International Economic Law and Policy Blog

Gary Horlick on Climate Change Measures and Trade

In testimony before the Senate Finance Committee, Gary Horlick raises a number of important issues related to climate change measures and trade:

Carbon Tariffs and Cap and Trade: The Devil is the Details

The Washington Post explains the details of the Waxman-Markey energy bill and argues that such tariffs are unnecessary:

... American firms that pay in order to comply with mandatory limits on carbon emissions would be at a disadvantage competing against foreign outfits whose leaders aren't as environmentally conscious.

But this measure is redundant. The bill already provides ample compensation to "trade-vulnerable industries" through at least 2026, devoting as much as a whopping 15 percent of allowances -- valuable pollution rights created under the bill's cap-and-trade regime -- to shelter firms from foreign competition.

The details of this rebate scheme leave ample room for overpayment. And because rebates are based on firms' historical output, argues Michael Levi of the Council on Foreign Relations, manufacturers might have even an incentive to scale back or close down and simply collect the cash. Better to head off these problems, Mr. Levi argues, by aiming to compensate U.S. firms for 75 percent of their compliance costs instead.

The tariffs, meanwhile, are meant to kick in if the rebates don't level the playing field enough. But they are questionably designed. The bill instructs regulators to apply tariffs to foreign exporters if the emissions per unit of their industrial sector back home are greater than that of the same sector in America. That makes no distinction between the carbon footprint of the goods countries export and those they consume domestically. More efficient exporters could get punished.

 

The FT on Carbon Tariffs

Here's an excellent, balanced look at the carbon tariff issue from the Financial Times.  A short excerpt:

Some trade lawyers point out that past WTO decisions have permitted governments to restrict trade in order to protect natural resources. But others say the case law is patchy, and it is hard to prove that such measures are being applied in a fair and consistent manner – a necessary condition for meeting WTO rules.

Carbon Tariffs "Are" WTO-Legal Versus Carbon Tariffs "Can Be" WTO-Legal

In a post entitled "Carbon tariffs — the legal aspects," Paul Krugman quotes Joost Pauwelyn as saying:

In sum, if carefully calibrated along the lines suggested above, carbon equalization measures at the border, imposed on certain imports, can be modeled in compliance with WTO non-discrimination rules and/or the WTO’s environmental exception.

Krugman then says:

So the economics are right; it’s WTO-legal; and it would neutralize a major political argument against controlling greenhouse gases. Why, oh, why, would Obama say “Ni”?

I think Krugman is overstating things when he draw the conclusion "it's WTO-legal" (that is, carbon tariffs are WTO-legal) from Joost's statement.  Joost was careful to say that such tariffs "can be" legal "if" designed in the right way.  Whether this condition will be met is far from clear.

China Does Not Like Carbon Tariffs

Reuters reports:

Proposals to impose "carbon tariffs" on imported products will violate the rules of the World Trade Organization as well as the spirit of the Kyoto Protocol, China's Ministry of Commerce said.

In a statement posted on its website, the ministry said collecting carbon duties from foreign products would enable developed countries to "protect trade in the name of protecting the environment."

"This will not help strengthen confidence that the international community can cooperate to handle the (economic) crisis, it also will not help any country's endeavors during the climate change negotiations, and China is strongly opposed to it," the statement said.

I looked for the statement on the Ministry of Commerce site, but could not find it.  What I wonder is the following:  Is China opposed to any and all carbon tariffs, or just those implemented in a way that imposes an unfair burden on foreign companies?  That is, if a WTO Member could write a carbon emission measure in a way that imposed equal costs on foreign and domestic companies (using tariffs for foreign companies), would China be OK with it?  Based on the quote above, my guess is they would not, but I wasn't completely sure.

Obama on Carbon Tariffs

From a NY Times interview:

Q. One of the provisions that got added very late to this bill that senators had expressed some reservations about was the one that puts tariffs on goods imported from countries that don't have these sort of restrictions. What do you think of that revision and would you like to see the Senate strip it out?

President Obama: At a time when the economy worldwide is still deep in recession and we've seen a significant drop in global trade, I think we have to be very careful about sending any protectionist signals out there. There were a number of provisions that were already in place, prior to this last provision you talked about, to provide transitional assistance to heavy manufacturers. A lot of the offsets were outdated to those industries. I think we're going to have to do a careful analysis to determine whether the prospects of tariffs are necessary, given all the other stuff that was done and had been negotiated on behalf of energy-intensive industries.

So certainly it is a legitimate concern on the part of American businesses that they are not disadvantaged vis-a-vis their global competitors. Now, keep in mind, European industries are looking at an even more ambitious approach than we are. And they obviously have confidence that they can compete internationally under a regime that controls carbons. I think the Chinese are starting to move in the direction of recognizing that the future requires them to take a clean energy approach. In fact, in some ways they're already ahead of us -- on fuel efficiency standards, for example, they've moved beyond where we've moved on this.

There are going to be a series of negotiations around this and I am very mindful of wanting to make sure that there's a level playing field internationally. I think there may be other ways of doing it than with a tariff approach.

The article accompanying the interview is entited, "Obama Opposes Trade Sanctions in Climate Bill."  The article begins as follows:  "President Obama on Sunday praised the energy bill passed by the House late last week as an “extraordinary first step,” but he spoke out against a provision that would impose trade penalties on countries that do not accept limits on global warming pollution." I suppose it depends on what specific actions the measure would take, but I'm not sure I agree with the language used.  Are the trade measures envisioned here "trade sanctions" or "trade penalties"?  If I were one of the proponents of this bill, I would try hard to characterize any charges on importers/imported products as simply a non-discriminatory imposition of the costs of the measure.  (Also, I would try to make sure the costs actually are non-discriminatory!)

ADDED:  Paul Krugman says something similar here:

It has long been accepted that a VAT is essentially a sales tax — a tax on consumers — which for administrative reasons is collected from producers. Because it’s essentially a tax on consumers, it’s legal, and also economically efficient, to collect it on imported goods as well as domestic production; it’s a matter of leveling the playing field, not protectionism.

And the same would be true of carbon tariffs.

