The 1992 United Nations Framework Convention on Climate Change (UNFCCC) requires developed country parties to adopt policies and measures that demonstrate that they are taking the lead in reducing emissions consistent with the convention's ultimate objective of preventing dangerous climate change.Footnote 1 Yet nearly two decades after the signing of the treaty, many developed countries are still struggling to introduce limits on greenhouse gas emissions.
The decision in July 2010 by the Democratic leadership in the U.S. Senate to shelve its latest cap-and-trade bill and focus instead on mustering support for a much narrower energy bill ended months of speculation about whether the Senate would pass legally binding limits on greenhouse gas emissions. The decision will also make it harder for the United States to fulfill the Obama administration's Copenhagen pledge of a 17 percent cut in emissions by 2020 from a 2005 baseline, which already falls well short of scientific recommendations and the international expectations of China, the Group of 77, and the European Union. While the United States is the most significant player in the climate negotiations, other non-European developed countries have also failed to demonstrate climate leadership. The Canadian government is waiting to see what the United States will do, while the Australian Labor government decided in April 2010 to postpone the reintroduction of its national emissions trading scheme until after the August 2010 election. These delays have dampened hopes of a new, legally binding treaty emerging from the next Conference of the Parties, scheduled for Cancún, Mexico, in December 2010. Finding a way forward in the domestic politics of these countries, particularly in the United States, is crucial to the success of these international negotiations.
One of the key arguments raised by political opponents of robust domestic climate legislation in such countries as the United States, Canada, and Australia is that a national cap-and-trade bill will place domestic energy-intensive industries at a competitive disadvantage, and will also lead to the migration of industry, jobs, and emissions to developing countries that do not impose a price on carbon. Opponents have also argued that the migration of emissions, or so-called carbon leakage, to developing countries would defeat the purpose of domestic regulation. For many opponents, these problems are sufficient reason to reject the case for an emissions trading scheme (ETS) and to opt for softer measures that do not impose costs on industry. However, many would-be opponents in the United States have argued that an emissions trading scheme would be acceptable if it included border adjustment measures that effectively raise the price of imports from countries with a lower carbon price and lower the price of exports. This would be done by imposing a carbon tariff on imports (or requiring importers to purchase emission allowances under the domestic emissions trading scheme in the same way as domestic producers), and by allowing export rebates. The intended effect of such measures is to level the economic playing field, protect domestic industry and jobs from cheap imports, and prevent the migration of industry, jobs, and emissions offshore. Such a scheme helped to muster support for the Waxman-Markey Bill, which passed the U.S. House of Representatives on June 26, 2009. A similar scheme was envisaged for the draft Kerry-Lieberman Bill, which was forsaken by the Democrats in the Senate in July 2010.
Carbon equalization measures have appeared in many previous cap-and-trade bills that have been presented to the 110th and 111th Congresses, and they are likely to reappear in future efforts to promote a cap-and-trade scheme in Congress as a means of shoring up domestic political support. Debates over border taxes have also surfaced in the European Union, initially in the form of a “Kyoto tariff” to be applied at the border on imports from non-Kyoto parties (such as the United States) to prevent developed country laggards from gaining a competitive advantage at the expense of the developed country leaders that seek to fulfill their Kyoto obligations. More recently, France has actively defended the case for general carbon tariffs to be implemented at the EU's border to protect European industry and jobs from cheap imports and to prevent the relocation of European industry and emissions to jurisdictions with no or only weak climate regulation (so-called carbon havens).
To date, the case for border adjustments has received considerable scrutiny from economists interested in the competitive effects of placing a price on carbon in some jurisdictions and not others, and from trade lawyers interested in their compatibility with international trade law. However, there has been surprisingly little debate on the fairness of border adjustments and their compatibility with the climate leadership obligations of developed countries under the UNFCCC. This article seeks to take up this challenge using the burden-sharing principles of the climate change regime as the ethical yardstick. I show that the debate about carbon leakage and border measures in the United States provides an important window into the gap between the United States' understanding of its international climate responsibilities and those conferred by the UNFCCC. Although a cap-and-trade bill is currently off the table in the United States, the ethical issues raised by border measures remain important for U.S. climate policy—not only when the time comes to consider future proposals to put a domestic price on carbon but also in responding to a potential Kyoto tariff applied by the European Union.
I begin by clarifying the meaning of “carbon leakage” to prepare the ground for a critical review of the political and legal debates about border adjustment measures in the context of the twin challenges of promoting climate leadership by developed countries and addressing the unmet development needs of developing countries. I argue that the proposed border adjustment measures amount to an evasion of the leadership responsibilities of developed countries under the UNFCCC (to which the United States remains a party). I also argue that the “level commercial playing field” justification for border adjustment measures that has dominated U.S. domestic debates is simplistic and lopsided because it emphasizes the short-term disadvantages of domestic energy consumers and downplays the environmental and social injustices that arise from uneven development. In particular, the narrow focus on competitive disadvantage and possible “carbon leakage” arising from domestic cap-and-trade legislation ignores the changing distribution of emissions in the global economy arising from increasing specialization in production and market exchange, which has seen a more general movement of emissions-intensive industry to developing countries. This has enabled consumers in developed countries to enjoy the benefits of cheap imports without having to take responsibility for the emissions associated with their production. However, I conclude that it is possible to redesign border measures in ways that are sensitive to the changing flows of embodied carbon in trade, and that are consistent with the principles of common but differentiated responsibility and climate leadership under the UNFCCC.
