Trade, U.S. Competitiveness and Climate Change

It’s clear that reducing greenhouse gas (GHG) emissions is a costly process. Doing so at a level that stands a chance at stabilizing atmospheric CO2 at a “safe” level amounts to a fundamental transformation in the way we produce and use energy. We’re talking hundreds of billions of dollars, perhaps even trillions, spent over a long timeframe and in the face of considerable uncertainty.

In climate change negotiations, namely those held by the UNFCCC on the Kyoto Protocol, a major concern of the U.S. hasn’t been total costs, per se, but relative costs. In other words, our policymakers are in principle opposed to policies that would potentially hurt U.S. competitiveness. If our legislators were to enact costly mitigation policies in the absence of comparable efforts from, say, China and India, American firms would potentially be at a disadvantage relative to their foreign counterparts. In fact, past legislation—like the Byrd-Hegel Resolution of 1997—has made U.S. participation in international climate agreements contingent on emissions reduction commitments from the world’s largest emitters (like China, and others). Whether you agree with this approach, or not, it remains unlikely that the U.S. will participate in Kyoto—or whatever comes after—without credible reduction commitments from other large emitters.

One of the more interesting, and undoubtedly controversial, means of obtaining such commitments is through international trade. I’ll avoid the details here, as they’re both elusive and boring, but essentially it works like this: the U.S. enacts a law requiring that all domestically produced steel, say, must be manufactured in a way that reduces the steel sector’s GHG emissions by 20 percent by 2020. To get our trading partners to adopt the same standard, the legislation is accompanied with a clause stating that steel imported from China that fails to meet the 20 percent target will be subject to what amount to trade sanctions. In practice, the Chinese manufacturer would have to purchase emissions allowances to make up the 20 percent gap.

This approach is no doubt controversial. It smacks of trade protectionism and could potentially lead to a trade war, where China would retaliate by refusing to respect U.S. intellectual property, for instance. What’s more, this trade-based approach would most likely be viewed, externally, as a unilateral attempt by the U.S. to foist its regulations on the rest of the world. Finally, there are questions over equity and fairness. The U.S., which has been by far the largest emitter of GHG, would be forcing other countries to take on costly emissions reductions—despite the fact that these countries have, up til now, contributed very little to the problem of climate change.

Despite these potential snags, it seems as though U.S. policymakers are willing to explore the notion of combining trade-based measures with domestic climate legislation. The Lieberman-Warner Climate Security Act of 2008, which was debated a couple of weeks ago in the Senate, but failed to move forward, includes such measures for importers of primary goods—like iron, steel, aluminum, glass and cement. Under Title XIII, the Bill stipulates that importers “from countries not taking comparable action [compared to U.S. actions] to reduce GHG emissions must purchase special international reserve allowances to cover the GHG emissions associated with the manufacture of that good.” (Whether Senators Lieberman and Warner really envision enacting such measures or are simply just posturing to bolster their bargaining position vis-a-vis other countries, remains to be seen.)

Again, I won’t get into the details (because they’re boring and, admittedly, I don’t understand them all), but it’s not entirely certain that such a move would be disallowed by World Trade Organization rules. In broad terms, WTO members are permitted (under Article III) to implement any regulations they deem necessary provided they do not discriminate between domestic goods and imports. In the hypothetical case presented above, the U.S. could plausibly argue that since there’s no discrimination, there’s no violation of GATT (WTO) rules. Both imports and domestic goods would be required meet maximum carbon-intensity requirements.

Another issue, however, is whether WTO rules permit states to regulate how a particular good is manufactured—the so-called process and production methods (PPMs). Traditionally, the WTO Appellate Body has held that regulation of PPMs is unacceptable. To take an example, a state would be permitted to regulate those characteristics inherent to steel—it’s tensile strength, for example—but not those aspects of its manufacture (i.e., the amount of CO2 released in the steel-making process). If challenged, the U.S. could try to claim an exception under Article XX. Whether such an exception would be upheld remains unclear.

In the end, there are a lot of unknowns. There’s a lot of allure to the notion of regulating emissions through trade measures, mainly because they provide firm enforcement measures to ensure compliance, while at the same time addressing concerns about American competitiveness. The risks of setting off an era of protectionism shouldn’t be weighed lightly, however.

For more reading (i.e., if you want to geek out on some climate-related trade law), be sure to check out this 2007 working paper by Joost Pauwelyn: “U.S. Federal Climate Policy and Competitiveness Concerns: The Limits and Options of International Trade Law” (PDF)