 

Krugman on the WTO and Cap and Trade

Paul Krugman is happy with the recent WTO/UNEP report on trade and climate change:

There was some question about how the WTO would handle cap-and-trade — whether it would accept the need for carbon tariffs, if some countries (cough China cough) drag their feet, or whether it would adopt a purist free-trade rule. The answer seems to be in — the WTO is going to treat cap-and-trade the same way it treats VATs, with border taxes allowed if they can be seen as reducing distortions.

I suppose one way to define the "purist free-trade" position is that no import tariffs/charges of any sort are allowed.  So, in this sense, he is correct that accepting the need for carbon tariffs goes against the purist view.

Another way to think about the "purist free-trade" position, though, is to say that any such tariffs/charges must not be imposed in a discriminatory manner, that is, they must be equivalent to a domestic counterpart.  If that definition is used, than the WTO report is completely consistent with a "purist free-trade" stance.

Lowering the Costs of Cap and Trade

The Economist reports the following on the latest "cap and trade" proposals in the U.S.:

On May 15th Henry Waxman and Edward Markey, the Democratic point-men on climate change in the House of Representatives, unveiled a bill that would give away 85% of carbon permits for nothing, with only 15% being auctioned.

From a trade perspective, perhaps this is good news:  If the costs on domestic producers are going to be so low, it may not be necessary to impose carbon tariffs on imports to equalize the burden!

Tuna-Dolphin Update

A WTO panel was established on Monday in the new tuna-dolphin dispute (DS381).  During the meeting, the U.S. had this to say:

• Mr. Chairman, the United States is disappointed that Mexico has chosen to move forward with its request for panel establishment a second time.
  
  
• As we explained at the DSB meeting on March 20, the United States considers its dolphin-safe labeling regime central to the protection of the dolphin population in the Eastern Tropical Pacific ocean.  Furthermore, we are confident that the U.S. dolphin safe labeling measures that Mexico has challenged are consistent with U.S. WTO obligations.
  
  
• In addition, Mr. Chairman, we are very concerned that Mexico is proceeding with this request for another reason.  On March 24, 2009, the United States invoked Article 2005(4) of the North American Free Trade Agreement. 
  
  
• In that provision, the NAFTA parties agreed that certain disputes which pertain to matters arising under the WTO Agreement and the standards-related provisions of the NAFTA, and which concern human, animal or plant life or health or the environment and raise factual issues regarding the environment or conservation, would be heard – at the responding party’s option – solely under the NAFTA’s dispute settlement procedures.  This dispute meets the criteria set out in that NAFTA provision, and the United States has the right to have this dispute considered under the NAFTA. 
  
  
• We understand that a panel will be established today.  The United States deeply regrets Mexico’s decision to seek establishment of a WTO panel despite its prior agreement with the other NAFTA parties on a choice‑of‑forum provision in our free trade agreement, and our invocation of that provision.  We urge Mexico to reconsider its position.  We will also be considering our options moving forward.

[Second intervention:]

• Mr. Chairman, this meeting is perhaps not the best place to debate the meaning of NAFTA’s dispute settlement provisions.  However, in light of Mexico’s comments, it may be helpful to say that, at the time the NAFTA was negotiated, the NAFTA parties understood that disputes concerning standards-related measures for the protection of human, animal or plant life or health or the environment could arise under either the NAFTA or the WTO.  As a consequence, the NAFTA parties specifically included the NAFTA choice of forum provision to give the responding party the right to have such disputes heard before a NAFTA panel.
  
  
• We are very concerned that Mexico’s approach would mean that NAFTA Article 2005(4) would never apply.  That was certainly not the intention of the NAFTA parties, and it is a cause for serious concern.
  
  
• We appreciate Mexico’s acknowledgment that the international community may have an interest in this dispute.  We hope that we can count on Mexico’s cooperation in making sure that the proceedings in this dispute – whether in the WTO or under the NAFTA – are as transparent as possible, including by making submissions publicly available when filed and by opening the panel hearings to public observation.

The NAFTA provision they cite, Article 2005, states:

Article 2005: GATT Dispute Settlement

1. Subject to paragraphs 2, 3 and 4, disputes regarding any matter arising under both this Agreement and the General Agreement on Tariffs and Trade, any agreement negotiated thereunder, or any successor agreement (GATT), may be settled in either forum at the discretion of the complaining Party.

...

4. In any dispute referred to in paragraph 1 that arises under Section B of Chapter Seven (Sanitary and Phytosanitary Measures) or Chapter Nine (Standards-Related Measures):

(a) concerning a measure adopted or maintained by a Party to protect its human, animal or plant life or health, or to protect its environment, and

(b) that raises factual issues concerning the environment, health, safety or conservation, including directly related scientific matters,

where the responding Party requests in writing that the matter be considered under this Agreement, the complaining Party may, in respect of that matter, thereafter have recourse to dispute settlement procedures solely under this Agreement.

I'm going to have to think about this one a bit more before I have anything to say about it.  If anyone else has thoughts, though, USTR has requested comments on the case here.

On a somewhat related topic, although it will probably not come up in the case, blog reader Chad Bown points me to the following and notes, "who said Dolphins weren't for free trade?":

Thousands of dolphins block Somali pirates

Thousands of dolphins blocked the suspected Somali pirate ships when they were trying to attack Chinese merchant ships passing the Gulf of Aden, the China Radio International reported on Monday.

The Chinese merchant ships escorted by a China's fleet sailed on the Gulf of Aden when they met some suspected pirate ships. Thousands of dolphins suddenly leaped out of water between pirates and merchants when the pirate ships headed for the China's.

The suspected pirates ships stopped and then turned away. The pirates could only lament their littleness before the vast number of dolphins. The spectacular scene continued for a while.

 

Trade and the Environment and Subsidies

There's a lot going on in this story about subsidies to U.S. pulp producers.  I'm not sure exactly what all the trade implications are, but it's interesting enough that I'm going to talk about it anyway.  As explained in the article, the basic story is as follows:

... it has been common practice in the pulp sector for 30 years to use a 100-per-cent biofuel called black liquor — a by-product of pulping wood chips — for heat and energy. Now American companies are blending in a percentage of diesel fuel in with the black liquor to qualify for the subsidy.

...

