Renewable Energy Incentives from Legal and Economic Perspectives: Time for a TRREI Agreement

9 March 2017

Greenhouse gas emissions are a market failure. How might international trade rules respond?


Renewable energy has a key role to play in mitigating climate change and guaranteeing long-term energy supply. Climate change and energy security concerns may compel governments to provide incentives for investments in renewable energy. Such incentives can be given to consumers for purchasing renewable energy products via tax reduction or offered to enterprises manufacturing renewable energy technologies via grants, funds or awards, among others.

Despite the need for incentives to stimulate generation of renewable energy under certain circumstances, the legality of some renewable energy incentive mechanisms has been questioned in the framework of the WTO dispute settlement system, in so far as these might be unfair or discriminatory vis-à-vis trade partners. In 2010, the US challenged China at the WTO for providing grants, funds, or awards to domestic wind power equipment manufacturers and subsequently, Beijing removed the measures at issue. Meanwhile, Japan and the EU filed formal WTO complaints against Canada over Ontario’s measures relating to its feed-in tariff (FIT) scheme. While these two disputes essentially concern domestic content requirements, the Appellate Body seems to have so far avoided addressing a systemic concern, i.e. whether FITs constitute subsides under the Agreement on Subsidies and Countervailing Measures (ASCM).[i] However, the Appellate Body’s reasoning appeared to prompt the US to drop its subsidisation claims in the course of the panel proceedings in a subsequent dispute launched by the US concerning India’s support policies for solar energy.

The WTO dispute settlement system, therefore, does not yet have a clear answer on whether, and if so to what extent, renewable energy incentives could be found to be illegal under the ASCM. This risks creating uncertainties for investors in renewable energy and for WTO members designing renewable energy incentive mechanisms. In order to reduce such uncertainty, this article seeks to examine the rationale for renewable energy incentives and analyse the legality of such incentives under the ASCM. It then proposes the establishment of an agreement on the “Trade-Related Aspects of Renewable Energy Incentives” (TRREI) in parallel with the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS).

Raison d'être: renewable energy incentives as part of the solution to address market failures

According to IPCC (2012), the rationale for the additional governmental support for innovative renewable energy technologies stems from two independent market failures: the first refers to the external cost of greenhouse gas (GHG) emissions; and the second is technological spillover in the field of innovation where if firms cannot appropriate the benefits of their investment in technological innovation, they tend to “invest less than is optimal from a macroeconomic perspective.”[ii] Whereas intellectual property rights (IPRs) are created to address the second market failure, renewable energy incentives may be part of the solution to deal with the first market failure. This section studies the rationale for renewable energy incentives.

Positive externalities of renewable energy

Externalities are costs or benefits of an economic activity that are conferred on other parties without this being reflected in the price of products involved and over which other parties have no control.

GHG emissions primarily deriving from the burning of fossil fuels have been characterised by British economist Nicolas Stern as “the biggest market failure the world has ever seen.” Such externalities include atmospheric warming and associated human health problems. Since the industrial revolution, commercial enterprises have been operating in an environment where they did not bear the full cost of production by internalising these wider GHG emission costs. When harmful GHG emissions are not properly priced, private firms face weaker incentives to invest in a switch to renewable energy, resulting in continued demand for fossil fuels with adverse competitiveness implications for cleaner alternatives. In contrast, renewable energy has many positive externalities, such as guaranteeing long-term supply and addressing environmental concerns. To avoid an under-use of renewable energy, incentives should be provided to compensate the producer or consumer for the external benefit generated by renewable energy.

The presence of positive externalities associated with renewable energy and negative externalities associated with fossil fuels create the rationale for governments to provide renewable energy incentives. The WTO Appellate Body in Canada-Renewable Energy found that consideration of these externalities can inform the reasons why governments intervene to create markets for renewable energy generation.

The “public good” nature of renewable energy

Renewable energy also has a public good character. In contrast with private goods, public goods are non-excludable, meaning that no one could be excluded from enjoying their benefits without compensation. Free-rider problems, thus, occur: an individual can enjoy the benefits of public goods such as GHG emissions reduction and energy security without having to contribute to the costs of their production. The consequence is a “tragedy of the commons”: private provision of the public good will be socially suboptimal and GHG emissions will continue to be too high.[iii]

Indeed, given its public good attributes, investors or consumers cannot fully recover the benefits of renewable energy, thereby resulting in investment and consumption below socially desirable levels. This also provides a strong rationale for government to introduce renewable energy incentives.

