INTERNATIONAL trade has become one of the pillars of the global economic system; an overlap between climate change policies and the multi-lateral trading system administered by the World Trade Organization (WTO) therefore seems inevitable. International trade affects climate change as it potentially increases economic activity that may in turn lead to increased greenhouse gas emissions. Conversely, taking measures to reduce greenhouse gas emissions might adversely affect competitiveness and hence reduce countries’ willingness to participate in such measures.¹ The WTO Committee on Trade and Environment has only dealt with the interactions between climate change and international trade in a limited manner within the Doha mandate on trade and environment. At the same time, climate negotiations under the United Nations Framework Convention on Climate Change (UNFCCC) have paid very little attention to the relationship of the climate regime to WTO norms. Still, there are a number of important overlaps, which are outlined here.

The Kyoto Protocol establishes three flexibility mechanisms which allow developed countries to comply cost-effectively with their emission limitation and reduction objectives outside their borders: (i) the Clean Development Mechanism, (ii) Joint Implementation, and (iii) International Emissions Trading. These flexibility mechanisms raise several trade issues which have so far largely remained unresolved.

 

The protocol’s exclusion of developing countries in international emissions trading would only amount to a violation of WTO non-discrimination principles if emission credits could be defined as either ‘goods’ or ‘products’ under the General Agreement on Tariffs and Trade (GATT) or ‘services’ under the General Agreement on Trade in Services (GATS).² In the context of emissions trading, certain allocation methods of carbon allowances could be interpreted as a favourable treatment of a domestic industry over foreign competitors, in particular if a domestic emissions trading scheme stipulates the free-of-charge distribution of allowances. In fact, such a free allocation of financial assets might be classified as a subsidy under WTO rules.³ However, the WTO Agreement on Subsidies and Countervailing Measures prohibits subsidies that are specific to an enterprise or industry or subsidies that can bring adverse effects to the interests of other members.

As the Kyoto Protocol does not specify the concrete steps developed countries need to take to implement emission reduction policies and measures, it is problematic for the climate regime to claim jurisdiction over such behaviour, let alone to entitle a regime body or mechanism to address it.⁴ At the same time, it is possible that parties to the climate agreement implement policies and measures that are trade-distorting and/or violate WTO rules. Developed countries might consider such measures to flank their greenhouse gas emission reduction activities or to protect domestic industries that are adversely affected by the implementation of climate policies.⁵

Subsidies to firms for climate-friendly products, research, development or export might not be allowed under the WTO Agreement on Subsidies and Countervailing Measures.⁶ The key questions are how specific a subsidy is and what injury it might cause to others.⁷ Governments might also choose to put burdens on energy-inefficient foreign companies by imposing tariffs or taxes on their greenhouse gas-intensive imports.

 

One major uncertainty about the WTO-compatibility of such measures relates to the question of product related processes and production methods. Marginal taxes on energy intensive goods from countries which are not party to the Kyoto Protocol or do not take ‘comparable’ climate change action might violate both the national treatment and most-favoured nation principles of the GATT. Such ‘border adjustment measures’ might become a reality in the not too distant future as they are currently being considered in both the United States and the European Union. Furthermore, any product standards, labels or technical regulations, which establish minimum requirements for goods on the basis of their energy or greenhouse gas intensity during production or use, might conflict with the national treatment principle under the GATT or with the Agreement on Technical Barriers to Trade.⁸

The climate regime also permits certain government procurement policies – i.e. government purchases of goods and services – that might create tensions with the WTO Agreement on Government Procurement. Yet, while subsidies, tariffs and border adjustment measures might be more prone to a legal challenge, government procurement, labelling and standards (at least voluntary ones) are rather unlikely to collide with WTO rules.⁹

 

There are also potential win-win constellations in the climate-trade interplay. In particular, this holds for the removal of trade barriers in favour of climate friendly goods or services, and the development and transfer of low emission technologies. One provision of the UNFCCC seeks to facilitate and finance the transfer of, or access to, environmentally sound technologies and know-how to developing countries. The Agreement on Trade Related Aspects of Intellectual Property Rights (TRIPS) strengthens the position of technology developers, since it opposes national sovereignty – and subsequent protectionism – over intellectual property rights.