The tax credit was originally passed by Congress in 2005. It was dubbed the Highway Act, as it was designed to reduce the use of fossil fuels and promote the use of alternative fuels in the transportation sector.

But a recent interpretation of the U.S. tax code printed in a September 2008 Internal Revenue Service bulletin opened to door to the use of black liquor. It stated alternative fuels only need to contain 0.1 per cent of a taxable fuel to qualify.

By adding a small percentage of diesel to their black liquor, pulp mills were able to demonstrate they had switched to a blend of fossil and alternative fuels. It didn’t matter that they had switched in the wrong direction. The lawmakers hadn’t considered that alternative. They got the tax break.

Basically, U.S. pulp producers had been using a kind of biofuel on their own accord.  Then along came legislation which offered a tax credit to companies who added alternative fuels to their fossil fuels.  The pulp producers didn't qualify for the credit based on their use of the biofuel.  However, by adding some diesel fuel to the mix, they qualified for the credit in reverse -- they added fossil fuels to their alternative fuels!  

Here's the trade part.  Foreign pulp producers are upset about the subsidy their U.S. counterparts are now getting:

The Canadian government is attempting to convince the U.S. administration to change the policy and several European governments are considering taking the issue to the World Trade Organization.

They have a point.  However, it seems to me that it may be tough for them to achieve a good outcome here.  They may be able to convince the U.S. government that the policy of rewarding companies when they use less alternative fuel makes no sense.  On the other hand, if the subsidy is taken away from the pulp producers, you end up with a policy that rewards (with subsidies) companies who were polluting a lot but improved a bit, whereas companies who were polluting very little, on their own accord, get no subsidies.  It's not clear that is a good approach either.  The end result of all this may very well be that the law is changed so that pulp producers still get their subsidies, but they get them without having to add diesel.  If that happens, then we may get to a more traditional trade and the environment question:  Do subsidies to promote a cleaner environment violate trade rules?

Rachel Brewster on Carbon Tariffs

She thinks they are likely to be unfair:

... if the United States decides to apply a carbon tariff, then it must decide how much carbon it gets to produce compared with other countries. The Boxer-Lieberman-Warner bill, for example, determines whether another country's environmental regulation is comparable to the US (and thus exempt from a carbon tariff).

The bill establishes a dividing principle that freezes everyone at their current share of greenhouse-gas emissions and requires that countries reduce emissions from these levels. Under this standard, the US, which represents less than 5 percent of the world's population, is allocated over 18 percent of the world's greenhouse-gas production.

The problem for the planet's atmosphere is that other countries can do the same thing but based on different dividing principles. China could apply carbon tariffs to any country that has a higher per capita level of greenhouse-gas emissions than it does. (This would include the US, Canada, and the European Union.) India could adopt a formula that gives nations that have already contributed significantly to the current stock of greenhouse gases fewer emissions rights in the future.

This series of conflicting national level environmental measures is bad for the environment and bad for the global economy. ...

More here.

I think she is right to identify this as an inherent problem with unilateral cap-and-trade plans.  Both an international cap-and-trade agreement or a unilateral carbon consumption tax seem better in this regard.

Ron Kirk on Trade and Climate Change

USTR Ron Kirk talks about trade and climate change:

I would like to emphasize the Administration's view that global climate change is a priority and
that our response includes asserting U.S. leadership to establish a domestic cap-and-trade system and put us on a trajectory to gradually reduce our carbon emissions. I share the views of Special Envoy Todd Stem, our lead climate negotiator, that by transforming ourselves to a low-carbon economy, we can stimulate global economic growth and put our workers, farmers and manufacturers at the forefront of the global economy. Having said that, I acknowledge some of the concerns of certain U.S. manufacturers, particularly in those sectors that are energy and trade intensive, that increased costs associated with carbon reductions could lead to competitive disadvantages vis a vis producers in countries that do not take action to reduce their carbon emissions. This phenomenon is directly relevant to concerns with "carbon leakage" because any shifting of production to other countries could lead to the unintended effect of only limited or zero net decreases in global carbon emissions associated with that production. Climate change is a global environmental challenge and we want to ensure that the U.S. response is not weakened by the failure of other countries to take action. I understand that Energy Secretary Chu's comments during his hearing reflected such concerns.

The Administration believes that the best approach to address concerns with carbon leakage is to
negotiate a new international climate change agreement in the United Nations that ensures that
all the major emitters take long term, significant action to reduce their greenhouse gas emissions.
VVe look forward to working with these countries to negotiate a meaningful global climate
agreement and actively avoiding circumstances in which we are simply exporting carbon
emissions abroad.

...

The Administration is seeking to address many of the issues you raised in your letter, particularly
in ensuring that the design and implementation of domestic energy and climate policy are
compatible with our international trade obligations and minimize incentives for our trading
partners to pursue counter measures that could negatively impact U.S. exports. Our
consideration of the necessity of, and options for, addressing carbon leakage will include how
potential measures might be targeted towards the circumstances of energy and trade intensive
industries. The Administration, however, does not support any specific measures, including
border measures, at this time. As we move forward in our engagement with Congress on the
design of domestic climate change policy, we will evaluate the various options to address carbon
leakage under consideration on Capitol Hill.

Cap and Trade: Coming Soon in the U.S.?

Via Ben Muse, I see this Reuters summary of the trade aspects of the U.S. House draft carbon legislation:

INDUSTRY REBATES/TRADE

Authorizes U.S. companies in industries that use a lot of energy to receive "rebates" to compensate for additional costs of cap and trade. If rebates are not sufficient, the president would have the power to establish a "border adjustment" program, possibly tariffs on goods from countries that do not take action on cutting greenhouse gases.

Hopefully there is a large team of trade lawyers somewhere trying to keep all this consistent with WTO rules!

ADDED:  More details at the Huffington Post:

Preserving domestic competiveness. The draft adopts the Inslee-Doyle proposal for transitional rebates to certain energy-intensive manufacturing facilities making basic commodity products that are subject to strong international competition. The goal is to counter pressures to shift production, jobs, and emissions to countries that do not have carbon emission reduction programs. Rebates cover both direct and indirect (e.g., electricity-related) emissions and are based on a formula based on an industry benchmark emission rate and facility-specific output data.

