Climate legislation and trade

Legislation to address greenhouse gas emissions is coming, and will have implications for trade.  Jeffrey Frankel of Harvard reviews the issues in a recent working paper (Global Environmental Policy and Global Trade Policy).  Here's the abstract, broken into short paragraphs:

The global climate regime, as represented by the Kyoto Protocol, may be on a collision course with the global trade policy regime, as represented by the WTO (World Trade Organization). Environmentalists fear that international trade will undercut reductions in greenhouse gas emissions as dirty production migrates to non-participating countries, a phenomenon known as leakage. Meanwhile businesspeople fear the effects on their own competitiveness of the same phenomenon.

These fears have now become prominent in the policy-making process. In early 2008, legislation to enact long-term targets for reduced emission of greenhouse gases included provisions for possible barriers against imports from countries perceived as non-participating -- in both Washington, DC (where the bills have not yet passed) and in Brussels (where the EU Commission Directive has gone into effect).

Such provisions could be interpreted as violations of the rules of the WTO, which poses the nightmare scenario of a WTO panel rejecting a major country’s climate change legislation. In light of the hostile feelings that such a scenario would unleash, it would be a nightmare for the supporters of the WTO and free trade as much as for the supporters of the Kyoto Protocol and environmental protection.

The issue is just the latest and largest instance of fears among many environmentalists that the WTO is an obstacle to their goals in general. The issue transcends institutions. For the critics, the WTO is a symbol of globalization, and their fears attach also to that larger phenomenon.

The first part of this paper discusses the broader issue of whether environmental goals in general are threatened by free trade and the WTO. The second half of the paper focuses exclusively on the narrower question of trade aspects of nations’ efforts to implement climate change policy and whether they are likely to come into conflict with the WTO.

The bottom line (from the conclusions):

Both the economics and the law are complicated. The issues need further study. Nevertheless, the central message of this paper is that border measures to address leakage need not necessarily violate the WTO or sensible trade principles, but that there is a very great danger in practice that they will.

I conclude with some subjective judgments as to principles that could guide a country’s border measures if its goal were indeed to reduce leakage and avoid artificially tilting the playing field toward carbon-intensive imports of non-participating countries. I classify characteristics of possible border measures into two categories, which I will name by color (for lack of better labels):  (1) the “Black” category: those that seem to me very dangerous, in that they are likely to become an excuse for protectionism; and  (2) the “White” category: those that seem to me reasonable and appropriate.

The Black (inappropriate) border measures include:

• Unilateral measures applied by countries that are not participating in the Kyoto Protocol or its successors.
• Judgments as to findings of fact that are made by politicians, vulnerable to political pressure from interest groups for special protection.
• Unilateral measures that seek to sanction an entire country, rather than targeting narrowly defined energy-intensive sectors.
• Import barriers against products that are further removed from the carbon-intensive activity, such as firms that use inputs that are produced in an energy-intensive process.
• Subsidies – whether in the form of money or extra permit allocations -- to domestic sectors that are considered to have been put at a competitive disadvantage.

The White (appropriate) border measures could be either tariffs or (equivalently) a requirement for importers to surrender tradable permits. The principles include:

• Measures should follow some multilaterally-agreed set of guidelines among countries participating in the emission targets of the Kyoto Protocol and/or its successors.
• Judgments as to findings of fact -- what countries are complying or not, what industries are involved and what is their carbon content, what countries are entitled to respond with border measures, or the nature of the response – should be made by independent panels of experts.
• Measures should only [be] applied by countries that are reducing their emissions in line with the Kyoto Protocol and/or its successors, against countries that are not, either due to refusal to join or to failure to comply.
• Import penalties should target fossil fuels, and five or six of the most energy-intensive major industries: aluminum, cement, steel, paper, glass, and perhaps iron and chemicals.

If countries follow these guidelines in enacting border penalties, they may be consistent with the avowed goals of preventing leakage and undue loss of competitiveness and are unlikely to fall afoul of the WTO. If they do not follow these guidelines – the more likely outcome – they can be consistent with these goals, and with the WTO as well.