UNDERSTANDING CARBON LEAKAGE
A simple definition of carbon leakage is the increase in emissions outside a country that are directly attributable to the introduction of climate regulations introduced in that country.Footnote 2 I shall call this “direct carbon leakage.” The use of the term “leakage” clearly suggests a problem. If carbon emissions are “leaking” out of a jurisdiction because firms are relocating to avoid new regulations, then it is necessary to tighten the regulatory net. From an environmentalist perspective, however, the point of regulatory adjustment should not be to prevent the relocation of firms per se, but rather to ensure a net reduction in emissions. For example, if an energy-intensive firm relocates to avoid rising fossil-fuel prices and to take advantage of cheap hydroelectricity elsewhere, then there will be a net reduction in emissions and the regulation is serving its purpose.
Before exploring whether and how much leakage is actually occurring, it is also necessary to situate direct leakage in the context of the emissions embodied in international trade. Just as carbon emissions can leak out of the jurisdiction with the migration of industry, it is also possible for “stowaway carbon” to sneak back into the jurisdiction unnoticed in the form of the carbon emissions embodied in imports. The stowaway carbon that enters a particular jurisdiction in an imported good has also left another jurisdiction as an export. The final carbon consumption in any given country equals the amount of carbon produced domestically minus the embodied carbon in exports plus the embodied carbon in imports. Increasing specialization and exchange in the global economy has lengthened the distance between the activities of production and consumption, increased the amount of such embodied carbon flowing through the trading system, and changed the distribution of emissions production and consumption.
Rapidly growing developing countries, such as China, are hosting a growing share of the world's factories, and consequently a growing share of the world's emissions. This production has also facilitated rising consumption of cheap imports in developed regions of the world, particularly Europe and North America. China's rapid growth in exports, especially since it joined the World Trade Organization (WTO) in 2001, has contributed to its new status as the largest aggregate emitter in the world, but a significant proportion of these emissions are embodied in Chinese exports. For example, a 2010 study by Steve Davis and Ken Caldeira from the Carnegie Institution for Science found, based on 2004 trade data, that around 25 percent of the emissions produced within China are embodied in China's exports and, thus, consumed elsewhere. More generally, they found that 23 percent of global CO2 emissions were traded internationally, primarily as exports from China and other emerging markets to consumers in developed countries.Footnote 3 The United States, of course, is a significant consumer of these exports.
The problem, however, is that the emissions associated with this consumption are attributed to China, not Europe or North America, since the UNFCCC system of compiling national emissions inventories is based on the emissions arising from the production of goods inside the territory, rather than the emissions associated with final consumption, and there is no allocation for emissions associated with international transportation.Footnote 4 This means that consumers in Europe and North America (and many other jurisdictions) are able to enjoy the benefits of cheap imports without taking any responsibility for the emissions associated with their production and transportation. The more a country is able to import emissions-intensive goods from elsewhere rather than produce them locally, the more its national emissions profile will improve under a production-based emissions accounting system and the more its final carbon consumption is camouflaged.
This general trend of “emissions offshoring,” sometimes referred to as “weak carbon leakage,” represents a type of carbon movement out of developed countries that cannot be directly attributable to new climate policies.Footnote 5 Rather, it is the by-product of a more general trend of industry relocation to the Global South to take advantage of a range of lower factor costs (labor, environmental regulation, energy, and others). I shall therefore refer to it as “indirect leakage” to distinguish it from “direct leakage.” In effect, general shifts in the international economic division of labor have enabled many developed countries to “outsource” their carbon pollution to developing countries, maintain their high-consumption lifestyles, and avoid responsibility for the unaccounted stowaway carbon in imports, although the patterns are by no means uniform. As we shall see, however, most of the domestic policy debates in the United States have focused only on the dangers of direct carbon leakage, while ignoring the advantages of “indirect leakage,” such as cheaper goods and reduced emissions attribution.
THE POLICY DEBATES
Domestic concerns over direct carbon leakage and competitive disadvantage have continued to hamper climate regulatory efforts in developed countries. However, these concerns have played out differently in the EU compared to many of the laggard states outside Europe. The primary concern in the EU has been to identify the particular sectors most at risk of carbon leakage, and to design policy measures to prevent or minimize leakage. So far, these policy measures have not included border adjustments. In laggard states, such as the United States and Australia, the political concerns have been to safeguard economic competitiveness, protect jobs, and prevent “free riding” by major developing countries, which are under no obligation to impose quantitative emissions reduction targets under the Kyoto Protocol, or under the negotiating road map for a successor treaty to the Kyoto Protocol.Footnote 6 Both emissions-intensive industries and associated unions have complained of unfair competition from cheaper imports manufactured in developing countries, while export industries have complained that they will be less competitive in the global market and have threatened to relocate.