The legality of renewable energy incentives at the WTO

As discussed, the legality of renewable energy incentives has been questioned in several WTO disputes. The current jurisprudence does not give a definite answer regarding whether renewable energy incentives provided to internalise environmental and social benefits are permitted under the ASCM.

The purpose of ASCM is to discipline trade-distorting subsidies at the multilateral level. Notably, the panel in US - Export Restraints found that not “every government intervention that might in economic theory be deemed a subsidy with the potential to distort trade is a subsidy within the meaning of the [ASCM]”. For a subsidy to be deemed to exist, Article 1.1 of the ASCM requires that a financial contribution or any form of income or price support confer a benefit. Thus, whether renewable energy incentives provided by governments are permitted under the ASCM in essence is a question as to whether such incentives confer a “benefit,” within the meaning of Article 1.1 (b). Specifically speaking, it is a question of whether renewable energy incentive mechanisms intended to internalise social and environmental benefits generated by renewable energy constitute a “benefit" in the sense of Article 1.1(b), so that these measures can be considered as subsidies.

It is well-established in WTO jurisprudence that the treaty terms of the trade body’s “covered agreements,” including the ASCM, are to be interpreted in line with the general rules of treaty interpretation mainly codified in Article 31 of the Vienna Convention on the Law of Treaties (VCLT). Accordingly, the term “benefit” in Article 1.1(b) should be interpreted in good faith in accordance with its ordinary meaning in its context, and in light of the object and purpose of the treaty. Under Article 31 of the VCLT, the contextual elements for the purpose of the treaty interpretation include but are not limited to the text, including its preamble and annexes, and any relevant rules of international law applicable in the relations between the parties.

The dictionary meaning of benefit contains some form of “advantage.” The panel in Japan-DRAMs (Korea) found that a financial contribution confers a “benefit” if it is provided to the recipient on terms “more favourable than the recipient could have obtained from the market.” The Appellate Body in Canada-Renewable Energy took account of externalities in its benefit analysis by differentiating markets for conventional from renewable energy sources. To the extent that renewable energy incentives are provided by governments to internalise social and environmental benefits, such incentives are not provided to the recipient on terms more favourable than the recipient could have obtained from the relevant market. Thus, such renewable energy incentives do not constitute in and of themselves a “benefit” within the meaning of Article 1.1(b).

This interpretation is further supported by WTO’s sustainable development objective and its context. First, the WTO sustainable development objective, as enshrined in the preamble of its founding Marrakesh Agreement, requires a balance between economic and social development and environmental protection. In US-Shrimp, the Appellate Body found that the objective of sustainable development “reflects the intentions of negotiators of the WTO Agreements” and that this objective “must add colour, texture and shading to [the] interpretation of the agreements annexed to the WTO Agreement”, including the ASCM. Therefore, in interpreting the term “benefit” in Article 1.1 (b), environmental and social benefits or costs should be taken into account together with economic benefits or costs.

Second, Article XX of the GATT provides context for interpreting Article 1.1(b) of the ASCM. Indeed, in line with the WTO jurisprudence, the GATT 1994 and the ASCM are both multilateral agreements on trade in goods contained in Annex 1A of the WTO Agreement, and, as such, are both “integral parts” of the same treaty, the WTO Agreement. Thus, in interpreting Article 1.1 (b) of the ASCM, Article XX of the GATT constitutes the context within the meaning of Article 31 (2) of the VCLT. Article XX(b) explicitly allows WTO members to adopt GATT-inconsistent measures to address environmental and social concerns, provided that such measure is applied in an even-handed manner and is “necessary to protect human, animal or plant life or health.” Accordingly, reading the term “benefit” in Article 1.1(b) in its context, environmental and social interests are expected to be considered. In other words, the term “benefit” in Article 1.1(b) should be interpreted to encompass not only economic but also social and environmental benefits.

Third, as part of the WTO legal system, the ASCM should not be read separately from public international law. Under the UN Framework Convention on Climate Change (UNFCCC) (with 196 parties implying universal participation), countries committed to promote and cooperate in the development, application and diffusion of climate friendly technologies including renewable energy technologies (Article 4.1(c)). In determining whether renewable energy incentives constitute a “benefit” under Article 1.1 (b) of the ASCM, Article 4.1(c) of the UNFCCC constitutes a relevant rule of international law within the meaning of Article 31(3)(c) of the VCLT, and thus should be taken into account. Also, the Appellate Body in US-Shrimpobliges a treaty interpreter to read the WTO agreements “in the light of contemporary concerns of the community of nations about the protection and preservation of the environment”. This further supports the need to consider the relevant rules provided by the UNFCCC, including obligations to promote and cooperate in the development, application and diffusion of renewable energy technologies, when conducting the benefit analysis under the ASCM.