International reserve allowances. A second provision addresses international competition concerns. Not later than 2017, the President is to report to Congress on the impact of the "Inslee-Doyle" program on specified energy-intensive. If negative impacts are found on these industries, then starting in 2019 U.S. importers of competing products must purchase special allowances to cover the emissions associated with their imports. Products from least developed countries and countries responsible for less than a half percent of world GHG emissions are exempted.

 

Trade versus the Environment: Shipping Pollution

The EPA is proposing regulations to control emissions from large ships:

The United States took a critical step towards protecting Americans from harmful ship emissions by becoming the first country to ask the International Maritime Organization to create an emissions control area (ECA) around the nation’s coastline, the EPA announced today at a joint news conference with the Coast Guard and New Jersey elected officials.

According to the EPA’s data, the creation of an ECA would save up to 8,300 American and Canadian lives every year by 2020 by imposing stricter standards on oil tankers and other large ships that spew harmful emissions into the air near coastal communities where tens of millions of Americans live, work, play and learn. The United States is proposing a 230-mile buffer zone around the nation’s coastline in order to provide air quality benefits as far inland as Kansas.

...

Under this program, large ships such as oil tankers and cargo ships that operate in ECAs will face stricter emissions standards designed to reduce the threat they pose to human health and the environment. These standards will cut sulfur in fuel by 98 percent, particulate matter emissions by 85 percent, and nitrogen oxide emissions by 80 percent from the current global requirements.

To achieve these reductions, ships must use fuel with no more than 1,000 parts per million sulfur beginning in 2015, and new ships must used advanced emission control technologies beginning in 2016.

According to one article, the old rules were not working very well, in part because they did not regulate non-U.S. ships:

The announcement comes a week after the EPA's inspector general issued a report concluding emission regulations for large vessels haven't protected human health. The report concludes the EPA has only moved to regulate nitrogen oxides from U.S.-flagged ships, but hasn't taken a position on foreign-flagged vessels, which produce 90% of the emissions in U.S. ports.

I didn't see anything in the news reports on this story regarding how foreign shippers feel about all this, but it certainly has the potential for some trade conflict.

(As a side note, the reference to places where people "live, work, play and learn" is an interesting variation on the Appellate Body's famous statement in Hormones about "the real world where people live and work and die"!)

Trade and Climate Change Advice from Jim Bacchus

In Forbes.  First, there's this:

Those who assume that WTO rulings will be "anti-environment" have evidently not read previous rulings, or not realized their positive implications for global environmental protection.

I think that's right.  It is no longer a GATT Tuna/Dolphin world (and hopefully the new WTO Tuna/Dolphin case will prove it).

Then we get to the more complicated part, how to design climate change legislation consistently with WTO rules:

... any unilateral U.S. actions on climate change that included trade restrictions would unquestionably be challenged by one or more of our trading partners in the WTO. So it makes sense also to craft legislation in ways that would survive scrutiny in WTO dispute settlement.

For example, the additional carbon price imposed on domestic products can be imposed also under WTO law on like imported products as an offsetting "border tax adjustment." But any such adjustment will be legal under the WTO only if imposed on products, and not on producers.

Likewise, any discrimination in the legislation will run afoul of WTO law if it discriminates in favor of domestic producers over foreign producers of like products, or if it discriminates in favor of some foreign producers of like products over others.

Furthermore, tax rebates on exported products, emission allowances, and other contributions by government to assist domestic industries affected by new carbon restrictions will need to comply with WTO rules on subsidies.

ADDED:  I should clarify the part about the new Tuna/Dolphin case.  I haven't looked at the facts and law closely enough to decide what I think the outcome of the case should be.  So when I talk about my hope for the case, what I mean is that I hope the panel's findings convince all sides that their views have been taken seriously.

Obama and Lula on Trade in Biofuels

From their recent joint press conference:

Question:  President Lula said that during their meeting they talked about energy, President Obama talked about a possible partnership for energy within the hemisphere. The question I have is can't this partnership get off-balance? Because there's a lot of interest in the future of Brazilian oil. Brazilians do not understand today how come that a fuel -- that a clean fuel that is renewable fuel can't reach U.S. market because of duties, whereas the same product, essential clean fuel in the United States gets incentives. Where would be the balance between these two issues?

PRESIDENT OBAMA: Is that directed at me? Well, look, I think Brazil has shown extraordinary leadership when it comes to biofuels. And I've been a great admirer of the steps that have been taken by President Lula's government in pursuing biofuels and developing them. And this is an investment that Brazil has made for a very long time.

My policies coming into this administration have been to redouble efforts here in the United States to pursue a similar path of clean energy development. And I think we have a lot to learn from Brazil.

As I mentioned to President Lula, I think we have the potential to exchange ideas, technology to build on the biodiesel cooperation structure that we've already established. I know that the issue of Brazilian ethanol coming into the United States has been a source of tension between the two countries. It's not going to change overnight, but I do think that as we continue to build exchanges of ideas, commerce, trade around the issue of biodiesel, that over time this source of tension can get resolved.

PRESIDENT LULA: This is the very first meeting that we have between the Brazilian administration and President Obama's administration to discuss this issue. Actually, my answer is built in your question. I can't also understand while the world is concerned with climate change and with carbon emissions that bring greenhouse effect, (inaudible) fuel gets tariffs, and clean fuel also gets tariffs. I have discussed this with Angela Merkel, with Tony Blair when he was Prime Minister, with President of France, Sarkozy, with former President Bush.

I never expect an immediate answer. This is a process. As time goes by, Brazil is proving that biofuel is an extraordinary alternative. And slowly the countries will be convinced. And slowly other countries will join the biofuel effort. That's what I believe.

A seminar will be held in New York City on Monday, where I will attend, and this will be a strong issue that will be discussed there. I talked with President Obama about the possibility for us to build partnerships with third-party countries, especially a joint project with the African continent. And things will move forward as people start changing. No one can change overnight, in terms of their energy matrix. Thank God for 30 years Brazil has already control -- technological control and know-how on this issue.

And when President Obama comes to visit Brazil I'm going to ask him to get inside a car that is run by a flex-fuel engine and he will feel very comfortable.