These arguments have been politically effective in inhibiting the adoption of robust mitigation targets, particularly among many members of the so-called Umbrella Group.Footnote 7 From the standpoint of those countries that have been historically dependent on cheap fossil fuels (such as the United States, Canada, and Australia), a commitment to a bold mitigation target for 2020 in the absence of developing country commitments is akin to unilateral disarmament. The Copenhagen pledges of carbon emissions reductions offered by these countries fall well below the range recommended for developed countries by the Intergovernmental Panel on Climate Change (IPCCC) of minus 25–40 percent by 2020 from a 1990 baseline. Australia's Copenhagen pledge amounts to a unilateral commitment of only minus 5 percent from a 2000 baseline, while the U.S. target (also adopted by Canada) of minus 17 percent from a 2005 baseline translates as a reduction of only 3–4 percent from a 1990 baseline.
These targets stand in stark contrast to the EU's 2020 target of minus 20 percent from a 1990 baseline, rising to minus 30 percent if other developed countries adopt comparable measures. Concerns over the loss of competitiveness and carbon leakage have also been raised by industry and unions in the EU, but these concerns did not deter the EU from launching an ETS in 2005 as the centerpiece of EU climate policy, although they have compromised the design and effectiveness of the ETS. For example, in the first phase of operation of the ETS, the allocation of free emission permits to electricity suppliers enabled them to make windfall profits simply by passing the market value of the permits on to consumers without any reduction in emissions.Footnote 8 In response to these criticisms the European Commission has recommended phasing out free allocation to the power sector, with full auctioning of permits by governments beginning in 2013, by which time the sector will have to pay the full market price for all the permits needed to cover its emissions. However, the reform proposals enable continued free allocation to energy-intensive industries that may relocate as the price of carbon rises, and it leaves open the possibility of introducing further compensatory measures in the future, which may include border measures. At the 15th Conference of the Parties (COP15) to the UNFCCC in Copenhagen in 2009, the EU strongly urged other developed countries to commit to comparable targets, but only Norway and Japan rose to the challenge.Footnote 9 The gap in the level of ambition between the EU, Norway, and Japan, on the one hand, and the remaining developed countries outside Europe, on the other, was one of the key sticking points that led to the failure of the parties to produce a legally binding treaty in Copenhagen.
In the United States and Australia, however, domestic fears over the loss of competitiveness and carbon leakage have so far thwarted the passage of national cap-and-trade legislation. The domestic political debates in both countries have been highly polarized and protracted, and the carbon pricing signals in the proposed schemes have been heavily compromised through the introduction of considerable concessions to reduce the costs of adjustment for industry. In the case of Australia, it has been shown that much of the proposed protection for emissions-intensive industries is unnecessary, poorly targeted, and would delay the necessary structural adjustment to a low-carbon economy.Footnote 10
Fears over competitive disadvantage have a particularly long history in the U.S. Congress, which has never accepted the bifurcated structure of the Kyoto Protocol. For example, in the lead-up to the Kyoto conference after the Clinton administration had given its support for a binding protocol that imposed targets only on the industrialized countries, Senator Jesse Helms (R-NC) echoed the concerns of most senators in declaring, “The U.S. position turns basic principles of sound economic policy on its head, since it directs industrialized countries to subsidize developing countries by polluting less while incurring higher costs so that developing countries can pollute more without incurring cost.”Footnote 11 Just five months prior to COP3 at Kyoto in December 1997, the U.S. Senate unanimously passed the Byrd-Hagel Resolution, announcing that it would not ratify the protocol if developing countries did not undertake to limit or reduce emissions “within the same compliance period” or if the agreement “would result in serious harm to the U.S. economy.”Footnote 12 Among the key concerns of the senators were the unfair advantage (“free ride”) given to developing countries, the fear that the U.S. economy and employment would suffer from climate regulation, and that the treaty would not be effective without the participation of such major emitters as China and India. For the Senate in 1997, “taking the lead” in combating climate change should not mean that the United States or other developed countries should “go it alone.”Footnote 13 These arguments were enlisted by the Bush administration and the Howard government in Australia when they announced their repudiation of the Kyoto Protocol in 2001.Footnote 14
While President Barack Obama has reengaged with the multilateral climate negotiations and accepted the argument that the United States, as a developed country, must play a leadership role in mitigation, his administration's climate diplomacy has been severely constrained by these enduring congressional concerns and the legacy of inaction they have produced.
ENTER BORDER MEASURES
Carbon equalization measures have emerged as a simple solution to the problems of competitive disadvantage and carbon leakage. Such measures have been defended as having many virtues: as a means of leveling the competitive playing field and avoiding free-rider problems; preventing the outflow of production, jobs, and associated emissions; ensuring the effectiveness and political acceptability of domestic climate policy; and providing leverage by creating an incentive for other countries to strengthen their climate policies to avoid having to pay carbon tariffs at the border. While the European Commission has so far resisted calls from industry, unions, and some environmentalists for border measures, U.S. legislators have been much more receptive. Indeed, most of the cap-and-trade bills introduced into Congress in the past four years have included border measures.