Accordingly, interpreting the term “benefit” in Article 1.1 of the ASCM in line with Article 31 of the VCLT confirms that renewable energy incentives provided by governments to internalise the environmental and social costs or benefits do not constitute a benefit within the meaning of Article 1.1 of the ASCM.

Outlook: A TRREI Agreement in parallel with the TRIPS Agreement?

Despite the justification for renewable energy incentives, there are no explicit provisions within the WTO agreements confirming their legality or governing their provision, thus leaving uncertainties for investment in renewable energy. It is clear that the urgency of addressing climate change and energy security concerns requires a clear and coherent governance regime for renewable energy incentives.

IPRs are state-created rights to reduce technological spillover effects and address market failures associated with technological innovation. In essence, they are statutory incentives for technological innovation. Equally, renewable energy incentives should be created to internalise positive externalities of renewable energy and address the market failure associated with GHG emissions. Global efforts have been made to foster technological innovation. In particular, the TRIPS Agreement was adopted to provide global minimum IPR standards to incentivise innovation. Similarly, universal minimum standards for renewable energy incentives should be established to internalise the social and environmental benefits generated by renewable energy, thereby stimulating the generation, diffusion and application of renewable energy. Thus, in parallel with the TRIPS Agreement, WTO Members should adopt an agreement on TRREI.   

The object and purpose of the TRREI Agreement is to reduce distortions and impediments to international trade in renewable-energy-related goods, in particular through internalising the social and environmental benefits of renewable energy. Meanwhile, this agreement should ensure that measures to provide renewable energy incentives do not themselves become barriers to legitimate trade. Such understanding could be a cornerstone for an agreement on TRREI under the auspices of the WTO.

Bearing the above in mind, the TRREI Agreement should contain, at a minimum, the basic principles of non-discrimination and proportionality. The principle of non-discrimination includes national treatment and most-favoured-nation treatment, requiring the renewable energy incentives to be provided in an even-handed manner. The principle of proportionality requires the level of incentives to be proportionate to actual benefits generated by renewable energy. The incentives provided by governments should be just sufficient to internalise the positive externalities associated with the use of renewable energy. Exceeding this necessary level, incentives may have distorting effects on trade and competition. Renewable energy incentives should be phased out once the relevant market for certain type of renewable-energy-related goods is well established. Thus, similar to IPRs, the incentive period should be limited.

The TRREI Agreement recognises the vulnerability of the least-developed countries and small island developing countries to climate change and energy crisis and their limited ability to provide renewable incentives and reap benefits of economies of scale. In order to meet their special needs, the Green Climate Fund established by UNFCCC parties in 2011 to promote a “paradigm shift towards low-emission and climate-resilient development pathways”[iv] in developing nations, should provide financial support to those countries to establish and implement the necessary renewable energy incentive mechanisms.

As a response to the Paris Agreement by international trade community, the initiative to adopt the TRREI Agreement could follow the example of the Environmental Goods Agreement at the WTO. The provision of renewable energy incentives could also be traded off with reduction in agricultural – and fisheries – subsidies currently among the remaining Doha Round issues. The renewable energy incentive mechanisms could be designed in line with the best national practices in the countries which have achieved almost 100 per cent of renewable energy. Furthermore, given the difficulty of reaching multilateral agreements at the WTO, the TRREI agreement could be pursued initially as a plurilateral option and eventually be “multilateralised.”

 
Wei Zhuang, Associate, Van Bael & Bellis

 

This article is published as the winning essay in the 2015 TDS Bridges Writing Competition.

 

[i]    The majority of the panel found that the complainants failed to establish that the FIT programme confers a benefit within the meaning of Article 1.1(b) whereas the Appellate Body found it could not complete the legal analysis and thus could not determine whether FITs confer a benefit and whether they constitute subsidies under the ASCM. See also Appellate Body Report, Canada — Renewable Energy, para. 5.246.

[ii]    IPCC (2012), Renewable Energy Sources and Climate Change Mitigation: Special Report of the Intergovernmental Panel on Climate Change, Cambridge University Press, at p. 870.

[iii]   Woerdman E. (2004), The Institutional Economics of Market-based Climate Policy, Elsevier, at p. 9.

[iv]   UNFCCC (2014), Report of the Green Climate Fund to the Conference of the Parties to the United Nations Framework Convention on Climate Change, UN Doc. FCCC/CP/2014/8, Annex, at p.12.

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