A Trade and Environment Success Story

Not all trade and the environment conflicts result in protests outside the WTO.  The Economist reports on one success story:

UNTIL recently, the glaze on most Mexican pottery contained lead. ... . [As a result,] products were banned from the American market, where their hand-painted beauty could fetch much higher prices than in rural Mexico, where the pots were merely a practicality.

Over the past 15 years the lead has gradually disappeared, thanks to the efforts of Fonart, a government entity that promotes handicrafts, and various NGOs. Researchers sponsored by them came up with a non-toxic, low-temperature glaze based on boron. They also encouraged potters to install fans costing just $40 in their kilns so that combustion became more efficient. Thanks to these changes, some Mexican potters who used to make less than $1,000 a year are now earning up to $40,000 by exporting to the United States and Europe, says Eric O’Leary, an American potter who has worked with Fonart.

Jeffrey Frankel on Trade and Climate Change

From the conclusions of a paper entitled "Environmental Effects of International Trade" by Jeffrey Frankel of the Kennedy School:

Concluding recommendations regarding trade penalties in climate legislation

The central message of this section of the report is that border measures to address leakage need not necessarily violate the WTO or sensible trade principles, but that there is a very great danger in practice that they will.

I conclude with some subjective judgments as to some principles that could guide a country’s border measures if its goal were indeed to reduce leakage and avoid artificially tilting the playing field toward carbon-intensive imports of non-participating countries. I classify characteristics of possible border measures into two categories, which I will name by color (for lack of better labels):

(1) the “Black” category: those that seem to me very dangerous, in that they are likely to become an excuse for protectionism; and

(2) the “White” category: those that seem to me reasonable and appropriate.

The Black (inappropriate) border measures include:

• Unilateral measures applied by countries that are not participating in the Kyoto Protocol or its successors.
• Judgments as to findings of fact that are made by politicians, vulnerable to political pressure from interest groups for special protection.
• Unilateral measures that seek to sanction an entire country, rather than targeting narrowly defined energy-intensive sectors.
• Import barriers against products that are further removed from the carbon-intensive activity, such as firms that use inputs that are produced in an energy-intensive process.
• Subsidies – whether in the form of money or extra permit allocations -- to domestic sectors that are considered to have been put at a competitive disadvantage.

The White (appropriate) border measures could be either tariffs or (equivalently) a requirement for importers to surrender tradable permits. The principles include:

• Measures should follow some multilaterally-agreed set of guidelines among countries participating in the emission targets of the Kyoto Protocol and/or its successors.
• Judgments as to findings of fact -- what countries are complying or not, what industries are involved and what is their carbon content, what countries are entitled to respond with border measures, or the nature of the response – should be made by independent panels of experts.
• Measures should only [be] applied by countries that are reducing their emissions in line with the Kyoto Protocol and/or its successors, against countries that are not, either due to refusal to join or to failure to comply.
• Import penalties should target fossil fuels, and a few of the most energy-intensive major industries: aluminum, cement, steel, paper, glass, and perhaps iron and chemicals.

If countries follow these guidelines in enacting border penalties, they may be consistent with the avowed goals of preventing leakage and undue loss of competitiveness and are unlikely to fall afoul of the WTO. If they do not follow these guidelines – the more likely outcome – they can be inconsistent with these goals, and with the WTO as well.

Unfortunately, I think he may be right about the way things will operate in practice.

More on Carbon Emissions and Trade

As a result of my post the other day on the carbon tax proposal by Congressman Inglis and Arthur Laffer, I received a call from Congressman Inglis' office, inviting the media, which to my surprise apparently includes me, to join a conference call hosted by Inglis and Laffer, where they would talk about their proposal and take questions.  I had never done one of these before and it sounded like fun, so I joined in.

My question for them was, how exactly would they structure this carbon tax?  In my view, the structure is key for making such a tax consistent with trade rules, so I was curious to see what they had in mind.

Dr. Laffer was thinking of a pure gas tax. If this just means increasing the rate of the current federal gax tax, such a measure is, in my view, unlikely to be a problem under WTO rules.

By contrast, Congressman Inglis wanted a dual approach -- a gas tax to keep gas above $3 or so per gallon, as well as a carbon tax of some sort.  The Congressman has prepared a document which elaborates a bit on both aspects (it's not linkable for now, but it should be on his web site soon).  He explains that there will be a "price" on carbon (if I understand correctly, either through a direct tax or through a cap-and-trade program).  In addition, the tax "would apply to fossil fuels as they enter the economy: at the mine mouth, the oil refinery and the natural gas pipeline."  Then, to prevent carbon leakage, there will be a border tax applied to imports: "In order to accord similar tax treatments to domestic and imported goods, products imported from countries without carbon constraints would be subjected to the U.S. carbon tax. The tax would be applied at the U.S. port of entry."

I worry about this approach.  It seems to me it would be difficult to set this up in a way that treats imports and domestic products equally, not to mention treating imports from different countries equally.  Just trying to do the calculations so that everyone is equal is hard enough, but then when you have domestic industry lobbying on the issue as well, the task may be too much.

At the risk of being too bold and weighing in on issues I don't know enough about, I thought I might offer a suggestion for how I think a carbon tax might be designed so as to reduce carbon emissions in a way that does not violate trade rules.  Mind you, this will be a very brief description, leaving out a A LOT of important details (it's just a blog post, after all).  And it no doubt ignores many political realities.  But maybe it can provide a useful framework (or at least an interesting discussion).  So, without further ado, here's my two-step proposal.

Step 1 would be to require labeling of all products sold in the United States to indicate the carbon emissions that result from their production and distribution.   (Other countries have already suggested doing this, for some products at least.)  There would be as little differentiation between imported and domestic products as possible here.  There may be a couple implementation areas for which you would need different rules, but for the most part it would just be a labeling requirement that applies to all products.

Once Step 1 has been successfully implemented (which could take a little while, I admit), you could then move to Step 2, which is to impose taxes on these goods in relation to their carbon content.  If Step 1 goes well, Step 2 really won't be that difficult.  It's just a question of setting the appropriate tax rates.

There is no getting around the fact that this will be enormously complicated to set up.  But is it any more difficult than the alternatives?  Cap-and-trade sounds much harder to me.

And in terms of trade concerns, I think this approach would be much less of a problem than the alternatives.