On the other hand, the TRIPS Agreement might render the acquisition of technologies more costly, to the disadvantage of developing countries.¹⁰ Moreover, the WTO Agreement on Trade Related Investment Measures can constrain the ability of acquiring country governments to act by excluding the use of certain interventions, for example by not allowing enforcement of performance requirements on multinational corporations.¹¹

 

As international efforts to address climate change have been intensifying in recent years, two interrelated problems have become central in domestic climate policy discussions in both the United States (US) and the European Union (EU), namely international competitiveness and carbon leakage which refers to an increase of emissions in countries without climate policies that can be related to emission reductions in countries with climate policies in place.¹² Recently, there has been much focus on unilateral offsetting measures such as border adjustment measures flanking domestic climate policies.¹³ Two broad design options are commonly distinguished: (i) border tax adjustments; and (ii) the requirement for importers to surrender allowances at the border.¹⁴

Most of the cap and trade bills in the US Congress provide for an ‘International Reserve Allowance Programme’, which would require US importers of specific goods from selected countries to purchase emission allowances from a separate reserve connected to the domestic emissions trading system. Most importantly, the American Clean Energy and Security Act (tabled by Representatives Henry Waxman and Edward Markey), which was passed by the House of Representatives in 2009, includes a provision on border adjustment measures.

 

Several aspects about the provisions in the various bills can be highlighted. First, the proposed coverage of goods has slowly expanded and may eventually include finished goods. However, the inclusion of such goods will likely pose significant administrative challenges given the possible different countries of origin of the various components of the finished goods.¹⁵ Second, the coverage of countries has changed over time. The 2008 Climate Security Act includes a stringent ‘comparable action’ test, effectively requiring any foreign country to adopt the same kind of greenhouse gas emission caps as the US.

A third important aspect concerns the basis for calculating the number of reserve allowances required for imports. In most bills, this takes place through a formula that considers: (i) the national greenhouse gas intensity rate in a covered country for a category of covered goods; (ii) an allowance adjustment factor for the allowances that are allocated free of charge in the US; and (iii) an economic adjustment ratio for foreign countries.

Finally, the bills differ with regard to the date of entry into effect of the measure. The gap between enactment and the start of the programme is important as it buys some time for potentially affected countries to develop and implement domestic climate change mitigation policies, and allows the international climate change negotiations to come up with results.¹⁶

 

Border adjustment measures also play a role in the EU. European industries – especially energy intensive industries – argued that the start of the scheme would adversely affect their international competitiveness even before the European Union Emissions Trading Scheme (EU ETS) was in place.¹⁷ Most of the discussions in the EU in 2008 concerned the question of how to identify the sectors that are at significant risk of carbon leakage. The final text of the directive contains a compromise that was reached on the criteria and thresholds for determining the sectors exposed to leakage.

Sectors are deemed to be exposed if the production costs increase by 5% or more and their non-EU trade intensity is above 10%. Sectors are also considered to be exposed if either the production costs increase by 30% or more, or their non-EU trade intensity is at least 30%. With respect to the measures addressing leakage, the Directive lists adjusting the amount of free allowances and inclusion of importers in the EU ETS as possible options to address leakage.

Although border adjustment measures are still included as a possibility in the directive, it is notable that more detailed provisions comparable to the US proposals did not make it into EU law, and that the main proposed measure to appease member states’ concerns about competitiveness and leakage is the free allocation of emissions allowances.

