Trade policy and climate change: opportunities and challenges

Trade policy and climate change: opportunities and challenges

Frontier’s Amar Breckenridge, who leads our work on international trade, spoke on a panel addressing the interaction between trade policy and climate change, at the UK Trade Policy Forum last week.

The forum, the first of its kind, was convened by Centre for Inclusive Trade Policy and hosted by Chatham House.

In his comments, Amar noted that the dominant “mood music” surrounding trade and climate change was broadly negative. This was partly because of the externalities associated with trade such as carbon emissions from production and transport. There are also concerns that differences in climate ambitions globally might lead to “carbon leakage” and that instruments responding to such concerns, such as the EU’s Carbon Border Adjustment Mechanism (CBAM), could exacerbate trade tensions.

But these matters obscure the broader contribution trade policy can make to climate change, both on the emissions reduction side and the adaptation side. These contributions reflect the gains from specialisation. These have in turn reduced the costs of accessing, and increased the quality of, technologies required for both emissions reductions and adaptations. They facilitate resilience to climatic shocks by allowing for diversified value chains. And in advanced countries, they have stimulated the decoupling of growth from emissions intensity, notably by favouring a transition towards a more services-based economy.

All these contributions did not happen by accident. They were, in part at least, underwritten by a system of global trade rules that improved the conditions for cross-border trade and investment. It is this system of rules that is now under threat because of industrial policy rivalry dovetailing with geopolitical rivalry.

One area in which this rivalry is evident is the “subsidy war” now under way between major economies, particularly in relation to “green” industries. From an economic point of view, subsidies are required to overcome the market failures associated with large scale industrial transformation. This is all the more so because the question of emissions pricing – the mainstay of emissions reduction – is still shrouded in uncertainty in various jurisdictions, and notably the United States. Subsidies on this scale will inevitably fall under the scope of WTO rules. These are relatively permissive in relation to their use, but also allow partners to take action if they feel the subsidies adversely affect them. WTO rules also rule out some of the worst aspects of these subsidies, notably provisions that require the use of domestically sourced inputs over foreign ones.

The danger is that with countries turning their backs on multilateralism, and with WTO dispute settlement functions now essentially inoperant, mechanisms that could limit the negative international spillovers of subsidies have now been weakened. At best this will mean a waste of financial resources as countries outbid one another. At worst this could lead to the proliferation of measures like local content requirements that will make a low carbon transition that much more costly and difficult to achieve.

There are ways of addressing this, notably by taking more seriously the WTO’s functions that seek to facilitate transparency, peer review and finding common ground through deliberation. Above all, countries need to recognise that multilateralism in trade has been a great contributor to the fight against climate change. That global problems require multilateral solutions, and that multilateralism is to an extent indivisible: you cannot wreck multilateralism in trade policy and expect it to work in climate.

Frontier Economics regularly advises clients on international trade issues.

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