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CQ: Cap-and-Trade Efforts Risk World Trade Backlash

April 01, 2015

The challenge of curbing carbon emissions has never been simple, either politically or technologically. Now, as Congress gears up to debate new legislation to reduce carbon emissions and combat climate change, policy makers are grappling with another complication, concerning economic fallout from a capand-trade measure: the prospect that they could touch off international trade wars.
Whatever plan Congress adopts will almost certainly impose costly curbs on polluting industries. And those industries will just as certainly protest that such restrictions will place them at a disadvantage with competitors in foreign countries that have not yet adopted similar measures. So most cap-and-trade proposals include a remedy: tariffs and subsidies to help affected industries.
The World Trade Organization will ultimately have to decide whether such measures jibe with legal precedent and existing trade and treaty agreements. And there’s no doubt that, once cap-and-trade gets a footing in the enormous U.S. economy, the WTO will field a steady stream of challenges to the quasi-protectionist efforts of governments to shield their home industries from some of the more painful adjustments in the new carbon- pricing playing field.
What’s more, the global trade body is known to take its time in deliberating, even over far less complicated issues, raising the specter that the tariffs could cause significant economic damage in the meantime. “Perhaps the single biggest risk to the global trading system going forward is what’s going to happen on climate change,” said Susan Schwab, President George W. Bush’s chief trade negotiator from 2006 until the end of his presidency. “It is the biggest danger we face.”
The European Union instituted its own cap-and-trade regime in 2005, and so far such trouble hasn’t emerged there. But that’s largely because the EU has deferred a decision about imposing tariffs on imports produced by countries, such as the United States, that have yet to institute curbs on greenhouse gases. 
One early test of how many countries may be willing to take on the costs of cap-and-trade could be an upcoming conference sponsored by the United Nations Framework Convention on Climate Change this December in Copenhagen, Denmark. Many experts expect that effort to run into the same difficulty that has dogged climate-change accords for the past 20 years: Obtaining a binding buy-in from the manufacturing powerhouses in the developing world as well as all advanced economies. Two of the globe’s fastest-growing economies, China and India, insist they have the right to continue using high-carbon energy sources such as coal that generations ago fueled the West’s economic growth — and in some cases, sustain it still. 
Containing Carbon Leakage
The term of art in trade disputes over national carbon levels is “carbon leakage,” which describes in shorthand form two different but related outcomes of carbon-curbing measures: the loss of market share by industries that comply with emissions caps to less-compliant competitors and the decision of some of those companies to move offshore to evade the caps. The net effect in both cases is the same: lost jobs and no net reduction in the global warming threat. 
Carbon-leakage scenarios are already figuring prominently in the debates in Congress over cap-and-trade legislation, and the present global recession gives special urgency to questions of job loss and international competitiveness. 
The central legislation in the debate is a bill cosponsored by Rep. Henry A. Waxman of California, chairman of the House Energy and Commerce Committee, and his senior Democratic ally on the committee, Rep. Edward J. Markey of Massachusetts. The bill, which the committee approved on a largely partisan vote May 21, seeks to address the leakage problem with free allowances — basically, permits to emit greenhouse gases — to affected industries, such as steel and cement. The allowances would be eliminated over time, beginning in most cases after 2025, subject to presidential findings of significant progress in curbing carbon emissions. The bill would also grant discretionary authority to the president to ramp up tariffs against imports from manufacturers profiting from more lenient curbs in their home countries.
The trade mitigation language in the bill came largely via heavy lobbying by at-risk industries. In testimony before the House Energy and Commerce subcommittee chaired by Markey, Thomas M. Conway, international vice president for the United Steelworkers, insisted that “a trade measure is imperative to ensure that all goods consumed in the United States — whether imported or domestic — bear the same costs based on their associated emissions. Emissions generated by imports entering our market should be treated the same as emissions associated with domestic goods in the market.”
Conway shrugged off a suggestion that the allowances and tariffs might run afoul of the WTO, saying, “I guess we would cross that bridge when we get to it.” Somewhat later he added, “We’re not particularly thrilled with everything the WTO says, anyway.”
Sizing Up the Stakes
Other trade analysts aren’t so quick to dismiss the prospect of disputes over carbon allowances. In a recent report on global trade and climate-change measures, the Peterson Institute for International Economics, which conducts research promoting trade liberalization, concluded that the kinds of subsidies in the Waxman-Markey measure could distort trade and “cause adverse effects on other countries” in violation of a WTO agreement. 
“The amount of money changing hands through this process is enormous: tens of billions of dollars; like a tax bill, but not as visible,” said Gary Clyde Hufbauer, a senior fellow at the institute and a co-author of the study. “It is a huge subsidy bill like what goes on in agriculture but again, it is large: $10 billion vs. what will end up being in the range of $30 billion-$40 billion a year. Once in place, it will be hard to change.” 
The WTO does not object to tariffs that equalize costs between an import and a comparable domestic product that may bear a heavier tax burden. The organization has also long approved border measures that insulate countries from some competitive pressures, so long as the restrictions are designed to conserve scarce natural resources or to protect public health. 
But it’s far from clear how those precedents might apply to measures designed to reduce carbon leakage, since the objective would be to regulate the means of production, rather than the markets for the good produced. “The traditional thing you regulate is the product and not the process. That is a venerable old trade distinction,” said I.M. Destler, a trade historian and foreign policy specialist at the University of Maryland. “In terms of the greenhouse gas issue, how something is produced is the critical issue.” 
Destler and other experts suggest that the WTO would balk at restrictions that could conceal a protectionist agenda under the guise of barring carbon-heavy imports. “The more punitive you get, the more trade-obstructive it becomes, the harder it is to justify” as a necessary step to protect the environment, said Andrew Green, a professor at the University of Toronto law school and an expert on trade and the environment. 
Green also notes that the technical difficulties of implementing such trade protections could be daunting — determining, for example, just how much carbon escaped into the atmosphere when a particular import was produced or how a greener, carbon-safe import could effectively be distinguished from an identical product that issued from a carbon-intensive process of production. Such questions are “extremely controversial at the WTO level,” Green said, and their resolution would be “extremely complicated.” 
Democratic Rep. Jay Inslee of Washington, who helped create the bill’s formula for allocating allowances, grants that the trade implications of cap-and-trade deals are still far from clear. “I think the trade aspects of this are a lot like the global warming issue itself,” he said. “It could blow up our trade regime, just like global warming could blow up the climatic regime.”
Inslee has a direct stake in ensuring that the trade balance protects the global market for U.S. exporters. According to Seattle’s Office of Economic Development, the manufacturing sector in Inslee’s Puget Sound district accounts for nearly 87 percent of his state’s exports. Inslee also noted that the state’s vital aluminum, steel and paper industries are directly threatened by carbon leakage. 
At the same time, Inslee has committed to containing the global warming threat. A lifelong skier and environmentalist, he says he worries about global warming’s affect on mountain snowfields where he skied as a boy, adding, “I have a 5-month-old grandchild, and he may not be able to ski the places I skied. That’s a very personal thing. It’s not cosmic. It’s not global. It’s personal.” 
He confesses that “trade is a more subordinate issue” when measured against the “imperative that we provide trade-sensitive, energy-intensive industries with a measure of security against foreign competition from countries that may not have a carbon regime.” 
But the tariffs, he said, are meant to send a message to the rest of the world. “It’s an appropriate measure,” Inslee said. “It wasn’t draconian. It wasn’t throwing a match into a room full of powder kegs. But it was a real, tangible and pointed reminder to our trade allies that we all have to engage in this.”