A recent report by the Roundtable on Climate Change and Sustainable Transition identified five major design choices that could affect whether and how a European border carbon adjustment could survive World Trade Organization (WTO) scrutiny. They are worth exploring in some detail, as policymakers in the US could soon confront similar questions.
1. Coverage of trade flows. A BCA could apply to just imports, or alternatively also apply to exports. In the latter scenario, European exporters would get a rebate to compensate them for their higher cost of production relative to countries that don’t de-carbonize. A two-sided adjustment would be the most beneficial for Europe’s economic competitiveness. However, from a trade law perspective, the optimal policy would be imports-only coverage, as an export adjustment would likely be considered a prohibited subsidy. In other words, a trade-compliant border adjustment would sacrifice European companies’ share of global markets.
2. Geographic scope. Europe could apply a BCA to all countries, or it could exempt certain countries on the basis of their lower level of economic development (as is common in many trade policy regimes) or their enactment of robust de-carbonization regimes. From a climate perspective, the optimal policy would be to reward rather than penalize countries that are also de-carbonizing. But from a trade law perspective, the superior move would be to respect most-favored nation rules and apply the levy to all countries.
3. Sectoral scope. Assessing the carbon intensity of imports is a difficult regulatory task. For that reason, some BCA proposals would apply only to the most energy-intensive and trade-exposed (EITE) industries. A common example is steel, the production of which utilizes a lot of carbon, and for which small increases in price could seriously damage Europe’s competitiveness with low-cost Chinese producers. By applying a BCA to only steel imports, regulators have a manageable task and also make non-steel exporters to Europe happy. For that reason, the course of action is also most likely to survive trade law scrutiny. Contrarily, to maximize de-carbonization benefits, Europe should apply a BCA to as many sectors as possible.
4. Emissions scope. In producing goods, firms produce both direct and indirect emissions. The narrowest category of emissions for producing, say, an automobile, would include only those emitted by the auto factory. In contrast, a more expansive look would incorporate emissions made by the suppliers to the auto factory as well. As with the other design criteria, the best solution for the environment (inclusion of indirect emissions) is the most problematic from a trade law perspective, as it increases the chance of unjustifiable discrimination.
5. Determination of embedded emissions. There are numerous ways for customs authorities to assess how much carbon is embedded in a given shipment. The most labor intensive is to calculate and apply different BCA rates to every single item that enters their custom areas based on a careful carbon audit of each. This would be extremely burdensome, and few border authorities would be likely to undertake it. An alternative approach is to make simplifying assumptions and come up with benchmark rates based on criteria like the source country for the imports, the lowest common denominator practices globally, or the best de-carbonization practices globally. These would imply, respectively, treating all goods from the US based on the average carbon intensity of the whole US economy (even if some industries and producers have a higher-than average green record), treating all US goods as bad as the worst polluting country (China or Saudi Arabia), or treating all US goods as good as microstates that emit very little carbon. Here, the best solution for both trade law and de-carbonization purposes is the most labor intensive and probably non-feasible: shipment-by-shipment rates. Of the feasible options, the best solution from a trade law perspective would be to give importers the best treatment afforded the lowest carbon emitters. However, this would give countries’ little incentive to de-carbonize.
In sum, there are certainly ways to design climate policy so that it maximizes the chance of surviving trade law scrutiny. But those ways significantly decrease the feasibility, de-carbonization benefits, or both. This is why modernizing trade rules is so vital.