Climate change and carbon dioxide control policies have become major public policy issues in the U.S. and many other countries. The trade impacts of carbon policies started to receive attention as the Ad Hoc Working Group on Further Commitments for Annex I Parties Under the Kyoto Protocol two-week negotiating session began on March 29 in Bonn, Germany. The Ways and Means Committee Subcommittee on Trade of the U.S. House of Representatives also held a hearing on March 24 to begin delving into the impact of carbon policy on trade.

At the heart of the issue in the U.S. is concern about “the carbon leakage problem” of industries moving to manufacturing nations that have less aggressive carbon reduction regulations. This would also result in a loss of U.S. jobs in manufacturing industries. It primarily affects energy-intensive industries that face foreign competition including iron and steel, copper, aluminum, cement, glass, ceramics, chemicals and paper. Leakage would occur whether Congress chose the much talked about cap and trade approach to regulate carbon or a direct carbon tax.

At the Ways and Means subcommittee hearing John J. McMackin speaking on behalf of The Energy-Intensive Manufacturers’ Working Group on Greenhouse Gas Regulation outlined two possible approaches, “It is possible to divide the proposed solutions into two broad categories: cost mitigation at the plant level which includes grants of free allowances or tax credits, and import and/or export cost-equalizing provisions.” Cost mitigation would directly reduce costs “through free allowance grants, rebates of the cost of allowances, or tax credits to the manufacturer” while the second equalization approach would “impose comparable allowance requirements on imports or rebate a value-added type tax on exports.”

Imposing tariffs has been suggested by others. At a House hearing last month Energy Secretary Steven Chu said tariffs and other trade barriers could be used to offset U.S. industry costs for carbon policy if other countries don’t impose carbon regulations. Chinese government officials have already voiced concerns that such a policy would be an excuse to impose trade restrictions. The International Brotherhood of Electrical Engineers and American Electric Power have proposed a special international allowance obligation on energy intensive imports.

Also at the subcommittee hearing Joost Pauwelyn, Professor of International Law, Graduate Institute of International and Development Studies, Geneva, Switzerland, a former Professor of Law at Duke University who worked for the WTO, believes “WTO rules are flexible enough to deal with both carbon and job leakage.” The WTO could have a positive role by avoiding wasteful protectionism and discrimination that would not help the environment or preserve American jobs. Professor Pauwelyn said the best solution is an international agreement that limits emissions across countries and eliminates the need for border adjustments. If the U.S. used cost mitigation as a unilateral policy, he believes there are strong arguments that they would not be subsidies as defined by the WTO or may be covered under the safe haven for “green subsidies.” Border measures also would likely be allowed as long as they do not favor domestic products over imported one or imports from one country over products from another. The U.S. could also claim an environmental exception.

In preparation for the Ad Hoc Working Group session, the Secretariat of the United Nations Framework Convention on Climate Change (UNFCCC) prepared a 16-page “information note” to facilitate deliberations. Under a section on Increased Market Access for Environmentally Sound Goods and Technology one benefit noted would be stimulating demand for environmental goods and services from foreign suppliers and increased incomes for exporting companies. The benefits would only occur if there are no barriers to trade. If only domestic suppliers qualify for contracts, no benefits would be gained. “Technology spillover” is also explained as a benefit from trade and investment. “Technology leapfrogging” could also occur as newer participants in carbon reduction programs by-pass some of the intermediate steps others have taken earlier. Under Relocation of Industries it is noted that countries have tools available to address competitiveness and leakage concerns, including free allocation and border carbon adjustment.

Carbon policy adds another level of complexity to trade policy. Fifty years ago the issues were mostly how to deal with tariff amounts. Then market access limits with tariff rate quotas were added followed by sanitary and phyto-sanitary issues. Next came the era of worrying about how products are produced with labor and environmental standards. Carbon policy is the latest offshoot of those concerns.

At this stage of the policy process the biggest issue is can open trade survive these latest potential non-tariff barriers to trade? At the extreme, if complaints can be raised about every product presented for trade then trade benefits like using efficient suppliers and technology spillover and leapfrogging cannot occur. The policy becomes self-defeating rather than enabling. The comments by Professor Pauwelyn are encouraging that these concepts may fit within the existing WTO framework since negotiating a new WTO framework is not likely to happen.

Perhaps the starting point should be that all countries declare at the beginning of any negotiations on carbon policy that free trade is good and carbon reduction programs, whatever they may be, must encourage trade to achieve the benefits outlined in the UNFCCC information note. While countries can change their minds, and often do, at least it would put on notice the protectionists guarding narrow market niches that the negotiations are headed in a different direction.

Without that commitment to more open trade, the complexities of carbon regulation will likely overwhelm efforts to further economic efficiencies through freer trade. A better approach is to move toward freer trade and use other means, possibly the free transfer of the rights to use pollution control technology, to reduce the cost of adopting new technology. Trading away the economic benefits of freer trade for the hopes of reducing pollution is not the bargain it may look to be.

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