Carbon adjustment mechanisms at borders: will an innovative climate policy trigger a trade war?

The ThyssenKrupp Steel Europe factory in Duisburg, Germany on January 7, 2020. Photo by Leon Kuegeler / Reuters.

The Biden administration may only be several months old, but its statements and actions have already raised the global profile of climate issues. The new climate czar, John Kerry, has traveled the world for bilateral pledges of more aggressive action to tackle climate change. And expectations are growing for a new consensus on collective mitigation activities at the 26th United Nations Conference of the Parties on Climate Change (COP26) in Glasgow, Scotland, in November. These are welcome developments, especially when combined with further regulatory action by major emitting economies, including China and India, to reduce their carbon footprint and the revolutionary possibilities of the European Union. (EU) to move forward with its own green deal.

As climate issues finally gain prominence, business experts are peeling down angles and business opportunities. An informal group of World Trade Organization (WTO) countries, inelegantly referring to their deliberations as structured discussions on trade and environmental sustainability, developed a broad agenda, including specific aspects of the process. overlap between trade and climate. There is once again talk of resuming dormant negotiations at the WTO, and even within the Asia-Pacific Economic Cooperation (APEC), on environmental goods (e.g. solar panels, wind turbines and lithium batteries) from here. the end of the year. , ideally structured in such a way as to avoid the pitfalls of the past.

The concept of carbon border adjustment mechanisms (CBAMs) is also receiving increasing attention. While CBAM may sound like the name of the most prominent new boy band, it is more of a hypothetical form of trade restriction intended to tackle ‘carbon leakage’: the hope that aggressive mitigation efforts in some countries could divert investment and production to countries with more relaxed carbon rules. The approach has been proposed in the US and the EU but has never been formally implemented. As such, CBAMs exist only in the realm of lawyers and academics arguing over whether they comply with WTO rules. There is not yet a CBAM in place, and therefore no concrete examples to consider in terms of trade impacts and trade tensions.

What form a CBAM takes will likely depend on the type of national system a country has in place to reduce greenhouse gases from major national emitters such as steel companies and transport services. A carbon tax, calculated as a fixed amount linked to the volume of emissions, can be fairly straightforward and more likely to be considered WTO-compliant if it is applied on a non-discriminatory basis to imported goods and services. Other national regulatory approaches with corresponding CBAMs, such as a system that requires both domestic producers and importers to purchase “allowances” to account for their emissions, raise more complex questions.

While these questions have been largely academic to date, that could change. Certainly, previous early warnings from CBAMs have failed. Under the Obama administration, I participated in discussions about an international reserve quota system, which would have imposed new de facto tariffs on importers to offset carbon leakage in energy-intensive and trade-intensive sectors such as steel, aluminum, cement, paper, and a few others. It was an essential part of US cap-and-trade legislation aimed at creating a market for greenhouse gas emission allowances. But, after being passed by the House in 2009, cap and trade died in the Senate in 2010 and has not been relaunched since. In 2012, the EU explored creating some form of carbon adjustment for airlines when it expanded its emissions trading system. The two proposed actions created international tensions at the beginning, to the point that China, India, South Africa and a host of other developing countries have pushed for a ban on such unilateral measures in climate negotiations. In fact, the reason why there have been no specific commitments to avoid the unilateral trade restrictions negotiated in climate agreements to date is probably because CBAMs have remained academic.

Today the EU, under new leadership, pursues a much broader climate agenda with his green accord, including the transitional implementation of CBAMs from 2023. Until now, the EU Emissions Trading System provided free allowances in high emission sectors. However, it is now moving towards a system in which companies in these sectors have to buy allowances. This change creates a host of political problems involving further restrictions on carbon-intensive industries, and CBAMs, which would apply trade restrictions to competing imports, are seen as an antidote. The EU’s ambitious initiative may well establish a CBAM model that other countries may aspire to or face, just as the EU has set benchmarks on digital privacy and competition regulation. Those who follow in the EU’s footsteps can learn from this experience, while those who feel negatively impacted are likely to back down. The United States under the Biden administration is on an uncertain path in terms of climate policies and measures to reduce greenhouse gas emissions, and comments from administration officials suggest so far that it has not fully considered the issue of CBAMs.

In order to have a serious debate on the implications of CBAMs, including WTO legality, policymakers need to consider some fundamental questions before enthusiasm takes precedence over international realities. The way forward is likely to be full of drama, confrontation and uncertainty.

Here are some of my initial questions:

  • What is a CBAM adjustment used for? This can be relatively straightforward in carbon tax or cap-and-trade systems, like the EU’s, as they set clear prices for greenhouse gas emissions, but not so simple when considering a series of regulatory restrictions on these emissions, which is more likely to be the case in the United States.
  • What regulatory actions should be included or excluded in determining the effective price of carbon in order to determine the level of a CBAM? Should only mandatory measures such as specific emission limits be included? What about discretionary incentives such as tax breaks to invest in renewable energy sources?
  • How is the level of a CBAM calculated? Is this simply an “equivalence” of another country’s measures or does there need to be a detailed analysis of the actual price of carbon in a foreign market? How objective is an equivalency assessment and how could allies and friendly countries be treated more generously than adversaries?
  • How should economies that set up CBAMs respond to concerns or even retaliation from other economies? Is it naive to assume that there will be no backlash against the CBAMs? For example, will developing countries react strongly to CBAMs restricting imports when they view developed countries as historically responsible for climate change and having higher levels of carbon emissions per capita?
  • What is the commercial policy of CBAMs? Are carbon-intensive sectors among the most politically sensitive and the most vulnerable to increased imports? If so, will the future imposition of CBAM parallel the dynamics of past actions to enforce tariffs in these sectors and raise new trade disputes and new threats to the system? WTO?
  • Are CBAMs compatible with WTO obligations? Can any convincing arguments be made that these measures are non-discriminatory or fall within certain WTO exceptions?

These and other questions suggest that setting up CBAMs will prove difficult. In fact, we could see multiple new battle fronts, including bilateral trade tensions, WTO disputes, and proposals in the climate negotiations to ban unilateral implementation of CBAMs. For example, Indian Minister of Commerce Piyush Goyal recently noted that he would “very unfair today put in place trade policy and trade barriers and use trade as a means of imposing [new restrictions] on the developing world or less developed countries.

Before all of this begins, discussions between like-minded countries should take place, ranging from academic and legal circles to government officials, including trade officials, on how to avoid misunderstandings and even the next generation of trade wars. As climate leaders like to remind us, this is a global and even existential challenge. So actions that could create cracks in the global response must be pursued with eyes wide open.

Mark Linscott is a Senior Non-Resident Researcher at the South Asia Center of the Atlantic Council. He served as the United States Deputy Trade Representative (USTR) for the Environment and Natural Resources between 2003 and 2012 and was the senior US trade official involved in the Obama administration’s efforts to push for US legislation. cap and climate trade. He then served as USTR Assistant for WTO and Multilateral Affairs, as well as South and Central Asia.

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