For example, the Waxman-Markey Bill directs the administration to achieve a number of “objectives” in international climate negotiations, including reaching “an internationally binding agreement in which all major greenhouse gas-emitting countries contribute equitably to the reduction of global greenhouse gas emissions,” and to ensure that the agreement recognizes and addresses competitive imbalances and carbon leakage and does not prevent parties from addressing the competitive imbalances that lead to carbon leakage.Footnote 15 If a binding international treaty meeting these objectives is not in place by 2020, then importers will be required to purchase emission permits under the U.S. emissions trading scheme that are equivalent to what would be required by domestic firms producing the same products. Exemptions are provided for importers that can demonstrate they are subject to comparable regulation in their own jurisdiction.Footnote 16
President Obama welcomed the Waxman-Markey Bill, but initially criticized border measures as protectionist, even though they helped to secure the final passage of the bill in the House of Representatives.Footnote 17 However, he has since conceded the need for such measures to shore up both Republican and Democratic support. For example, in 2009 he was presented with a letter from a group of ten Democratic senators from coal-dependent states with a strong manufacturing base indicating they would not support a cap-and-trade bill without carbon equalization measures, including energy-cost rebates for energy-intensive and trade-exposed industries, to ensure a level playing field for U.S. industries.Footnote 18 Border measures have also attracted strong support from industry, unions, environmentalists, and antiglobalization activists.Footnote 19
The Efficacy and Irony of U.S. Border Measures
While border measures have helped to build domestic political support for cap-and-trade measures in the United States, they raise a number of political and practical problems. Indeed, critics have argued that it is by no means clear that border measures would prevent carbon leakage or provide the desired leverage to ensure the enactment of comparable measures elsewhere, and that there are also risks that such measures may backfire. First, critics have argued that unilateral border measures are likely to set off tit-for-tat trade restrictions or a “carbon tariff war,” undermining the hard-won trade gains arising from liberalization, and setting back the already overburdened Doha development round of trade negotiations that promises to remove restrictions on trade in environmental goods and services. The EU has so far resisted calls for a Kyoto tariff or for more general, nondiscriminatory border adjustments for fear of sparking retaliatory measures by the United States, and to avoid upsetting major emerging emitters from the developing world in the international negotiations. However, as noted above, the failure of the 2009 Copenhagen meeting to produce strong, comparable mitigation targets on the part of developed countries has prompted renewed calls for border measures as the EU moves to implement its 2020 target of reducing emissions by 20 percent while also moving toward full auctioning. France, with the support of Poland, has mounted a concerted case for EU border measures, but many other EU members remain concerned that such measures may spark a trade war.Footnote 20
Second, unilateral border measures are tools that are available only to powerful trading nations, such as the United States, or trading blocs, such as the EU—not to small and economically vulnerable nations with little market power. Moreover, even when applied by powerful trading nations, unilateral border measures may not exert the required leverage (that is, the strengthening of climate policy elsewhere), but instead may simply divert trade to other markets.Footnote 21 Most of the growth in demand for energy-intensive products, such as steel, cement, aluminum, iron, chemicals, and pulp and paper, now emanates from developing countries, not developed countries.Footnote 22 China accounts for approximately 11 percent of carbon-intensive U.S. imports, which may not be enough to ensure that border measures would prompt changes in Chinese climate policy.Footnote 23 In contrast, some of the largest suppliers of carbon-intensive goods to the United States are not located in China and India but in Canada and the EU, and the latter emits considerably less emissions in aggregate and/or per capita terms than the United States.Footnote 24 Given that the price of fossil fuels is much higher in the EU than in the United States, and would remain so even if the Senate were to pass a cap-and-trade scheme, there seems to be a stronger case for EU border measures against U.S. imports than U.S. border measures against Chinese imports. Indeed, during the Bush administration there were calls from within the EU from industry, trade unions, environmentalists, and the European Parliament to impose a Kyoto tax only against developed countries that lack adequate carbon constraints, such as the United States, so as to compensate European industry for the disadvantage arising from the EU's pioneering ETS.Footnote 25 The irony seems lost on U.S. legislators.
Third, most of the claims about carbon leakage are highly speculative. There is little empirical evidence to date to support the claim that new domestic carbon constraints have led to carbon leakage, and the theoretical estimates based on modeling vary widely.Footnote 26 Moreover, identifying systemic or overall leakage between jurisdictions is much harder than identifying leakage in particular industry sectors.Footnote 27 The International Energy Agency has found no significant relocation of industry from the European Union following the introduction of ETS.Footnote 28 However, as the price of carbon rises in the EU, this is destined to change. Yet in the interim period, countries that have acted as climate pioneers by adopting ambitious targets and policies, such as Germany, have been able to enjoy a “first-mover” advantage (rather than a disadvantage) by facilitating technological innovation and gaining a growing share of the environmental technology market. Even for late movers, the effects of rising energy prices resulting from a cap-and-trade bill would be concentrated on only a narrow set of energy-intensive industries; and many other industries, particularly renewable energy industries, would benefit.Footnote 29
Fourth, critics have raised concerns about the practical challenges associated with setting carbon tariffs or other border measures, a task requiring access to detailed information about energy use, production methods, and the costs faced by firms operating in other jurisdictions—not all of which may be available, easily accessible, or willingly provided.Footnote 30 While this problem can be managed by placing the onus on importers to provide the necessary information to demonstrate comparability of carbon costs with U.S. producers, this necessarily requires U.S. regulators to pass judgment about the climate policies of other states. This may entail making judgments about comparability or, according to the provisions in the Waxman-Markey Bill, evaluating whether developing countries have made “equitable” contributions to emissions reductions.Footnote 31 I explore this point in more detail below when I examine the fairness of border measures. Suffice it to say here that the dominant view in the United States, particularly in Congress, about the meaning of equitable burden sharing has historically been at odds with the understanding of most of the parties to the UNFCCC and the Kyoto Protocol.