Any thoughts?  What are the advantages and disadvantages of this idea as compared to the alternatives?

More on Carbon Taxes

Somewhat related to yesterday's post on using consumption taxes to fight carbon emissions, Congressman Bob Inglis and economist Arthur Laffer argue in the NY Times for a carbon tax that is offset by income tax cuts.  In doing so, they say:

The United States can’t solve climate change alone. The Kyoto climate treaty was rightly rejected by the Senate because China and India weren’t subject to its provisions. If China and India join the United States in attaching a price to carbon, their goods should come into this country without a carbon adjustment. But if they do not, every item they place on our shelves should be subject to the same carbon tax that we would place on our domestically produced goods, again offset by a revenue-neutral tax cut.

If World Trade Organization rules entitle members to an unwarranted exemption from such a carbon tax, then we should change them.

I wasn't sure exactly what they meant by this last statement.  I think their concern is that under WTO rules, a carbon tax would have to be imposed only on domestic products, and not on imported goods.  That seems wrong to me as a matter of WTO law.  At least in theory, you should be able to impose a carbon tax on all products sold domestically, including both imports and domestically produced goods.  In practice, of course, such a law might be written in a way that violates WTO rules, by adding various discriminatory elements, for example.  So, my advice to the authors is, don't worry about WTO rules preventing the use of a carbon tax.  Instead, worry about writing the law in a neutral, non-discriminatory way.

Trade and Carbon Emissions: Consumption versus Production Models

How can we effectively fight carbon emissions, while at the same time limiting trade conflicts that result from such measures?  Geoff Carmody explains that the answer is to focus on consumption rather than production:

But an emissions production model only works if all nations sign on at the same time. History tells us they won’t. The EU has tried to get acceptance of this model for a long time and has failed.

Why? When nations act at different times or to different degrees, production models undermine trade competitiveness of early movers compared with others. This causes concern about “carbon leakage”, job losses, and little or no net reduction in global emissions. Nations won’t sign, or want “carve outs”.

So the production approach has a fundamental flaw.  If every country signed on to a similar model, it might work.  But they won't, so it won't.  By contrast, with a consumption model:

A consumption model is trade competitiveness-neutral. Imports are priced the same as domestically produced substitutes. Exports are affected when received as imports. National concerns about “carbon leakage” and job losses are eliminated. National efforts in reducing emissions count as net contributions to lower global emissions. Emissions are not “exported”. Nations can act unilaterally.

Because it is trade-competitiveness neutral, the consumption model is an international “confidence building” approach. This is important when the current international financial crisis threatens more trade protectionism while attempts are being made to revive the Doha Round.

...

A consumption model (i) is better in principle; (ii) is practical; (iii) is WTO-compliant; (iv) is more likely to secure a global deal; (v) has lower welfare losses than a production model; and (vi) while delivery via a carbon tax is better than an ETS (especially for investment certainty), either could do the job.

It's no contest, right?  Focus on carbon consumption, not production, and you will get more effective policies and fewer trade conflicts.  Unfortunately, the perception is that consumption models are much harder to sell to the public.  This may be true, but I wish more people would try to push them anyway. 

Trade Versus the Environment: More on Biofuels PPMs

Updating this old post, there has apparently now been a threat of a WTO complaint against proposed EU biofuel restrictions.  Here are the restrictions:

[The EU] intends to introduce new restrictions defining what type of land is suitable for creating biofuels. If the plans were to go ahead, fuels coming from what Brussels deems to be ecologically unsound sources would not be purchased by EU member states.

Here's the trade problem:

Argentina, Brazil, Colombia, Malawi, Mozambique, Sierra Leone, Indonesia and Malaysia have written a letter of complaint to the EU, criticising these new proposals, and threatening action unless Brussels reconsiders:

“They impose unjustifiably complex requirements on producers,” said the draft letter, which was obtained by the news agency Reuters. “Some of our countries don't exclude the possibility of defending their rights in the World Trade Organisation, as a last resort.”

The biofuel producers say that this legislation amounts to a double standard. European nations have already expanded into their wild areas so as to improve their overall quality of life, so Europeans have no right to stop other countries from doing the same, they argue:

“Provisions relating to land-use change will impinge disproportionately on developing countries, where there are stocks of undeveloped arable land which can be used for biofuels production,” the letter said.

That's some very diplomatic language.  First of all, it is worth noting that only "some" of the listed countries would pursue a complaint.  In addition, they "don't exclude the possibility" of a WTO complaint, and even then it's only a "last resort."   This suggests to me that a complaint is not all that likely.  On the other hand, if the EU goes ahead with the restrictions without making any concessions, a complaint may be the only option.  It would make for some very interesting legal interpreations, that's for sure.

When I read about issues like this, the question I always ask is, who was behind this measure?  Here, the two likely candidates are:  (1) environmentalists who worry about destroying the environment in developing countries and (2) domestic biofuel industry folks who want to keep out foreign competitors.  How much of a role did each one play?  To me, this is a crucial issue.  Unfortunately, I can never find out the answer to these kinds of questions.

 

Doha negotiation on Fisheries Subsidies

On 30 November 2007, Chairman of the WTO Negotiating Group on Rules issued Draft Consolidated Chair Texts of the AD and SCM Agreements (TN/RL/W/213), which contained Annex VIII to the SCM Agreement on Fisheries Subsidies. Annex VIII provides a wide range of prohibited fisheries subsidies that contribute to overcapacity and overfishing, including, inter alia, (1) subsidies conferred on the acquisition, construction, repair, renewal, renovation, modernization of fishing vessels, (2) subsidies conferred on operating costs of fishing including fuel, (3) subsidies in respect of port infrastructure, (4) income support to fishermen, and (5) price support for fisheries products (Art.I). On the other hand, it provides a limited number of exceptions, including (1) subsidies for improving fishing vessel and crew safety, (2) subsidies for the adoption of environmentally friendly technologies and equipments, (3) subsidies for early retirement of fishworkers as a result of government policies to reduce fishing capacity or effort (Art.II), on condition that any member maintaining such subsidies shall operate a fisheries management system within its jurisdiction based on internationally recognized best practices for fisheries management (Art.V).

