Europe’s carbon emissions plan risks more damage to global trade regime

Author: Editorial Board, ANU

The European Union (EU) recently announced its ‘Fit for 55’ plan to reduce carbon emissions by 55 per cent from 1990 levels by the end of this decade and to reach net zero carbon emissions by 2050.

The commitment of the European Union and other major industrial powers to similar carbon reduction targets will require an upheaval in established patterns in global production and international trade the like of which has not been witnessed since the industrial revolution.

Central to the EU’s plan is a carbon border tax. Europe plans to charge higher tariffs on imports of products made in ways that generate higher emissions than EU producers will be permitted to generate for the same goods. The scheme will begin by targeting four prominent carbon-intensive sectors: cement, steel, aluminium and fertiliser.

The United States is developing its own plan to tax carbon-intensive imports as part of its pending budget reconciliation package — to expedite their congressional passage — although the details of the scheme are not clear.

These are among a suite of other trade restrictions that are being considered both by the United States and the European Union to force international compliance with labour protection, human rights and other social and political goals, including national security.

There are many questions about the implementation of the EU carbon border adjustment measure and the practicalities of making such schemes work without offending core trade rules. The main concern is how they stack up against the central principles around which the global trade regime is ordered.

The global trade regime, which underpins protections against discriminatory treatment and coercion in international trade, is under attack from many sides. Managed trade, embraced by the Trump administration in its trade war against China, mimicked by China against the United States and in its application of trade coercion for political purposes (against Australia among others), has been let out of the cage by the two most important players in the world economy.

The foundational principle of the WTO free trade system is non-discrimination, embedded in Article I of the General Agreement on Tariffs and Trade (GATT). The EU’s and other carbon tariffs potentially pile more pressure on that principle, threatening to sink it altogether. Their application will necessarily be complex — and open to abuse — with supply chains and different emissions reduction policies across different jurisdictions.

Measures that seek to rid the atmosphere of carbon, improve human rights in Xinjiang or Myanmar, or protect labour conditions in Bangladesh may all seem eminently reasonable, indeed righteous, international social causes. Using trade instruments to achieve them creates a global economy divided by ideology, contested values and environmental commitments, the cost of which are offloaded onto others by those who espouse them.

That world will certainly be a less efficient world, one in which businesses will need to tune both investments and production decisions to the values of the countries they wish to sell to. And it will be a world in which there is vastly more economic conflict.

The more exceptions to the principle of non-discrimination become embedded in the trade system, the easier it will be to expand them in the future. The road to this kind of managed trade is a slippery path into more damaging protectionism.

The EU has pledged to ensure the new border carbon tax mechanism will not violate WTO rules, but implementation is likely to be very complex. The means for assessing the carbon content of imports are unclear, and EU firms will lobby for the highest possible tariffs to protect their markets. In the United States, where there is still no domestic carbon price, the risk of protectionist discrimination through carbon import tariffs is higher.

As Ken Heydon explains in our lead article this week, ‘the EU plan reflects concerns about carbon leakage and fear of a, largely unsubstantiated, race to the bottom as production moves to countries with less strict emissions regulation’.

The eventual outcomes and the extent of distortion to world trade are difficult to predict, Heydon says. They will depend on two main factors: the extent to which affected exporters shift away from Europe towards other markets, and the extent to which they incorporate carbon costs in their exports, or are deemed by the European Union to have done so.

What is clear is that the measures will have an important impact on Asia Pacific producers who, as Heydon says, are by far and away the largest exporters of the four sectors in the firing line. Over the period 2025–2035, the measures would see subsidies phased out and border protection implemented against aluminium, cement, fertilisers and steel trade. Doing so without discriminating between countries, as required by the WTO, is likely to be even more challenging.

The difficulty of measuring the carbon emitted in taxable imports — especially those within complex supply chains — and establishing how far foreign governments have already taxed such emissions makes trade conflict almost inevitable. Targeted countries and companies will complain they’re being treated unfairly, retaliatory tariffs will ensue, and trade conflict will be difficult to control given the intensity of the convictions involved.

Given the assault upon the global trade regime, environmental policy, including reducing fossil fuel subsidies and increasing public investment in green technology, rather than trade policy measures that distort trade, is the most efficient and least systemically damaging way to deal with carbon emissions.

The EAF Editorial Board is located in the Crawford School of Public Policy, College of Asia and the Pacific, The Australian National University.

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