Fifth, there are concerns over whether border measures are likely to be compatible with WTO rules. This is not the place to explore the intricacies of WTO law, but the balance of legal opinion suggests that appropriately designed, nondiscriminatory unilateral border measures are most likely to be WTO compatible as an environmental exemption under Article 20 of the General Agreement on Tariffs and Trade (GATT).Footnote 32 While the UNFCCC does not provide multilateral authorization for the use of trade restrictions, it does provide that unilateral measures taken by the parties to fulfill their obligations should not constitute “a means of arbitrary or unjustifiable discrimination or a disguised restriction on world trade.”Footnote 33 However, there remains sufficient uncertainty to create the possibility of a legal challenge under the WTO's dispute settlement procedures, and China and India have already indicated that they would initiate such a challenge.Footnote 34 Indeed, China and India have strongly criticized border adjustment measures on the grounds that they represent “back-door targets.”Footnote 35 Unilateral border measures also conflict with the recommendations of the Organisation for Economic Co-operation and Development (OECD) that assistance to polluters is incompatible with the polluter pays principle, except in very limited circumstances.Footnote 36
Finally, the number of industry sectors in which direct carbon leakage is likely to occur as the price of carbon rises is relatively small, and is mostly confined to the energy-intensive industries already mentioned: steel, cement, aluminum, iron, chemicals, and pulp and paper. There has been a variety of calls for a more targeted international response to the problem of carbon leakage and competitive disadvantage, such as the negotiation of international sectoral agreements in each of these specific industries. For example, the 2008 Garnaut Climate Change Review, commissioned by the Rudd Labor government in Australia to inform the development of a national cap-and-trade scheme, recommended international sectoral agreements whereby each relevant country subjects its trade-exposed, emissions-intensive industries to a carbon tax, pending economy-wide pricing commitments by all major countries.Footnote 37 This solution to carbon leakage would be preferable to border adjustments. Although I argue below that developing countries have a strong moral argument that they should be allowed to increase their per capita emissions relative to developed countries in general, this need not necessarily mean that they should be allowed higher emissions or cheaper costs in the production of particular products, especially when they are emissions-intensive.Footnote 38 Given that the direct leakage argument is most acute in relation to a small number of trade-exposed, energy-intensive industry sectors, international sectoral agreements that impose a common price on carbon on these industry sectors would seem preferable to unilateral border measures by the United States or the EU. Only a small number of countries need to be involved in such agreements; for example, to cover 80 percent of the emissions from developing countries in each sector, only three developing countries need be involved in the case of iron and steel, four in aluminum smelting and pulp and paper manufacturing, seven in cement, and nine in chemicals and petrochemicals.Footnote 39
The foregoing arguments suggest that the case for border adjustments is by no means as robust as it might first appear. However, let us assume for the sake of argument a best-case scenario: that border measures do not set off a tit-for-tat carbon tariff war, that they do not divert trade, and that they succeed in preventing carbon leakage and job loss—all while minimizing competitive disadvantage. Let us also assume that they are methodologically robust, based on adequate and reliable information, do not prompt (or at least can survive) a WTO challenge, and provide leverage on at least some countries by forcing stronger climate policies. Of course, this is an extremely unlikely scenario, but it will help us concentrate on the fairness, rather than the efficacy, of border measures from the standpoint of international climate justice. That is, if we assume that carbon equalization measures can be effective, this still begs the question as to whether they are a fair and appropriate response to the leakage problems they seek to address, and whether this type of leakage is the most or only significant leakage to consider. We have already noted that border measures could potentially poison the international climate negotiations by angering major developing countries, such as India and China, against which such measures are primarily directed. However, this claim must be more closely examined because it bears directly on conflicting interpretations of the burden-sharing principles of the regime and the broader questions of climate justice.
The Fairness of Border Measures
The case for border measures rests on two conceptually distinct arguments: preventing carbon leakage and preventing competitive disadvantage. Direct carbon leakage is a legitimate concern of policy-makers because it undermines the basic purpose of the regulatory effort, which is to reduce emissions. However, given the minimal empirical evidence of direct carbon leakage to date, it is clear that more general competitiveness concerns are at least, if not more, significant in prompting consideration of border measures.
