Originally published August 2009
Climate change and trade are inextricably linked. Increasingly, businesses will face cross-border differences in carbon regulation and related trade pressures.
Today, Canadian and U.S. legislators are pressing forward with policies that will regulate greenhouse gas emissions (GHGs). Policymakers are trying to achieve a regulatory framework that will have the desired impact on climate change, preserve the competitiveness of domestic industries, and manage any negative international trade implications.
These three goals may be difficult or impossible to reconcile. Several questions arise, specifically how regulations will impact international trade agreements, whether tariffs will become an issue and whether trade disputes could arise over these GHG agreements.
In addition to some of these more recent pushes for climate change legislation at the federal level in the U.S. and Canada, other regional groups have attempted to provide their own solutions both to climate change and international cooperation. Specifically, the seven western U.S. states and four Canadian provinces that make up the Western Climate Initiative (WCI) have offered a unique perspective on GHG regulation. Through a cross-border approach, the WCI seeks to find collaborative solutions to address climate change and implement a joint strategy to reduce greenhouse gas emissions.
This article seeks to answer some of the pressing questions facing the U.S., Canada and countries around the world on climate change legislation and trade, with the help of a WCI perspective.
How greenhouse gas regulation impacts international trade
Domestic GHG policies impose regulatory costs on industry. These costs may affect the competitiveness of an industry relative to imports from countries that don't impose similar costs on their producers.
While economists agree free trade makes everyone better off on average, the political reality is that domestic producers and unions spend a lot of political capital trying to limit imports that may not face the same costs. For many domestic manufacturers, the imposition of GHG costs provides a strong argument to "level the playing field" against imports.
And that is where many disputes arise – the line between making trade fair by leveling the playing field and imposing unfair costs on foreign producers almost always depends on one country's perspective. Governments may try to use various sorts of measures to do that, including tariff and non-tariff barriers, subsidies, and domestic tax policy.
Many of the same international trade agreements that limit governmental discretion to impose discriminatory trade barriers against goods from other countries will permit individual countries, in defined circumstances, to protect their environmental or health standards.
Health and environmental exceptions
While global free trade agreements including the North American Free Trade Agreement and those that fall under the World Trade Organization are expected to impose discipline on each country's trade policy, they don't eliminate each country's right to take action in areas such as the environment, health, or national security. Those actions can hurt trade.
The rulebook for international trade includes a number of exceptions and principles that have been built in over the years to preserve that balance. What is interesting about climate change regulation from a trade policy perspective is its often not clear whether it fits within these exceptions.
One prominent health example in the recent past: the U.S. prohibited the importation of toys and other products containing lead based materials, since they are illegal to produce in the U.S. and are deemed to present a safety hazard. In recent history, various countries have prohibited the importation of foreign meat or other food products in response to various health or food-poisoning scares.
Other exceptions, particularly those that aren't explicitly related to health, have failed however. One memorable example, this time in the area of environmental protection, occurred in the late nineties, when the U.S. imposed environmental restrictions on U.S. refiners of reformulated gasoline. At the same time, the U.S. also attempted to impose trade barriers on imported gasoline that it considered the equivalent of the domestic rules. Venezuela and Brazil brought a WTO complaint to challenge the imposition of these barriers and won: the U.S. trade barriers were found to be discriminatory and, therefore, prohibited. In this case, the trade barriers were not saved by the historical exception for health or environmental issues.
Therefore, a key question is whether a measure to curb various imports because of greenhouse gas, environmental issues or health concerns it is truly legitimate or directed to benefit a specific industry or industries.
In one as-of-yet unresolved example, the U.S. granted substantial renewable energy tax credits to domestic paper companies that reuse black liquor, a thick, dark combustible liquid generated in the production of paper. The tax credit benefits companies that combine "renewable" fuels (in this case, the black liquor) with fossil based fuels (in this case, diesel fuel). U.S. paper companies are able to qualify for this credit, thereby obtaining a major price advantage against Canadian producers. The Canadian producers, through the Canadian government, claim this tax credit is an unlawful U.S. subsidy under WTO rules and NAFTA. Despite the harm caused to Canadian producers, there are strong counterarguments to justify the incentive as part of a much larger, and generally-applied, domestic program to encourage renewable energy.
