Proposed U.S. policy to reduce the amount of carbon dioxide released into the atmosphere is pulling trade policy further into the carbon debate. The House bill passed in June includes beginning in 2020 a tariff equivalent to the price for emissions allowances under the cap and trade program for energy intensive products when less than 85 percent of the imports of those products are from countries with carbon control compliant programs. In early August ten Democratic Senators from manufacturing states in the Midwest and Northeast wrote to President Obama expressing their “strong support for the inclusion of a package of initiatives, including a border adjustment mechanism, to ensure the viability and effectiveness of any climate change policy crafted by Congress.”

Trade issues cannot be ignored in the debate about climate change. In 1950 trade accounted for 5.5 percent of world GDP; in 2007 it had increased to 27 percent. Developing countries accounted for 34 percent of merchandise trade in 2007.

International trade naturally allows for more efficient production of climate friendly goods. Not all countries have the research and development institutions to create these new goods. According to “Trade and Climate Change”, a report by the UN Environment Program and the WTO, 90 percent of what is now the environmental good and services industry is in about 30 developed countries. New government carbon mitigation policies will further accelerate developments in the industry. Markets in any one country are often not large enough to support economies of scale that drive down production costs. Smaller developing countries may particularly gain from the research work and economies of scale of production in developed and developing countries.

International trade is sometimes considered to be part of the carbon problem because it increases the release of carbon dioxide from transportation, but that is more than offset by the comparative advantage in production that decreases energy use per unit of output. That is the very same tradeoff made every day in production and consumption in domestic markets. While transportation costs would be minimized if all the products we use were produced within 100 miles of where we live, most of us would have only a few products to consume and they would be expensive because of the lack of economies of scale. The large cities that currently exist would not have developed without transportation of goods over long distances. Agricultural products like oranges and orange juice are produced in only a few U.S. states, but consumption occurs throughout the entire country. Growing oranges in greenhouses in North Dakota using local natural gas is not energy efficient compared to shipping them from Florida or California, or from Brazil.

Market prices need to reflect market conditions to efficiently utilize international trade to reduce carbon emissions. If transportation is subsidized, more trade will occur when the best outcome would have been more domestic production. Conversely, if government policies retard investments in transportation infrastructure local production will occur when the more efficient outcome would have been increased international trade. Agricultural production subsidies can also distort production decisions that influence the amount of goods moving in international trade.

How a border adjustment mechanism would be treated under current WTO rules is not clear. The UNEP-WTO report provides background on how the rules could be interpreted. The debate centers on whether imported goods are treated in an equivalent manner as like domestic products. Border adjustable taxes have a long history of debate within the WTO and its GATT predecessor. This debate will not be resolved before national governments actually pass legislation on carbon controls or there is some type of new international agreement on carbon reduction.

Franz Fischler, a former European Commissioner of Agriculture and member of the International Food and Agricultural Trade Policy Council (IPC), made some helpful suggestions in a May 2009 IPC policy brief. He noted that the UN Framework Convention on Climate Change states that actions related to climate change should not be simply disguised restrictions on international trade. Since current WTO rules may be flexible enough to deal with climate change rules, Fischler recommends that the Doha Round of talks should be rapidly concluded and aligning WTO rules should occur after a new international climate change agreement is concluded.

Fischler wrote that the WTO should consider a “peace clause” for a short time until understanding is clear on how countries will implement a new agreement and whether amendments to the WTO rules or the climate agreement are needed to harmonize the two sets of rules. Differentiating products based on their production and processing methods will need to be resolved. Calculating a life cycle analysis for a product will likely need to be standardized through some type of international standards setting body.

The U.S. is not alone in struggling with how to match up domestic carbon policies with the realities of the international marketplace. The EU, Japan, other developed countries and some of the more advanced developing counties must struggle with the same issues. These countries are major players in the debate on WTO policies in the Doha Round and will be among the influential participants in Copenhagen, Denmark in December when world leaders meet to work out an agreement to replace the Kyoto Protocol. The ministerial declaration for the Doha Round of WTO trade policy negotiations includes a paragraph on the relationship of WTO rules and obligations under multilateral environmental agreements.

Climate change and WTO discussions should be integrated based on the reality that international trade promotes economic growth, improves the standard of living of trade participants and leads to more efficient use of resources. Regardless of the carbon policies pursued by individual countries or an international agreement, trade is part of the solution. Once that framework is established, suggestions by Fischler and others can be used to establish interim and long-term policies.