Competitive disadvantage arises when a company or sector is unable to maintain profits or market share, which may not necessarily involve direct carbon leakage.Footnote 40 This is an obvious concern to companies, industry sectors, and unions. However, the basic purpose of the regulatory effort is to raise the price of carbon in order to reduce emissions by prompting lower levels of fossil-fuel usage and the switching to zero or low-carbon alternatives. Competitive disadvantage of the traditional fossil-fuel industry and those industries that are heavily dependent on fossil fuels is therefore a necessary and unavoidable consequence of placing a price on carbon. Indeed, the public may soon come to regard coal (which is the dirtiest of fossil fuels) as “the new tobacco,” insofar as it is a harmful industry that ought to be drastically curtailed rather than propped up. It is generally accepted that taxpayers should not be required to compensate the tobacco industry for loss of profits or reductions in asset value following the introduction of new regulations, and one could argue that the same considerations should apply to coal. However, that many workers and regions dependent on a harmful industry will bear a disproportionate burden of adjustment should certainly be the legitimate concern of policy-makers. It has clearly been a major preoccupation of the U.S. Senate, given that coal is extracted from twenty-six states.Footnote 41 Nonetheless, rather than propping up the industry, I would argue that public money should be spent on transition measures that ensure a gradual phaseout of the coal industry and assist with the development of new, sustainable industries; provisional income assistance for displaced workers; retraining schemes; and the development of new employment opportunities in sustainable industries. The full auctioning of emission allowances would provide a very significant revenue stream (in the order of hundreds of billions of dollars) that could be used to assist severely affected regions, compensate for the socially regressive consequences of increased energy prices, and assist in the transition to a low-carbon economy.
However, defenders of border measures are likely to argue that the problem is not competitive disadvantage per se, but rather unfair competitive disadvantage arising from the fact that U.S. industries are required to incur additional costs relative to industries based in countries that do not impose a comparable price on carbon. The appeal of border measures is that they level the competitive playing field—what Gary Hufbauer, Steve Charnowitz, and Jisun Kim have called “the argument for carbon price equivalency.”Footnote 42 It proceeds from the premise that the atmosphere is indifferent to the source of emissions, and that the main political focus should be on reaching agreement on a common price on carbon among the major emitters from the developed and developing world (whether by means of a cap-and-trade system or a carbon tax) to ensure a level playing field. This approach is forward-looking, as opposed to the backward-looking proposals that have received the most attention to date. Accordingly, whatever happened in the past in terms of historical emissions cannot be changed, and ought not to be judged. The point is to curb and ultimately reverse growth in future emissions from all major emitters to reduce the risks of dangerous climate change.
I take this argument to represent the dominant framing of the climate policy challenge in Congress. It was a core component of the Byrd-Hagel Resolution, it underpinned the Bush administration's repudiation of the Kyoto Protocol, and it has served as one of the key barriers to the successful passage of cap-and-trade legislation in Congress. The problem, however, is that this argument disingenuously assumes that the playing field between developed and developing countries is level but for the new climate regulation. However, the negotiators of the UNFCCC recognized that this is patently not the case, that the world is divided into early and later developers, and that additional atmospheric space and regulatory slack were needed for the late developers to “catch up.” This is explicitly acknowledged in the preamble to the UNFCCC, which provides “that per capita emissions in developing countries are still relatively low and that the share of global emissions originating in developing countries will grow to meet their social and development needs.”Footnote 43 The burden-sharing principles are articulated in various sections of the UNFCCC, but the most significant provision is Article 3(1), which states:
The Parties should protect the climate system for the benefit of present and future generations of humankind, on the basis of equity and in accordance with their common but differentiated responsibilities and capabilities. Accordingly, the developed country parties should take the lead in combating climate change and the adverse effects thereof.
These general burden-sharing principles of “common but differentiated responsibilities” (hereafter CBDR) also give rise to a specific commitment on the part of developed countries to undertake policies and measures that demonstrate that they are taking the lead in reducing emissions, as stated in Article 4(2)(a). Article 4(3) also requires them to provide the financial resources (including technology transfer) to enable developing countries to meet their commitments. CBDR has been carried forward and given effect in the Kyoto Protocol (1997), which requires that only the industrialized countries listed as Annex I countries commit to quantified emissions reductions, while non–Annex I countries have only qualitative obligations. CBDR has also been reiterated in the Bali Action Plan (2007) and the Copenhagen Accord (2009). The latter seeks to lay the political groundwork for the negotiation of a new treaty on long-term cooperative action that includes the United States.
CBDR, then, explicitly acknowledges the lack of a level playing field in emissions production and consumption. This is precisely why the parties did not accept a common carbon tax or a simple requirement of tit-for-tat reductions in emissions by all countries, following the model of tariff reductions under the trade regime, for this would have effectively “kicked the ladder down” for developing countries.Footnote 44 CBDR also takes a significant step beyond the trade regime's acknowledgment of the special needs of developing countries, expressed in the principle of “special and differential treatment” (SDT). Whereas SDT grants developing countries additional time and assistance to meet their common trade obligations (thereby enabling differential compliance with common obligations), CBDR requires differentiated obligations according to differentiated responsibility and capacity. By acknowledging asymmetrical responsibilities, the UNFCCC represents a more significant departure from the traditional liberal contractual norms of multilateralism based on generalized principles of conduct, diffuse reciprocity, and a rough equivalence of benefits over time.Footnote 45 CBDR represents a blending of the polluter pays principle with the beneficiary pays principle. The obligation of developed countries to lead in the mitigation effort rests on their significant historical/cumulative emissions over the past two decades, their much higher per capita emissions, and their greater capacity to pursue mitigation—acquired, in part, through a much longer history of fossil-fuel exploitation.