The Annex thus introduces new disciplines on fisheries subsidies aiming at addressing overcapacity and overfishing, and connects them with internationally recognized fisheries management practices. This is totally different from the disciplines on subsidies under the SCM Agreement, whose aims at addressing trade-distorting subsidies. If adopted, the Annex will open a new page in the history of trade and environment under the GATT/WTO by introducing direct disciplines on overcapacity and overfishing. Also, it will require close cooperation with relevant international organizations such as FAO and regional fisheries organizations. This will provide both opportunities and challenges for the WTO. For instance, will WTO dispute settlement panels be able to decide on the adequacy of fisheries management system of a member country?   

It was announced that a follow-up negotiation on the Annex VIII would be held in early September this year. I'm not sure whether it was held, but am thiking of followin up the negotiation.

 

Peter Mandelson on Carbon Taxes

From a speech by Peter Mandelson:

The elephant in the room when we talk about trade incentives for the right climate policy is of course the idea of a carbon border tax. This is intended to punish free-riders who don't sign up to a global climate deal and who therefore don't bear the competitiveness costs of paying for the carbon they emit. In the jargon they benefit from 'carbon leakage' – carbon that is used without being paid for. The Commission recognised the potential risks of free riding in its January package - in particular in relation to energy intensive industries.

Clearly the best way to stop carbon 'leaking' out of a global regulatory system is to make sure that nobody stays outside of the system. That is why the Commission's priority has always been a comprehensive international climate agreement that has no free-riders.

There are also numerous potential complications with a carbon tax. Border measures may provide some relief to energy intensive industries, but there would be pitfalls and negative side effects for other sectors and consumers. Measures would be extremely difficult to administer and enforce. Input prices for industry would rise, which would in turn push up prices of European exports and reduce competiveness.

Border measures could also invite retaliation and provoke a negative spiral of protectionism, under the pretext of environmental protection. Quite aside from the fact that it is technically difficult to design a measure that is WTO compatible.

Most importantly, we cannot really address the problem of free-riding until we know the extent of it. So first we must be sure we have done everything we can to secure a globally inclusive climate change package for the post-2012 period, with all the key players inside.

It is clear that the problem and the debate on carbon leakage won't go away. But right now we should be focusing on building a global coalition for a new global climate treaty. Tough talk on a climate tax will only alienate the very partners we need to get on board. I think the Commission's action reflects this reality.

(emphasis added)  There's a lot in here, but I wanted to focus on the WTO compatibility issue.  Maybe I'm being naive, but I'm not convinced it's that hard to design a WTO compatible carbon tax.  Here's one thought in this regard.  First, set up a labeling system, under which the amount of carbon emissions is identified for each product.  Then, put together a related tax regime, with higher taxes on products with higher carbon emission.  I think this could possibly be consistent with GATT Article III, but even if not, could be justifed by Article XX(g).

Granted, the labeling part would not be easy, but I think it could be done.  From what I gather, various private and public entities are already trying it in some areas.

Am I missing anything here, in terms of the legal issues?  Is this less likely to be consistent with WTO rules than I am suggesting?

On the other hand, maybe he is not referring to the legal design by itself, but rather the political task of coming up with a carbon tax that all the relevant players can agree to.  That might be difficult.

GSP and Climate Change

In the latest issue of the JIEL, Michael McKenzie discusses the interaction of climate change and the Generalized System of Preferences (GSP).  He notes two ways that preferences could help fight climate change:

The first way that preferential tariff treatment under a GSP scheme could be tied to the issue of climate change, is to make preferences under the scheme conditional upon a developing country taking certain actions to mitigate and/ or adapt to climate change.

...

The second way that preferential tariff treatment under a GSP scheme could be tied to the issue of climate change, is for developed countries to provide preferential tariff treatment to low carbon goods and services originating in developing countries.  The aim would be to encourage the production of low carbon goods and services in developing countries.

The first option is something I've heard of before with GSP programs:  Give tariff preferences to countries who adopt particular policies or take certain actions.  By contrast, the second is something I have not come across:  Tariff preferences are granted only where the products at issue are made in a certain way.  I suppose this is the intersection (or perhaps "collision" is a better term) of GSP and PPMs.  This may have been tried before, but it's the first I've heard of it.

He concludes:

Despite presenting a number of legal and practical challenges, it is an approach that has significant potential and merits further consideration by trade and climate change policymakers in developed countries.

Taxing Big Engine Cars

I'm sure many of you remember the U.S. - Auto Taxes GATT dispute.  There were several U.S. measures at issue, one of which was a "gas guzzler" tax.  Car manufacturers were required to pay taxes on their automobiles based on the fuel efficiency, with higher taxes for less fuel efficient vehicles.  The EC claimed that because most automobiles subject to the tax were of EC origin, with very few of these of U.S. origin, "treatment under the measure was discriminatory."  Examining this claim under Article III:2, first sentence, the Panel used the "aim and effect" test to conclude that there was no violation.  (And no violation of Article III:2, second sentence either.) (See paras. 5.17-38)

Of course, in Japan - Alcohol, the Appellate Body abandoned the aim and effect test in the context of Article III:2, first sentence.  (While using some version of the test under Article III:2, second sentence.)  So how would Article III:2, first sentence be applied to this kind of measure today?   It's possible that we could find out.  The Economist reports that China has adopted its own version of the gas guzzler tax:

On August 13th the government announced a new “green” tax that will come into effect on September 1st. The new tax is meant to reduce fuel consumption and fight pollution. Rather than further raising the tax on fuel, which increased by almost 20% in June, the government is taxing gas-guzzling cars. By an amazing coincidence, most such cars are foreign-made.

Cars with engine capacities larger than 4.1 litres will now incur a 40% sales tax—twice the previous level. Cars with engines between 3 and 4.1 litres will be taxed at 25%, up from 15%. The tax on the smallest cars, with engines smaller than 1 litre, will fall from 3% to 1%. The 8% and 10% taxes on other cars will not change.

The government says the new tax will encourage a shift to more fuel-efficient cars. It will also help Chinese carmakers, as they tend to make cars with engines smaller than 2.5 litres. Foreign carmakers, which make most of the cars with larger engines, will suffer.