 

There are indeed a number of legitimate reasons for concern for developing countries, especially regarding the design of some of the bills in the US Congress. First, it can be argued that the design of some of the measures, as proposed in the US, runs counter to the principle of common but differentiated responsibilities and respective capabilities. Second, the mere discussion of border adjustment measures in the US and the EU may have political repercussions. Third, it can be questioned whether border adjustment measures are even effective in achieving the stated goals. Although border adjustment measures may have some impact on leakage, an import requirement is unlikely to be very effective as it ‘only affects the relative price of domestic and foreign goods in the home country.’¹⁸ On the other hand, border adjustment measures could reduce leakage, but the effects would be small as the extent of leakage itself is also small.

Unless border adjustment schemes are set on a plant-by-plant basis, rebate exports and cover indirect emissions, it is not clear that they would level the CO2 playing field to the point where competitiveness levels are restored and leakage is avoided.¹⁹ The environmental and economic effectiveness of border adjustment measures depends to a large extent on the coverage of goods and sectors; the inclusion of marginal climate policy costs (direct and indirect costs); and the application to all trade flows (imports and exports).

Opponents of border adjustment measures will argue that they are illegal,²⁰ while proponents will argue that, if well-designed, they should withstand a challenge before the WTO dispute settlement body.²¹ The border adjustment option on both sides of the Atlantic seems to be aimed more at developing countries, particularly China.

 

Whereas policy-makers in the EU are not fully convinced of its necessity and are wary of the implications for international negotiations, there is a significant chance that the measures may be adopted in the US. This leads to the question of what could be done to avoid adverse impacts on developing countries. Developing countries that wish to challenge border adjustment measures before the WTO could argue that the measure targets products that can be considered ‘like’ (e.g. it needs to be argued that steel produced with carbon-intensive processes is ‘like’ low-carbon steel). Furthermore, if the measure contains a determination of ‘comparable action’, it can be argued that it is not applied to all countries, as required by the most-favoured nation principle.

 

The affected country could also argue that the measure is a disguised restriction on international trade. Of course, affected countries could start proceedings before the WTO but it is not yet possible to tell whether a border adjustment measure will be considered illegal. Two other options are possible: (i) starting a multilateral discussion on limiting the use of border adjustment measures; and (ii) ensuring that the design of border adjustment measures takes into account the concerns of developing countries.

There are several rationales for international coordination to limit the unilateral application of border adjustment measures.²² First, coordination could ensure that the measures will not be used to discriminate against developing country producers. Second, it could reassure the trade community that protectionist measures will not be implemented. Third, the disciplined use of border adjustment measures could smoothen the transition to full carbon pricing policies across the globe while addressing potential leakage problems.

It is an open question what the most appropriate forum would be for limiting border adjustment measures. One option would be to discuss border adjustment measures (or more broadly: climate-related trade measures) in the context of the UNFCCC. However, it seems unlikely that parties to the UNFCCC, which have so far largely refrained from any discussion of climate-trade interactions, would be willing to take up such a sensitive subject. If international cooperation on border adjustment measures proves to be impossible, the design of border adjustment measures could better account for the position of developing countries.

First, an extensive examination of the (sub-) sectors at risk of carbon leakage at a high level of disaggregation is necessary before putting in place border adjustment measures, in order to target the measures at (sub-) sectors where leakage is a real concern. Second, depending on the outcome of such analyses and on sector-specific characteristics, other options to address competitiveness and leakage, including lowering non-climate policy related burdens for affected industries, should not immediately be discarded.

Third, border adjustment measures would become legally and politically more feasible if they were accompanied by a reimbursement mechanism that keeps the general principle of common but differentiated responsibilities unaffected. This special mechanism could provide for the reimbursement of the ‘full incremental costs’ incurred by firms in developing countries in upgrading their facilities to become more energy efficient.

Although no border adjustment measures have been adopted, there is a real possibility that this may be the price of passage for cap-and-trade legislation in the US. It makes sense to pursue multilateral discussions on limiting their use to avoid adverse impacts on developing country economies. If such multilateral discussions prove impossible, it is important that the design of such measures take into account developing country interests, and if possible, is designed in such a way that their application is eventually unnecessary.