The argument for carbon price equivalency clearly contradicts the norm of developed country leadership that flows from CBDR by reintroducing a requirement of reciprocity in the form of equivalent costs.Footnote 46 Whereas the argument for carbon price equivalency assumes a fair level playing field, and posits differential obligations as unfair, CBDR acknowledges uneven development in the global economy and calls for developed country leadership. This requires developed countries to take the first and most significant steps in mitigation and to find ways to make it easier and affordable for developing countries to assume mitigation obligations so they can pursue rather than forsake their legitimate development aspirations by following a low-carbon development pathway. This explains why the border measures contemplated by the United States would not receive multilateral endorsement by the developing country parties to the UNFCCC: unilateral measures are against the spirit of the UNFCCC. Indeed, India and China, with the support of developing countries, put forward negotiating texts in the lead-up to COP15 at Copenhagen that explicitly ruled out the unilateral use of border measures by developed countries against the goods and services of developing countries.Footnote 47
The question, then, is whether it is possible to design border measures that are in keeping with the spirit of the UNFCCC. It has been argued that a Kyoto tax against laggard developed countries, of the kind mooted in the EU, is more in keeping with the burden-sharing principles of the UNFCCC than the unilateral measures so far contemplated in the United States because they provide a means of enforcing leadership by developed countries.Footnote 48 Such a discriminatory tax would allow developing countries' share of global emissions to rise (at least in the short term) in order to narrow the development gap. However, this proposal raises a catch-22: the unilateral border measures that are most consistent with CBDR, such as those directed only against developed countries that fail in their leadership responsibilities, are likely to be the least consistent with the WTO's core principle of nondiscrimination, and are therefore likely to provoke a legal challenge in the WTO.Footnote 49 Conversely, border measures that are applied to imports from both developed and developing countries without discrimination would more likely conform to WTO requirements, but would offend CBDR and the associated principle of developed country leadership, and can thus be expected to be strongly resisted by developing countries.
The politically favored method of avoiding this dilemma in developed countries has been to compromise the integrity of cap-and-trade schemes through free allowances, and to provide maximum flexibility to industry through carbon trading, offsetting, banking and borrowing of allowances, international linking, or to peg the price of carbon for an interim period. So far, the United States, as the most powerful trading nation, is the only country that has seriously contemplated adding border measures to this list, although the EU can be expected to give the matter more serious consideration as it seeks to implement its more aggressive 2020 targets. Given that border measures have been necessary to garner political support for cap-and-trade schemes in the United States, in the next section I consider whether it is possible to design them in ways that respect the spirit of the burden-sharing principles of the UNFCCC, are unlikely to provoke a WTO challenge, and acknowledge the development needs of developing countries. In tackling this challenge, it is necessary to return to our earlier distinction between direct and indirect carbon leakage.
ACCOUNTING FOR DIRECT AND INDIRECT CARBON LEAKAGE
I have argued that competitive disadvantage should not deter national policy-makers from imposing a domestic price on carbon if it is accepted that developed countries should take the lead in mitigation based on CBDR, and that the imposition of nondiscriminatory, unilateral border measures to address competitive disadvantage undermines this leadership. I have also argued that carbon leakage is a legitimate concern for policy-makers. However, it is necessary to consider direct carbon leakage alongside the indirect leakage arising from the more general trend in “emissions offshoring.”
Of course, trade economists would not consider indirect carbon leakage to be a problem. It is, after all, the “natural” outcome of liberalization and the workings of the law of comparative advantage, which have provided new development opportunities for developing countries, expanded world output, and flooded the international market with a cheaper and wider variety of products. However, many environmentalists and critics of globalization are not so sanguine. Increasing specialization and exchange increase not only world output but also the material-energy throughput in the world economy, as well as aggregate emissions. Specialization and exchange also increase opportunities for the externalization of the social and ecological costs of production and consumption through space and time. It is now widely acknowledged that the worst impacts of climate change will be suffered by communities in the poorest and least developed regions of the world—those who are the least responsible for emissions and the least capable of adapting to new conditions.
However, the problem, as we have already noted, is that the current system assigns responsibility for emissions based on territorially-based production, rather than the final demand or consumption of goods and services. This means that indirect leakage arising from the shift in energy-intensive industries to developing countries has actually worked to the benefit of developed countries. (Emissions from aviation and shipping have escaped this net entirely, but that is another debate.) These findings have been used to support the case for consumption-based accounting on the basis of the beneficiary pays principle rather than the polluter pays principle, since it is OECD consumers, through their purchasing power, who enjoy the primary benefits.Footnote 50
Indeed, many critical political economists have argued that outsourcing emissions is part of a more general phenomenon of “ecologically unequal exchange” arising from globalization.Footnote 51 The theory of unequal ecological exchange maintains that structural asymmetries in the global economy have produced overconsumption and improved domestic environments in the Global North and underconsumption and the degradation of domestic environments in the Global South.Footnote 52 However, this theory fails to acknowledge that rapidly growing countries, such as China, enjoy the benefit of the foreign exchange earned from its exports, and that the global environment will deteriorate, not just the environment in developing countries, from this mutual dependency. Export-led development in the Global South depends on continued consumption in the Global North. Efforts by Americans or Europeans to reduce their consumption of imports from rapidly growing developing countries would not only break this mutual dependency but would also sacrifice the other advantages of specialization and exchange as well as the development aspirations of developing countries.