This would be a great case for helping to clarify the GATT's non-discrimination rules.   In particular, it could help answer the question of what role, if any, does an environmental purpose behind a measure play in the Article III:2, first sentence context; and what is the precise role of a discriminatory effect against foreign products.  (The same issues also arise under Article III:2, second sentence, although the answers are much clearer there).  And if a violation were found, we would then get into interesting issues under Article XX(g) and the chapeau.

Somewhat surprisingly, the Economist concludes the piece by saying that this measure, in contrast to the current Chinese auto tax measures being disputed at the WTO, "prevents any more pesky calls from Geneva."  I wonder if they are right about that.  There are certainly legal claims that can be made, although the chances of success are not entirely clear.  On the other hand, the most likely complainants, the EC and the U.S., may be reluctant to start a new trade/environment dispute right now.

Carbon Labels

I love labeling as a solution to many trade-environment conflicts.  I think it can be done in a way that is consistent with trade rules, and can also have a positive impact on environmental problems.  So I was happy to read this piece in the Guardian:

Japan is to carry carbon footprint labels on food packaging and other products in an ambitious scheme to persuade companies and consumers to reduce their greenhouse gas emissions.

The labels, to appear on dozens of items including food and drink, detergents and electrical appliances from next spring, will go further than similar labels already in use elsewhere.

They will provide detailed breakdowns of each product's carbon footprint under a government-approved calculation and labeling system now being discussed by the trade ministry and around 30 firms.

The labels will show how much carbon dioxide is emitted during the manufacture, distribution and disposal of each product, the ministry said.

It is possible that I'm overestimating the benefits to the environment, and underestimating the extent to which labeling might lead to trade conflicts.  But I'm happy to see it tried nonetheless, to see where it leads.

Domestic Tap Water Versus Imported Bottled Water

From AFP:

A debate over water is boiling over in the United States and elsewhere amid growing environmental concerns about bottled water and questions about safety of tap water.

The US Conference of Mayors in June passed a resolution calling for a phasing out of bottled water by municipalities and promotion of the importance of public water supplies.

While largely symbolic, the vote highlighted a growing movement opposing regular use of bottled water because of its plastic waste and energy costs to transport drinking supplies.

...

The Pacific Institute, a California think thank on sustainability issues, contends that producing bottles for US water consumption required the equivalent of more than 17 million barrels of oil in 2006, not including the energy for transportation.

The group says bottling water for Americans produces more than 2.5 million tons of carbon dioxide and consumes three liters of water for each liter of bottled water produced.

I assume that public (tap) water supplies are almost exclusively of domestic origin (probably a safe assumption, although I suppose there could be some exceptions in border areas).  By contrast, bottled water is sometimes imported (I'm not sure what the percentages are, and they probably vary by country).  So, would government action to promote public water over bottled water violate GATT Article III:4, by favoring domestic products over imported ones?  A key question:  Is bottled water "like" tap water?  It is probably "substitutable" to some extent, but "like" may be a harder question.

This is all putting aside the Article XX issues, of course.

Obama on Ethanol Tariffs

Via Peter Gallagher, I saw this NY Times article on ethanol subsidies, which referred to an old Obama speech where he said the following:

Greater Brazilian production of renewable fuels could boost sustainable economic development throughout Latin America, and reshape the geopolitics of energy in the hemisphere, reducing the oil-driven influence of Venezuela's Hugo Chavez. The more inter-hemispheric production and use of ethanol and other biofuels occurs, and the more such indigenously-produced renewable fuels are used to replace fossil fuels, the better it is for our friends in the hemisphere.

As it relates to our country’s drive toward energy independence, it does not serve our national and economic security to replace imported oil with Brazilian ethanol. In other words, those who advocate replacement of US-based biofuels production with Brazilian ethanol exports however well intentioned they may be, are both misunderstanding our long term energy security challenge and ignoring a valuable foreign policy opportunity. The U.S. needs to dramatically expand domestic biofuels production, not embrace a short term fix that discourages investment in the expansion of the domestic renewable fuels in industry. Also, accelerating technology advances and transferring the technology to our neighbors in the Caribbean and South America will help them employ their own resources to produce environmentally clean ethanol to reduce their imported oil bill, thereby promoting economic stability in the Caribbean and South and Central America and strengthen the U.S.-Brazil relationship.

So imported Brazilian sugar-based ethanol is bad because it undermines U.S. corn-based ethanol.  But as the NY Times article says:

Corn ethanol generates less than two units of energy for every unit of energy used to produce it, while the energy ratio for sugar cane is more than 8 to 1. With lower production costs and cheaper land prices in the tropical countries where it is grown, sugar cane is a more efficient source.

Here's what I'd like ask Obama:  How much will it cost U.S. consumers to keep a permanent system of protection in place to allow corn-based ethanol to compete with more efficient sugar-based ethanol?

The Economist on Carbon Tariffs

The Economist has an interesting "Economics focus" piece on the use of carbon tariffs against countries that do not take measures to limit their emissions.  The piece describes the issue as follows:

... how can policy ensure that legal limits on emissions do not put local firms at a disadvantage to their foreign competitors? After all, if the cost of compliance puts factories in countries with strict rules out of business, while those in grubbier places flourish, a regulation is worse than useless. The planet's emissions stay the same, or rise, while the country doing its bit for the environment loses investment and jobs.

That's not a bad explanation of the issue, although it may be that domestic companies do not necessarily go out of business.  Rather, as the opening sentence puts it, they are merely at a "disadvantage."  So, for example, they may just lose market share, not go out of business.  Later, the article points to some studies that examine how much harm specific industries would suffer in the face of domestic action against carbon emissions without an import component, and then states:

... even the most vulnerable industries would not suffer the Armageddon that lobbying groups are predicting.

That is important, since it suggests that the politicians are over-reacting, and that their remedies may actually make matters worse.

To me, this seemed like a strange way to conclude.  They recognize the problem, they quantify it by reference to the studies, but then they only say that the problem has been exaggerated.  They never offer a view of what to do about a problem they seem to think is a real one (even it has been exaggerated by some).  They seem skeptical of carbon tariffs, for reasons I can understand.  But what do they think should be done with regard to countries that do not take action on their emissions?  Nothing?  I have a hard time believing it is nothing, but they don't really offer any view.