The following blog post was originally published on the International Centre for Trade and Sustainable Development and was written in response to the paper Our Alarming Climate Crisis Demands Border Adjustments Now by John S. Odell.
With a trade war over steel and aluminium between the US and China, Europe, and other major economies looming, climate change represents another possible flashpoint for a new kind of trade war. President Trump has announced his intention to withdraw from the Paris Climate Agreement, meaning that the US would be the only country in the world not to participate.
Recently, President Macron of France has said that the EU would be “mad" to sign a free trade deal with the US after its withdrawal. During last year's international climate talks President Macron also hinted that Europe should set a border carbon tax to protect its industries against imports from countries that do not currently have a carbon price in place.
The idea of a border carbon tax, or a border cost adjustment, has been around for a long time, but the US withdrawal from the Paris Agreement has been the first instance where a climate change trade war could become a reality.
The unique nature of the Paris Agreement, where each country sets its own commitments to reduce emissions, moves the world towards a universal acceptance that climate change is a real and urgent threat that must be addressed by every country. This is vastly different from the top-down and developed vs. developing country set-up of the Kyoto Protocol which has governed international climate policy for the last 20 years.
The Paris Agreement also largely protects its own: as long as you have ratified it, there are no dispute mechanisms or penalties regardless of how you are (or are not) addressing climate change. With the announced US withdrawal, however, there is a sudden realisation amongst many governments and civil society organisation that the US could become a clear target for a trade dispute over climate change.
How would a border carbon tax or adjustment against the US or another country be applied? An easy way for a politician to rally for such a tax would be to apply it only to those countries who currently do not have a carbon price on pollution. However, this could prove tricky and controversial as it would not take into account equivalent measures that countries might be implementing which would produce an implicit carbon price.
According to the World Bank, there are currently more than 40 countries or regions that already have a price on carbon. This is typically applied either as an emissions trading system (ETS) or a carbon tax. All members of the European Union have a carbon price, along with Switzerland, Norway, South Korea, Colombia, Chile, Mexico, and most recently China, among others. In December 2017, China launched what will be the world's largest ETS when it is fully implemented, targeting more than 4 billion tonnes of carbon emissions. In contrast, the EU's annual carbon budget is roughly 2 billion tonnes. China's ETS will initially target emissions in the power sector before extending to energy-intensive sectors like oil and gas, chemicals, and cement. The Chinese government is steadfastly focused on reducing its emissions through the implementation of an ETS as a matter of energy security and political stability.
Carbon pricing policies have also been adopted in the Canadian provinces of Quebec, Ontario (withdrawal of participation in Western Climate Initiative announced by new provincial government), Alberta and British Colombia along with the US states of California, and 10 other states in New England and the northeast, including New York. Altogether, more than 50 percent of the global economy is covered by carbon pricing. Major economies which do not currently have a carbon price include the US, Brazil, Russia and India. Brazil and India, however, are both currently exploring how to set up a carbon pricing system with the help of the World Bank and other international climate initiatives.
Governments in any of the countries with a current price could adopt legislation which taxes imports (such as a border carbon adjustment) from countries that do not have a carbon price. Revenues from these taxes could be used towards environmental and renewable energy projects, to finance UN climate initiatives, or scientific research into low-carbon technologies, for example.
The US is likely the top target for any government seriously considering the application of a border carbon tax, because of the sheer size of its economy and as a retaliation for any of the recent tariffs imposed by the Trump administration against China and the EU. Russia also could be an additional potential hotspot for a trade dispute over climate change, considering that its emission reduction target submitted ahead of the Paris talks actually allows for Russian emissions to rise through 2030. European governments could retaliate against Russian sponsored cyberattacks by applying a border carbon tax on any Russian oil and gas imports.
It is quite apparent that the introduction of a border carbon tax would create a massive diplomatic conflict and could also backfire against a government in the event of substantial price increase in imported goods. The US or Russia could also easily retaliate with their own tariffs or they could pre-emptively introduce a meaningless carbon tax of a few US cents to avoid such a dispute from occurring in the first place, depending on the type of border carbon adjustment they would be facing. This would achieve very little for trade stability and saving the planet. If the US President decided to stay in the US-designed Paris Agreement rather than leaving it altogether, we could all avoid such trade conflicts from arising in the first place.
Jeff is an internationally recognised carbon markets and climate policy expert. If you're interested in reading more of Jeff's thoughts on the topic, have a look at the recent post he authored on the massive potential of Southeast Asian carbon markets.