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Special edition summer 2021

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World trade

Trade policy as an instrument for climate change mitigation?

By André Wolf

U.S. President Joe Biden's agenda has also raised hopes in the area of climate policy. His concept for achieving the long-term goal of a climate-neutral U.S. economy envisages not only national measures but also a new form of climate diplomacy, which propagates the integration of climate issues in international trade agreements.

At the same time, there have been calls in the European Union to accompany own intensified efforts by complementary trade policy measures, specifically a CO2 border adjustment mechanism. This is intended to guarantee that domestic companies burdened by emissions regulation measures do not experience a cost disadvantage compared to foreign exporters, while at the same time avoiding carbon leakage. The positive incentives of an emissions-based cost burden on investments in green technologies could thus ideally be transferred to foreign producers.

Economic research is divided in its assessment of the climate policy effectiveness of this instrument. A positive incentive effect contrasts with a tendency towards harmful despecialization. In any case, the literature agrees that the implementation of such an instrument is accompanied by detrimental global distribution effects: on average, poorer countries are affected more strongly, due to the higher CO2 intensity of their exported goods. Whether a positive climate effect materializes depends crucially on the political response of the countries exposed to the tariff. The hope is that, as a result, countries with currently weak emissions regulation will increasingly adopt national climate measures in the interest of tariff avoidance. In the case of China, this is not an unlikely response, given its strong trade linkages. In the case of uncoordinated action, however, the opposite scenario of retaliatory tariff measures is also conceivable.

In addition, there are question marks from both a legal and a practical perspective. Legally, compatibility with WTO statutes is at least not obvious. This applies in particular to the principle of equal treatment of foreign and domestic companies and the Most Favored Nation principle. The specific form of the tariff is crucial. For example, the tariff burden must not be based on the source of origin, but on specific product characteristics, for which the same criteria should be used for domestic and foreign companies. From a practical point of view, there is also the question of a suitable assessment basis. Against the background of today's international value chains, the quantification and allocation of greenhouse gas emissions is extremely complex and thus a sure source of dispute. Of particular concern is the issue how to deal with emissions from the production of intermediate inputs. A common recommendation is therefore to initially limit tariff imposition to a few energy-intensive sectors in primary industries, such as steel, cement or aluminum production. But even then, the regional focus of the assessment it is still open to question. From a global perspective, ideally emissions occurring in the production in the exporting country should be used as a basis for the tariff assessment. From the point of view of the importing country, however, this would require a high level of information on the energy intensity and energy mix of production in the country of origin. Such a scheme would also imply considerable potential for conflict given the resulting tariff differences between trading partners.
Alternatively, the emissions intensity in the importing country or even a global average value could be used as a basis. Although this would solve the above-mentioned problems, it would not have the same steering effect in terms of cost-based incentives. Above all, this would not provide an incentive for exporting countries to invest in the adoption of more emission-neutral technologies.

Against this backdrop, it seems more promising to integrate climate policy goals into trade policy through bilateral and multilateral channels, for example as integral components or ancillary provisions of regional trade agreements. A wide range of options are available for this. For example, it is possible to agree on the mutual dismantling of trade barriers for goods that play a major role in the transformation of the energy supply toward climate neutrality, such as wind turbines and solar cells. In addition to tariff dismantling, this can also involve non-tariff barriers, for example in the form of harmonization or mutual recognition of test standards in approval procedures. However, agreements can also relate to more far-reaching aspects beyond trade policy. Specific target agreements could be reached on increasing energy efficiency or the share of renewable energies in the participating economies. Trade agreements could also be a suitable vehicle for committing partner countries to a roadmap for the phase-out of national subsidies on fossil resources that avoids distortions of competition. Conversely, recognition of existing national support systems for renewable energy sources could increase legal certainty for the transformation of energy supply. Finally, another aspect that has often played an important role in recent rounds of negotiations is public procurement. Bilateral acceptance of environmental and climate protection standards as a criterion in public procurement could be a means of defusing the ongoing debates on non-discriminatory market access in terms of climate policy. In this regard, the new U.S. administration has an opportunity to put into practice its stated desire to resume multilateral efforts. The HWWI will continue to closely monitor the future trade policy developments with its research.

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"Handelspolitik als Klimaschutzinstrument?" (in German)