 

* Based on a paper presented at the ORF-RLS Conference on Sustainable Development and Climate Change held in New Delhi on 24-25 September 2009.

Footnotes:

1. S. Charnovitz, ‘Trade and Climate: Potential Conflicts and Synergies’, in Pew Center on Global Climate Change report, Beyond Kyoto: Advancing the International Effort Against Climate Change, 2003, pp. 141-170.

2. A. Petsonk, ‘The Kyoto Protocol and the WTO: Integrating Greenhouse Gas Emission Allowance Trading into the Global Marketplace’, Duke Environmental Law & Policy Forum 10, 1999, 185-220.

3. R. Howse and A. Eliason, ‘Domestic and International Strategies to Address Climate Change: An Overview of the WTO Legal Issues’, in T. Cottier, O. Nartova and S.Z. Bigdeli (eds.), International Trade Regulation and the Mitigation of Climate Change. Cambridge University Press, Cambridge, 2009.

4. Kommerskollegium (Swedish National Board of Trade), Climate and Trade Rules – Harmony or Conflict? Kommerskollegium, Stockholm, 2004.

5. J. Frankel, ‘Climate and Trade: Links Between the Kyoto Protocol and WTO’, Environment 47, 2005, 8-19.

6. T. Santarius, H. Dalkmann, M. Steigenberger and K. Vogelpohl, Balancing Trade and Environment: An Ecological Reform of the WTO as a Challenge in Sustainable Global Governance. Wuppertal Institute for Climate, Environment, and Energy, Wuppertal, 2004.

7. H. van Asselt and F. Biermann, ‘European Emissions Trading and the International Competitiveness of Energy-intensive Industries: A Legal and Political Evaluation of Possible Supporting Measures’, Energy Policy 35(1), 2007, 497-506.

8. Ibid., n 6.

9. Ibid., n 7.

10. M. Littleton, The TRIPS Agreement and Transfer of Climate-change-related Technologies to Developing Countries. DESA Working Paper No. 71. Doc. No. ST/ESA/2008/DWP/71, 2008.

11. P.S. Subbarao, International Technology Transfer to India an Impediment and Impetuous. IIM Working Paper No. 2008-01-07. Indian Institute of Management, Ahmedabad, 2008.

12. Ibid., n 7.

13. A. Cosbey, Border Carbon Adjustment. International Institute for Sustainable Development, Winnipeg, 2008.

14. Border adjustment measures can also apply to exports. For instance, exporters may receive a rebate at the border, or could be (partially) exempted from the obligation to surrender allowances in an emissions trading system.

15. P.R. Orszag, Issues in designing a cap-and-trade programme for carbon dioxide emissions. Testimony before the Ways and Means Committee, US House of Representatives, 18 September 2008.

16. J. Haverkamp, International aspects of a climate change cap and trade programme. Testimony before the Committee on Finance, US Senate, 14 February 2008.

17. D. Pocklington, ‘European Emissions Trading: The Business Perspective’, European Environmental Law Review 11(7), 2002, 209-218.

18. W.J. McKibbin and P.J. Wilcoxen, The Economic and Environmental Effects of Border Tax Adjustments for Climate Policy. Brookings Trade Forum 2008/2009, 1-23.

19. J. Reinaud, Issues Behind Competitiveness and Leakage. Focus on Heavy Industry. International Energy Agency, Paris, 2008.

20. R. Quick, ‘ "Border Tax Adjustment" in the Context of Emission Trading: Climate Protection or "Naked" Protectionism’, Global Trade and Customs Journal 3, 2008, 163-175.

21. R. Ismer and K. Neuhoff, ‘Border Tax Adjustment: A Feasible Way to Support Stringent Emission Trading’, European Journal of Law and Economics 24, 2007, 137-164.

22. S. Dröge, Tackling Leakage in a World of Unequal Carbon Prices. Synthesis report on Climate Strategies, Cambridge, 2008 and International Cooperation to Limit the Use of Border Adjustment. Workshop Summary, South Center, Geneva, 10 September 2008.