurate with their level of development or be required to adopt developed country standards.

The ability of WTO members to restrict imports of goods whose production process harmed the environment has already been litigated at the WTO. This issue has been extensively analyzed and we do not intend to revisit this debate here. Suffice to note that the WTO’s jurisprudence does not prevent government measures motivated by non-protectionist policies from treating goods differently based on their production process.

Moreover, this proposal is focused on negotiating the appropriate production processes – the low-carbon standard - and the trade barriers that would be eliminated for goods that meet the low-carbon standard. It therefore does not raise the type of issues litigated at the WTO when one country decides the appropriate production process. It is also anticipated that an international standard would need to be flexible enough to take into account the different resource endowments of countries, their different stages in development, and their access to climate change technologies. Proceeding on a sectoral basis could provide additional flexibility.

Customs officials would also need to identify goods used with lower carbon production process.
An internationally recognized labelling system would enable customs authorities to identify goods produced according to the agreed law carbon standard and allow consumers to identify low-carbon goods.

Conclusion

The scale and range of policies that countries are going to have to adopt in response to climate change suggest that trade and climate change policies must be mutually supportive. The starting point is to renew the bargain that has characterized the post-war international economic order, which John Ruggie has called embedded liberalism. Here, the economic dislocation and costs of international trade were ameliorated with domestic economic and social policy roles. Updated to account for the climate change challenge, the aim will be to ensure that the goals of the multilateral trading system are compatible and supportive of the demands climate change will make on governments.

Reducing trade barriers to low-carbon goods would be consistent with the WTO’s efforts to liberalize trade. In addition, tying market access to low-carbon production would create incentives for governments to reduce their GHG emissions. Making trade policy an enabler of climate change policy would also help address some of the suspicion and lack of understanding that the climate change community has of the trading system and the WTO.

As importantly, reducing trade barriers to low-carbon goods would make climate change policy a driver of trade liberalization. This should not only help reduce fear that climate change policy presents a looming train wreck for the multilateral trading system, but it should also focus the attention of the business community on the economic benefits of climate change policy.