Measures by individual states and provinces
There are many climate change regulations proposed at the sub-national level, including by the members of the Western Climate Initiative, bringing rise to the question: "Could an individual state or province take measures to reduce GHG emissions within its borders if the effect discriminates against imports?"
The answer is not entirely clear, but there is a possibility that a disadvantaged domestic producer could seek its own domestic subsidy to combat another country's trade barrier and preserve its competitive position relative to producers in that other country. But as we have seen, certain domestic subsidies can run afoul of multi-lateral anti-subsidy agreements if the domestic subsidy is too specific to a particular industry.
The Waxman-Markey Bill (HR 2454), which passed the U.S. House of Representatives on June 26, potentially includes such a provision. The House version provides free emission allowances to industries that must compete with goods from foreign nations that do not similarly regulate GHG emissions. The effect in trade terms would be to relieve certain domestic industries from some of the costs of compliance with the U.S. GHG regulations.
It is not certain the Waxman-Markey provision would limit exemptions only as necessary to compensate for goods produced in countries without climate controls. Furthermore, the legislation's imposition of border measures after 2020, which would require importers to buy carbon permits for imports from countries unlikely to take action to fight climate change, could make the law vulnerable to a successful challenge at the World Trade Organization.
What about offsets?
Another common question that arises is whether countries could erect defensible trade to protect domestic offsets relative to imports.
In fact, it's possible a country could decide only to recognize domestic GHG reductions as offset credits, just as governments usually only grant tax credits for domestic investments. It could be argued that a refusal to recognize all foreign reductions as offsets (a complete prohibition on trading of non-domestic offsets) is more likely to survive international scrutiny than any hybrid scheme where some, but not all, foreign reductions are recognized. A country that prohibits all foreign trading in a commodity can rightly claim to be treating all foreign companies and all foreign countries alike.
And "trade" in offsets is really about mutual recognition of certification or verification agencies and standards between countries. The U.S. would have an interest in ensuring the integrity of any credits purchased by U.S. companies for domestic use. This implies that the U.S. would have to approve or accept a determination by a foreign agency regarding qualification of an offset credit. Since it would be impossible to have an international carbon market without an international agreement that addresses some of these trade issues, we expect many of these issues to be defined before 2012 and the replacement of the Kyoto Protocol.
Will trade disputes arise?
While it's impossible to say whether, or where, trade disputes might arise, one thing is always clear: domestic manufacturers will demand protection from any policy that gives importers an economic advantage.
On the other hand, U.S. or Canadian climate change measures that affect imported goods negatively will be closely scrutinized for compliance with U.S. or Canadian trade obligations. Unless climate change policy is neutral in terms of its trade impact, there will always be the possibility of disputes over implementation. That may explain why several groups argue that a simple carbon tax is a better option than a cap and trade program.
Clearly, trade laws and remedies available under multi-lateral trade agreements are not perfectly suited to address all situations that involve real barriers to trade. We have observed many instances in which governments have enacted measures that restrict trade but nevertheless prevailed when challenged.
Industry cannot rely on trade agreements and domestic trade law remedies alone to achieve a level playing field. It's important for industry to be vigilant and proactive in addressing protectionist proposals or broad policy measures that may have unintended trade impacts. In the end, forming an effective strategy early can help nip those threats in the bud and avoid the very difficult job of reversing damaging trade restrictions.
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Peter Kirby, a Montreal-based partner in Canadian law firm Fasken Martineau, is a member of the firm's International Trade-Dispute Resolution Practice Group, with a focus on cross-border disputes, trade and regulatory compliance issues, international commercial arbitration and investor-state arbitration. He can be reached at firstname.lastname@example.org.
Michael House is a Washington D.C.-based partner in law firm Perkins Coie's Business Group, where he focuses on international trade law. He advises and represents clients in all aspects of trade remedy investigations, and can be reached at MHouse@perkinscoie.com.
Allan Abravanel, a partner in Perkins Coie's Business Group; and Mark Sills, an international trade and investment partner at Fasken Martineau, contributed to this article.
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