Could the threat of carbon tariffs save the Paris Agreement?

18 September 2018
  • A central weakness of the Paris Agreement on climate change is the absence of sanctions against recalcitrant countries. Border carbon adjustments could be the world’s best hope to strong-arm the US into action.
  • Leading trade experts are increasingly of the view that tariffs to account for traded carbon are compatible with World Trade Organization rules.
  • The new EU Emissions Trading System (ETS) Directive gives the bloc the legal means to target trade arrangements if climate safeguards are not met. The scale of America’s carbon tariff liability on its exports to Europe may be as high as US$3 billion annually, rising to over US$8 billion in 2021.

 

Less than two years into Donald Trump’s presidency, the multilateral global order has been severely shaken. He has torn up or resiled from an array of international agreements, unnerving allies and raising tensions. Partners have struggled to shape an appropriate response as strategies ranging from flattery (Macron), confrontation (Merkel) and servility (May) have to varying degrees failed to deliver. To achieve a real change in the administration, however, European leaders require a credible threat of countervailing action against Mr. Trump.

International norms and agreements are underpinned by such threats. The success of the WTO, and its predecessor the GATT, is predicated principally on the capacity of countries to legally respond to trade violations with action in kind. Similarly, the Montreal Protocol, which successfully reduced the production and consumption of ozone depleting substances, includes trade sanctions against non-signatories in order to incentivise them to join the treaty. Negotiators justified the sanctions with the argument that the depletion of the ozone layer is an environmental problem most effectively addressed at the global level.

However, a central weakness of the Paris Agreement is the absence of such sanctions against recalcitrant countries like the US. It is for this reason that some EU legislators have signalled their support for unilaterally introducing them. By doing so, they could upend the usual rules of international trade and climate relations.

The proposals are contained within changes to the continent’s flagship climate policy instrument, the EU Emissions Trading Scheme (ETS). The EU has said it will review the ETS “in light of climate policy measures in other economies.” The review would allow the European Commission to apply “carbon border adjustments” on imported goods. This means that if a country fails to implement robust climate policies to reduce carbon emissions, the EU now says it could apply an “adjustment” – effectively a tariff – on that country’s heavy industrial goods, for example steel, aluminium or cement.

If the US withdraws from the Paris Agreement in 2020 as announced, it would be an obvious target for such carbon tariffs. In such circumstances, tariffs would help bolster the world’s response to prevent dangerous climate change, just as the Montreal Protocol’s sanctions helped to save the ozone layer. Tariffs would also help to ensure that the US does not free-ride on other countries’ climate action. Otherwise, it would benefit from a safer climate, but its manufacturers would not have to face any carbon costs.

Carbon tariffs would thus punish America’s failure to move to cleaner production. Tariffs of this nature could also incentivise American producers to shift to lower emissions technologies and methods as higher emissions processes become less competitive. The charge would be equivalent to the carbon costs European industries face, currently at around €20 (US$23) per tonne of carbon dioxide emitted. It would thus level the playing field between domestic manufacturers and US competitors.

The scale of America’s carbon tariff liability on its exports to Europe could be significant. Based on trade patterns, estimates of the carbon embedded in US exports and the EU ETS emission price, it currently may be as high as US$3 billion annually. Given expected increases in the European emissions price, this could hit over US$8 billion in 2021.[1]

Any moves to tie tariffs to climate action would likely be met with fierce opposition: A backlash from the US would be swift. Retaliatory tariffs and appeals to the WTO would be inevitable. However, leading trade experts are increasingly of the view that tariffs to account for traded carbon are compatible with WTO rules as long as they are applied fairly and in a non-discriminatory manner. And there are precedents for tariffs of this nature: GATT Article XX, section g provides an exception for trade measures relating to the conservation of exhaustible natural resources, including air, and the WTO has approved measures that restrict trade citing Article XX.

Indeed, within the US, there have been precedents for tariffs of this nature. California has instituted a carbon charge at its border for the power sector and is considering one for industry too. Its low carbon fuel standard also treats fuels imported from other states differently based on estimates of regional carbon intensities. US federal courts have found that these regulations were legal on the basis that they did not target out-of-state producers because they were out-of-state. Rather, the differential treatment of external producers was necessary to protect the environmental integrity of the domestic policy instrument. Furthermore, America’s best attempt to introduce an ETS at the federal level – the Waxman-Markey Bill – included a proposal for carbon tariffs at the federal border.

However, there are currently no examples of carbon tariffs globally. They have not been seriously considered in the political sphere: policymakers were hesitant to disturb the complex arrangement of rules and norms underpinning the multilateral trading system. But this has all changed given Mr. Trump’s first salvos in the trade war. A political will is growing in some European capitals to act more forcefully to drive carbon abatement globally. The new EU ETS Directive has now given the bloc the legal means to target trade arrangements if climate safeguards are not met.

European leaders have so far used the muted tones of climate diplomacy to entice countries to reduce emissions. However, this strategy will singularly fail to convince Mr. Trump to act on climate change. He will only respond to a credible and forceful threat. Carbon tariffs could be the world’s best hope to strong-arm the US into action. Before the global trade order settles once again, European leaders have the chance to change it in a way which buttresses the Paris Agreement. The question is whether they will seize the opportunity.

 

Paul Sammon is Senior Economist within the Climate Strategy practice at Vivid Economics.


[1] Estimates are based on current EU ETS prices (€20/tCO2), the median carbon intensity of US exports (0.49kgCO2/$), and 2016 figures for the value of US exports to Europe ($293bn). Forecasts based on carbon prices peaking at €50/tCO2 in 2021 per Carbon Tracker.