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Trade and Climate Change

Two broadly accepted goals for the world community are: a) the achievement of fair and open trade; and b) clean-energy development to help mitigate climate change. Without trade, much of the socioeconomic development and poverty reduction we have seen around the world in the last two centuries (from the United States and Western Europe to the “East Asian Tigers” and the BRIC nations: Brazil, Russia, India, China) would not have occurred. And without the development of clean energy, we will not be able to prevent future climate change, and we will not be able to counter the effects of the climate change that is now inevitable.

Unfortunately, there is already tension in the simultaneous achievement of these two goals, arising from the fact that the effects of climate change are, and will be, felt transnationally—i.e. across all countries. However, the mechanisms to mitigate and adapt to climate change have to be adopted and implemented nationally—i.e. by individual countries. This means that countries opting for higher environmental standards and clean energy by reducing emissions may place their domestic industries at a competitive disadvantage in the global markets, and in doing so, threaten to reduce income and employment opportunities for their own citizens.

To reduce emissions countries may either tax them, regulate them, or introduce cap-and-trade systems. But all mechanisms lead to an increase in production costs. Indeed, this is the desired aim—to increase the price of CO2 emissions, thus providing incentives for producers to shift to clean-energy sources that emit little or no CO2 into the atmosphere. However, if other countries do not follow suit and act to reduce emissions, their industries will face relatively lower production costs, thus raising the disturbing prospect that such countries may become “pollution havens,” attracting companies that are looking to increase profits by lowering costs.

To illustrate this scenario one only need to consider the issue of labor standards. Over the last 50 years, many companies have relocated production to countries that have lower labor costs. This is often related not strictly to low wages, but also to relatively low labor standards (e.g. unsafe working conditions, no right to unionize) compared to those that exist in the United States and Western Europe. The intent of relocating was to lower production costs and increase profit margins. The practical effect, though, is to put companies and countries on a global slippery slope of worsening labor standards.

In addition to the economic problems, “pollution havens” would also pose the problem of “carbon leakage.” Because companies will just relocate to “pollution havens” and continue to emit CO2, global emissions of CO2 may not fall nearly to the extent needed. As such, the prospect of “carbon leakage” defeats the purpose of emission reductions in any one country.

To counter the problems posed by “pollution havens,” and to create incentives for clean-energy use across the world, countries may opt to introduce trade restrictions on goods produced in countries that do not enact emission reductions. These trade restrictions may come in the form of tariffs or technical requirements (such as labeling to indicate the energy efficiency of a product). A country may also choose to subsidize domestic clean-energy use by its industries, offsetting the higher cost of emission reduction technologies. Such measures will allow countries pursuing clean-energy development to maintain competitiveness vis-à-vis countries that are not. In doing so, these measures will make it less likely that “pollution havens” will develop and that “carbon leakage” will occur.

Here it is important to note that while the World Trade Organization (WTO) generally disallows trade restrictions, its rules allow trade restrictions in pursuit of certain policy objectives, as long as a number of specific conditions are met. Of particular interest here is the fact that WTO case law indicates that environmental objectives may take precedence over WTO rules. Therefore, trade restrictions imposed to further clean-energy development may well be permitted by the WTO.

Of course, the dilemma is that trade restrictions—even if they aim to further clean-energy development—will obviously go against the aim of achieving fair and open trade. Indeed, they may spark a trade war, as countries retaliate by pursuing “beggar-thy-neighbour” policies, enacting trade barriers against each other. The net result will be not only a decrease in world trade, but also a reduction in global economic growth.

Trade restrictions may also hamper the ability of countries to acquire the means of pursuing clean-energy development by introducing barriers to the transfer of technology. This problem is especially acute for developing countries, as they do not currently have the technology, skills and expertise to pursue clean-energy development.

Furthermore, the enforcement of fair and efficient trade restrictions against non-climate friendly products will be an extremely challenging task. For example, if a country chooses to impose a tariff on the carbon content of a product, how would this carbon content be calculated? Would the carbon content of intermediate goods used in the production of the end-product be taken into account? What if the intermediate processing of the product occurred in a third country? Importantly, how do we determine whether or not a country has acted to reduce emissions?

Copenhagen, Denmark, the site of the United Nations Conference on Climate Change, where countries of the world met in December 2009 to negotiate a new global agreement on climate change.

While emissions caps and taxes are meant to reduce CO2, countries may choose other measures. For example, China’s new building code, promulgated in 2006, requires all new buildings to halve their energy consumption. This policy will lead to emissions reductions, but since it does not directly introduce an emissions cap or a carbon tax it would be overlooked, exposing Chinese goods to unfair trade restrictions.

The last example speaks to the concern that many have about trade restrictions ostensibly imposed to promote clean-energy development—namely, that they may in fact just be plain old protectionist measures imposed under the false pretense of combating climate change.

No supra-national entity exists (nor is one in the cards) that can enact, monitor and enforce emissions reductions across the world. Therefore, in order to achieve global emissions reductions, stave off “pollution havens,” and prevent “carbon leakage,” the imposition of trade restrictions on non-climate friendly products is both inevitable and necessary. Ultimately, these trade restrictions will produce tension between trade and climate change; tension that will arise in the form of questions, the answers to which will hinge almost entirely on interpretations—for example, whether a tariff imposed on a product is fair or unfair.

That said, trade policy can also be creatively formulated to support measures that cut emissions. For example, the European Union’s trade policy provides special tariff rate cuts to developing countries that export to the EU, if these countries have ratified and implemented global environmental agreements. Indeed, trade policy can be designed to support trade in clean-energy goods, and to provide impetus for the spread of clean-energy technology around the world.

The relationship between trade and climate change will certainly lead to complicated and intense negotiations at Copenhagen, especially given the framework of “common but differentiated responsibility” for emissions reductions. Clear rules of engagement with regard to trade and climate change as part of a global deal will have to be an outcome of the Copenhagen summit. Such an outcome is imperative if we are to forestall states from acting individually and resorting to protectionist measures (albeit in the name of climate change) that will eventually result in damaging consequences for all.

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