Beat trade protectionism and carbon emissions in a single stroke

Trade and climate are related in many ways. Trade can either increase or reduce emissions, depending on whether the traded goods have higher or lower carbon content. For instance, liberalising trade in solar panels or wind turbines could lead to emission reductions. But opening up trade in iron or steel made with coal-fired electricity can lead to an increase in emissions.

Trade policy also interacts with climate policy. Trade measures, such as restricting market access or setting product standards, can be important to achieve environmental goals. However, because they limit trade, such measures may be incompatible with the rules of the World Trade Organization (WTO). Though protectionist measures are generally not allowed under the WTO, trade rules offer important exceptions authorising measures that have a genuine environmental intent.

At the moment, countries seem to be imposing tariffs and counter-tariffs on an almost daily basis. The trade conflicts started with U.S. President Donald Trump’s announcement of tariffs on imports from various trading partners. These tariffs applied not only to the “usual suspect”, China, but also to traditional allies such as Canada and the European Union. In turn, these countries have retaliated tit-for-tat. The outcomes of these tariff increases will likely hurt producers and consumers everywhere. No one really “wins” a trade war.

Our proposal advocates responding to the U.S. tariff increases by targeting products with a high carbon content through a so-called “border carbon adjustment” (BCA). These BCAs could levy a carbon charge on imports, which could level the emissions playing field. Producers lose incentives to manufacture goods in places with less regulation. Trade partners gain incentives to export low-carbon products to avoid penalties.

This tactic would link the United States’ refusal to play by the multilateral rules on both climate change and trade. It would also offer an incentive for the United States to stop its dismantling of domestic climate policy because its exports would be affected.

The practical experience with BCAs has been very limited. While measures have been proposed in the European Union (as part of a revision of its emissions trading system) and the United States (as part of several cap-and-trade bills that came before Congress in 2008–2009), none of them has been adopted.

The limited practical experience we have with BCAs is in California, where electricity imported from neighbouring states is subject to the same carbon constraints that Californian electricity producers face. This policy has prevented a shift in production away from California.

On the basis of detailed past proposals and an analysis of the laws of the World Trade Organization (WTO), we give several suggestions for policy design.

First, set a limited scope. To reduce the administrative burden, but still target a significant share of emissions, BCAs should apply to a limited set of high-carbon products, such as steel, aluminium, and cement.

Second, fairly calculate direct and indirect emissions associated with the given imported goods. We suggest calculating the adjustment by referring to sectoral benchmarks, and by creating a way to exempt low-carbon producers from the targeted country. The adjustment level should reflect the difference in carbon constraints between the imposing and targeted countries.

Finally, create a fair and open process. Affected producers and countries need predictability and clarity. They need to be consulted in the development of BCAs.

The research team has long worked on the issue of “carbon leakage”, which refers to the relocation of investment or production from countries with stronger carbon constraints to countries with lower constraints. Policymakers have been worried that strong climate policies will lead energy-intensive industries to leave the country. Although the practical evidence for carbon leakage is mixed, some industries may be at risk.

The policy response to carbon leakage, however, has been unsatisfactory. Specifically, policymakers have responded by handing out emissions permits for free rather than by selling them. This created windfall profits for some polluters, and it muted the signal that a carbon price should and could send.

BCAs offer a tool that can help address carbon leakage. In effect, they impose carbon constraints on carbon-intensive imported goods, while not letting domestic producers off the hook.

Some have argued that the adjustments are incompatible with WTO law, because they discriminate between products on the basis of emissions from the production process of goods – that is, on the basis of so-called “embedded carbon”. Trade lawyers have discussed this issue for many years, but we argue that WTO jurisprudence offers us clear guidance for the design of a BCA. Specifically, we say that WTO law should not be seen as a constraint as long as countries imposing BCAs can show that they have a genuine intent to reduce emissions.

Countries have tended to refrain from adopting trade measures for climate purposes out of fear of retaliation by other countries. This is why we emphasize the importance of fairness and transparency in developing a BCA.

It is also why we argue that the measure is best adopted by a coalition of countries, rather than by any country or region alone. High-level policymakers and politicians in affected countries – including France, Mexico and Canada – have already indicated that the option of BCAs should be on the table as a possible response to U.S. tariff increases.

We think it is time for these countries to come together to discuss linking their response to the United States’ challenge of both trade and climate multilateralism.

But, to be clear, we are aware that BCAs are not a first-best policy instrument. Ideally, we see a convergence of global efforts to reduce emissions, resulting in a carbon price that is roughly similar for all countries. Until that day comes, this serves as a start.

Unfortunately, we do not live in a first-best world. Efforts to address climate change are likely to remain uneven in both their ambition levels and their implementation. In this imperfect context, BCAs can help level the playing field and spur more ambitious climate action.