Carbon, trade policy, and carbon free trade areas

John Whalley, Yan Dong 25 November 2008

a

A

How much can trade policy contribute to global carbon emissions reduction and what are the potential impacts of proposals for both unilateral and regional carbon-emission-reduction-motivated trade policy arrangements now circulating?

These issues are raised as global negotiations enter the post-Bali/post-Kyoto process (out to Copenhagen 2009 and beyond), and as various entities around the world (particularly in the EU) debate possible unilateral measures. In Europe, the view is that individual countries (or groups of countries) that make emissions reduction commitments faster and deeper than others face issues of linkage to the trade regime if they are going to offset the anti-competitive effects their domestic producers suffer due to their environmental commitments.

The combination of the post-Bali road map discussion following the recent UNFCCC Bali Meeting (Dec 2007) and the EU commitments in their 2020 programme (20% emissions reductions by 2020, and 20% use of renewables by the same date) has lead to increased discussion as to how trade and environmental regimes may need to be more closely linked in a post-Kyoto world. The future, as seen in Europe, is for Europe to lead the world with deeper emissions reduction commitments than elsewhere. But while others lag, new trade measures may be needed. Such measures may well eventually involve fellow travellers joining new carbon-driven regional trade arrangements.

How does trade affect carbon emissions?

Economic growth plays a much larger role than trade in fuelling growing carbon emissions, and its containment is more likely to significantly reduce emissions than trade policy interventions. And since much of global merchandise trade is in emissions-intensive manufactures, the more critical issue may be the level of trade relative to non-traded services than the product and country composition of trade, which trade policy proposals largely address. Having said this, however, there are the large differences in emissions intensities across countries and hence there are potential roles for (non-MFN) country discrimination in trade policy.

Discussion of unilateral carbon-motivated border measures and carbon-motivated regional trade arrangements is likely to grow in significance as global negotiations on climate change intensify. This will occur especially as the impacts of such initiatives on the size and pattern of trade become more apparent, and trade measures to support climate change initiatives are explored. Unilateral carbon-motivated border measures could involve either or both of tariffs on high carbon imports and subsidies on low carbon exports.
At a trade policy level, there are emerging ideas and proposals for carbon-emission-reduction-motivated free trade areas and accompanying border measures when carbon reduction initiatives are implemented. Here we describe such proposals according to their objectives and forms, emphasising how such measures can in some cases serve to increase rather than reduce carbon emissions.

Carbon free trade areas

In their simplest form, carbon free trade areas would involve free trade in low-carbon-containing products among countries jointly committing to significant emissions reductions or renewable commitments and external trade barriers against third countries that do not follow. Discussion of both their form and impact is related to the long studied customs union issue originally analysed by Viner (1950), but now the impacts of carbon pricing/reduction policies on emissions is the focus.

Three different forms of possible trade arrangements seem likely. First, regional trade agreements with varying types of trade preferences for low-carbon-intensity products, low-carbon new technologies, and inputs to low-carbon processes may stimulate trade (and hence consumption) in low-carbon-intensity products, contributing directly to emissions reduction through changed trade patterns. A weakness of this approach is that there is greater differentiation in emissions intensity by country than by product. Also, this discussion does not focus on the external trade arrangements of the group of countries entering into such an agreement.

A second approach would focus on the anti-competitive effects on domestic producers when countries pioneer significant joint emissions reduction commitments that others do not follow. Such commitments raise costs for domestic producers, and some have raised the issue of whether there should be offsets for these relative cost effects compared to third-country producers operating outside of such arrangements, as well as the form they should take. This perceived need for border tax adjustment has already arisen in Europe (see Lockwood & Whalley 2008).

Hence, if various entities within the OECD, such as the US and the EU, were to jointly agree on carbon emission reduction initiatives, some forms of joint border measures against third parties might be used to counteract the anti-competitive effects on domestic producers from the joint environmental commitment. These could take the form of common or country-differentiated external barriers against third parties.

A third type of arrangement could involve countries establishing free trade areas or other regional trade agreements and using joint and discriminatory carbon-motivated trade barriers against third parties as a way of pressuring countries to join their joint environmental agreement. This form of trade arrangement is similar to that contained in the Montreal Protocol of 1987.

Impact of carbon free trade areas

What may be involved in each of these, and also in the wider use of trade policies to achieve global carbon-limitation objectives? Similar ideas to those now surrounding carbon-motivated trade policies could be discussed for a wide range of policy-related areas and their interaction with trade, quite besides climate change. Joint or unilateral trade policies could be argued for countries with, say, a high level of provision of social programmes, high labour standards, high minimum wages, or other policy features. Thus, including in the carbon emissions case, the motivation for these types of trade arrangements and their forms and impacts should be discussed as separate issues.

Such arrangements may also have systematic impacts on how the world trading system evolves during the next few decades. In light of the likely growing interface between trade and environmental policies, international agreements are critical for countries to avoid destructive policy retaliation and gain common benefits from cooperation. The Bretton Woods 1944 Conference yielded a global trade and monetary order whose main aim was to rebuild the international economy after World War II, but the resulting system only focused on trade and finance, not physical interactions between countries. Today, given concerns over global warming, the future evolution of the trading system may well be that environmentally motivated arrangements prevail over trade and financial arrangements in the WTO and IMF. The world of global policy coordination may thus move beyond WTO trade negotiations to linked trade and environmental policy bargaining.

References

Ahmad N. and A. Wyckoff (2003), Carbon Dioxide Emissions Embodied in International Trade of Goods, OECD Science, Technology and Industry Working Papers, 2003/15, OECD Publishing. doi:10.1787/421482436815.
Cosbey A. and R.Tarasofsky (2007), Climate Change, Competitiveness and Trade, Chatham House Report.
Ismer R. and K. Neuhoff (2007), Border Tax Adjustment: A Feasible Way to Support Stringent Emission Trading, European Journal of Law and Economics 24, pp 137-164.
Lockwood B. and J. Whalley (2008), Carbon Motivated Border Tax Adjustments: Old Wine in Green Bottles? NBER Working Paper No. 14025 , Issued in May 2008 .
Walsh S. & J. Whalley (2008), The Global Negotiating Framework for Climate Change mitigation, Paper prepared at CESifo conference in Venice July 2008 on European Global Environmental Negotiations.
World Bank (2008), International Trade and Climate Change, Washington, DC.

a

A

Topics:  Energy International trade

Tags:  trade policy, climate change, carbon emissions, free trade areas

Professor and William G. Davis Chair in International Trade, Department of Economics, University of Western Ontario

Research Fellow at the Institute of World economics & Politics, Chinese Academy of Social Sciences

Events

CEPR Policy Research