Climate change policy briefly met trade policy at the two-week UN conference in Copenhagen on December 7-18. While trade policy was not responsible for the limited outcome of the conference, it cannot be ignored as countries prepare for the next climate change conference in Mexico City in November 2010.

The U.S. and other developed countries have considered “border measures,” import tariffs of some type, on energy-intensive products from countries that do not have climate change mitigation efforts to offset the costs of domestic climate programs. The U.S. House of Representatives’ climate change plan imposes in 2020 a tariff equal to the cost of emissions allowances on products from countries without similar programs. China and India led efforts at Copenhagen against all border measures calling them pretexts for trade protectionism. The U.S., EU and Australia resisted efforts to renounce all border measures in climate change programs.

The debate is not new. For several years “carbon leakage” from developed countries to developing ones caused by domestic carbon legislation has been discussed. Products like cement, steel and aluminum are energy-intensive products that will have higher production costs under most carbon reduction programs. As developing countries continue to industrialize, they are expected to produce virtually all the growth in emissions in coming years.

The Director-General of the WTO, Pascal Lamy, noted on December 21 that border measures were an issue at Copenhagen and WTO members are divided on them. In an early November speech Lamy recalled that when he spoke to Trade Ministers in 2007 his message was “climate first, and trade second.” His argument was that trading systems are designed to enhance human welfare, not reduce it. If climate change is the biggest issue of our time, which Lamy believes it is, then climate policy must be established first and WTO trade policy must take its direction from that policy. Part of the problem is that some countries do not attach the same sense of urgency to climate change as Director-General Lamy.

The WTO website has a Background Note: Trade and the Environment in the WTO that explains, “…protection and preservation of the environment are recognized as fundamental goals of the organization.” Two fundamental principles govern international trade policy: national treatment and the most favored nation (MFN).

  • National treatment means any policy measure taken by a member should apply in the same way whether the good is imported or produced domestically. Provided they are similar, products imports should not be treated less favorably than domestic goods.
  • The MFN principle means that any trade measure taken by a member should be applied in a non-discriminatory manner across all countries.

The border measures in the House climate change legislation would appear to fit those two broad principles. The import tariff would be the same price as the emissions allowances purchased by domestic producers. All importing countries would be treated the same by having a carbon program similar to the U.S. or paying a tariff at the cost of compliance in the U.S. The U.S. plan would fail this simple test if domestic emissions allowances are provided free to producers.

A recent working paper from the Peterson Institute for International Economics, Reconciling Climate Change and Trade Policy, concluded that if developed countries reduce emissions by 17 percent from the 2005 level by 2020 and do not have border measures, the carbon leakage would be only 1 percent compared to the baseline scenario. The competitiveness issue is much larger. Without border measures, energy-intensive industries in the U.S. would have a 12 percent decline in exports and a 4 percent decline in output. A border tax on the carbon content of the imported products would result in an average merchandize tariff over 20 percent for products from India and China and reduce manufacturing exports by 16-21 percent. With a tariff based on the carbon content of U.S. production, the tariff would be 6-8 percent and result in import declines of 4.6 percent.

Policy makers like Director-General Lamy who want the UN to take the lead on climate change urged the WTO and others to go slow until after Copenhagen. A comprehensive agreement could possibly have included a compromise on the border measures issue. Now the wait and see approach requires another year of waiting. The U.S. and maybe other countries will likely move ahead with climate change programs including border measures that may have barriers that limit developing country imports more than necessary to protect their competitiveness.

Even if the U.S. House plan is accepted by the Senate and signed by President Obama, the border measures will not take effect until 2020. Ten years allow for time to take policy actions or for markets to solve problems without policy interventions as technology transfer programs decrease the disparity in carbon emissions in key industries. Some of the go-slow advocates suggest a period of monitoring individual country actions to watch for problems. Trying to anticipate future problems may cause more uncertainty than dealing with actual problems.

Despite the valid calls for go slow approaches, policy makers should not ignore the real potential trade problems and just hope for the best. The best way for trade to improve the standards of living for consumers and producers is to have free trade. Politicians are capable of fashioning logical arguments for trade restrictions aimed at the greater good, like climate change policy, into protectionists trade policy that favor a few domestic producers at the cost of all consumers. That tendency is as likely to happen in developing countries as developed ones.

As WTO Director-General Lamy has said, trade policy is supposed to improve living standards, not block activity in related policy areas. Now is the time to keep free trade principles firmly in mind before the policy trading begins. Import restrictions do not just limit imports; they also limit exports. Climate change policy solutions should be created that do not cause negative trade policy outcomes.