Trade Policy and Climate Policy: Moving beyond the CBAM

This is where trade enters:  trade breaks the identity between consumption and production. If you cannot trade, you are bound to consume what you produce and to produce what you consume. That, in fact, is why trade is economically so valuable: it allows you to specialise in what you do best, gain economies of scale and increase the variety of what you consume. And where there is trade, there is trade policy.

The EU Carbon Border Adjustment Mechanism

No country yet uses trade policy in its approach to climate change, but the EU is gearing up to do so through its Carbon Border Adjustment Mechanism (CBAM). The EU already charges firms for the carbon they emit through its Emissions Trading System (ETS) and the CBAM is designed to charge similarly for the carbon embodied in imports. It aims to ensure that, for the products included in the CBAM’s remit, every unit of EU consumption pays the same cost of emissions, whether domestically produced (through the ETS) or externally produced, i.e. via EU imports, (through the CBAM). More details are available in our recent report, Addressing UK greenhouse gas emissions through trade policy.

Both the ETS and the CBAM rely on the careful measurement of the emissions embodied in different goods, but there is a critical difference. The ETS is levied on production plants in the sectors it covers (steel, cement, etc), roughly eleven thousand units across the EU, for each of which quite detailed records were already kept for management purposes. The CBAM, on the other hand, is a border policy that must be applied at a product level: the customs classification contains about eleven thousand separate entries and there are perhaps 220 countries that might possibly export to the EU. Many imported products contain many inputs and many installations produce several products and/or have several production lines. Thus, tracing emissions down to product level is mind-numbingly complex. As a result, the expectation is that the CBAM will be applied to products in many fewer sectors than the ETS.1 Half of EU imports in the sectors proposed for inclusion come from Russia, China, the UK, Norway and Turkey, so not many partners will be significantly affected.

Admittedly the literature around the CBAM has some awkward subtexts: that it is designed to offset the effects of the ETS on EU competitiveness (which is a real concern for business) or that it aims to persuade others to adopt carbon controls (which is going to be necessary ultimately). However, I think we should see it primarily as part of a consumption policy not an attempt at protection or extra-territoriality. To reinforce this message the EU must:

·      avoid any suggestion of discrimination;

·      offer technical assistance to low-capacity countries and possibly small firms with the complexity of the processes; and

·      allow some exemptions/delays for developing countries.

The EU has been diligent in doing the first but has so far ignored the other two. However, on 22nd June the Parliament voted to transfer revenue raised from the CBAM to developing countries to facilitate their climate transitions.

The US alternative

In the US, the Federal Government’s proposed approach to managing emissions domestically is different from the EU’s; it is based on standards rather than market-based measures charging for carbon use. This makes it much harder to justify border taxes in international trade law because the equivalence between a standard for domestic producers and a border charge for imports is far from obvious. It is also harder to optimise domestically than a market-based measure because, rather than use a market, the bureaucracy has to determine the trade-offs between products – i.e. whether to tighten one standard or another.

Moving to a global level

For both standards and market-based measures, the question is how to create a global system, because ultimately, with a global problem, that is what we require (every unit of greenhouse gas is equally destructive wherever it is emitted). Talk of carbon clubs is beginning, with similar policies (carbon prices) on the inside and similar policies towards outsiders.2 This sounds benign, but it is complex – e.g. how similar is ‘similar’? There are no details yet, but what we don’t want is a world split into carbon blocks that can’t easily trade with each other because that would be both divisive and reduce the benefits of trading.

This, in turn, raises the technical and political question ‘How can we reconcile standards and market-based methods?’ This is also hugely complex on both levels, but on the politics, there are two encouraging signs. First, deep down, the EU understands that the CBAM is not the last word, but the start of an international conversation, as, perhaps, the vague German proposal on climate clubs shows.3

Second, the US–EU Arrangements on Global Steel and Aluminium Excess Capacity and Carbon Intensity may be a nascent carbon club; although we’ll have to wait to see how the details are fleshed out. One problem it has to overcome, however, is that it combines managing emissions with addressing ‘unfair’ subsidies, which makes an emissions policy look like a covert competitiveness policy, which is, by definition, discriminatory.[4] Exactly the same problem arises if one looks to free trade agreements (FTAs) to address climate issues: FTAs have to be consistent with climate policy but are not a substitute for it.

Jaw, jaw, not (trade) war, war

Until standards and market-based measures are reconciled, we won’t have a coherent policy even just among western economies, so international conversations/negotiations are absolutely essential to progress. But these must not be a US-EU stitch-up (or even trilateral with China); other countries need to engage. That is, we have a global problem and we need to make use of multilateral structures – the financial institutions, the trade institutions and the United Nations bodies. There is more than enough to be done for any of them to play a role, but it will need to be coordinated to avoid the turf wars that often bedevil inter-institutional projects.

High-income countries need to support this effort by, for example:

·      Delivering on existing and future promises of funding fully and at the agreed times;

·      Funding the necessary secretariat and technical expertise;

·      Being more imaginative and generous about technology transfer;

·      Explicitly recognising the Paris Agreement clauses on ‘Common but Differentiated Responsibilities and Respective Capacities’

In their turn, developing countries must think of the last not in purely mercantilist terms (what extra can they export), but also in dimensions like timing and their domestic policies.

The answer to climate change is not to stop trading. The trading system has delivered untold benefits precisely because it breaks the identity between production and consumption. So, we have to solve the problems I have been talking about. It will be technically demanding and politically sensitive, but there is no better place to start than a Continental-scale summit meeting.

This blog is based on L Alan Winters’ comments to Trade and Foreign ministers at the Summit of the Americas, Los Angeles, 7th June 2022.