The challenge, then, is to devise a fair means of assigning emissions and allocating responsibility while also facilitating a rapid transition to a low-carbon global economy. Shared producer and consumer responsibility along the commodity chain would seem to be the fairest response, which is still likely to attribute more responsibility for emissions to developed than developing countries than is currently the case under production-based accounting, given the high consumption in developed countries. However, politically and practically, it is now far too late to change the system of calculating national emissions given the entrenchment of territorially-based, production accounting under the UNFCCC framework.Footnote 53 There are also many methodological challenges and uncertainties associated with assembling consumption-based inventories, or combined consumption- and production-based inventories. Similar methodological challenges and verification problems confront calls for carbon labeling on all products to enable consumers to make informed choices about the consequences of their purchasing decisions, although a consumer campaign directed toward transnational corporations to “decarbonize” global supply chains might be more worthwhile and more efficient in terms of transaction costs. Such corporations have the most detailed knowledge of the energy use and emissions associated with global supply chains, and they are in a strong position to drive changes in their suppliers.
Nonetheless, consumption-based accounting can provide a useful “shadow indicator” to ensure that policy-makers are sensitive to the problem of indirect leakage.Footnote 54 It can help situate the U.S. policy debates about direct carbon leakage and competitive disadvantage in a broader and less flattering context. After all, if developed countries consider they are entitled to introduce unilateral border measures against imports from developing countries to redress the competitive disadvantages and possible direct carbon leakage to developing countries, then developing countries should also be entitled to seek recognition for the disadvantages they suffer from what might be called an “excessive attribution of responsibility” arising from both direct and indirect leakage. As we have seen, the political debate in the United States has drawn attention to rising emissions in major developing countries (which fall outside the regulatory net of the Kyoto Protocol), rather than rising consumption in the United States, not all of which is reflected in the United States' emissions profile.
One could offer an even less flattering portrayal of the EU, the identity of which as both an environmental leader in general and a climate leader in particular is based on its relative success in achieving reductions in emissions through ecological modernization, but much of this has been achieved, in part, via indirect leakage. For example, Davis and Caldeira found that in many wealthy European countries (such as Austria, France, Sweden, Switzerland, and the UK), the consumption-based emissions from imports were in excess of 30 percent, while in the United States the figure was around 10.8 percent.Footnote 55 Indeed, this argument has been made in terms of not just emissions but also biocapacity in general. According to one study by the Wuppertal Institute, the EU maintains balanced trade in monetary terms; but if trade is measured in terms of material and energy flows (from extraction to production, consumption, and disposal), the deficit is very large, with the EU importing about four times more biocapacity than it exports.Footnote 56
AN ALTERNATIVE POLICY RESPONSE
If border adjustments are necessary for the enactment of domestic climate regulation, then they should be designed in ways that are mindful of the benefits and costs of both direct and indirect carbon leakage, sensitive to the workers and communities dependent on energy-intensive industries, sensitive to the development needs of developing countries, and unlikely to provoke a WTO challenge. This is clearly a tall order, but not impossible.
A fair policy response might accept the general principles of CBDR but take issue with the rigid Annex I/non–Annex I binary, and note the considerable variation in responsibility and capacity on either side of this binary. For example, Annex I excludes some developed economies (notably Singapore and South Korea), and does not include all economies in transition. Those excluded from the latter category have formed a group known as CACAM—made up of the countries of Central Asia, the Caucasus, Albania, and Moldova—that are seeking to clarify their status under the climate regime. The non–Annex I bloc includes a range of states that is extraordinarily diverse in terms of economic development, emissions, technological and administrative capacity, population levels and growth, and vulnerability to climate impacts and adaptation needs. There is also a significant middle class in many developing countries—particularly China and India—that consumes at comparable levels to consumers in Annex I countries, just as there are many low-income groups in Annex I countries. Were it possible to move to consumption-based accounting, then ideally all affluent consumers, along with the countries in which they are situated, should take some responsibility for the “luxury emissions” associated with their consumption, just as all low-income groups in developed countries should not be penalized for their “subsistence emissions” or made to suffer from rising energy prices.Footnote 57 This is no easy task given the entrenchment of both production-based accounting systems and the Annex I/non–Annex I division. Obviously, the sooner large carbon-emitting developing countries, such as China, commit to aggregate emissions reduction targets the easier it will be to secure the passage of domestic cap-and-trade legislation in the United States, and the greater the prospects of minimizing the risks of dangerous climate change. Yet tackling climate change is about not only arithmetic but also fairness, and the UNFCCC requires developed countries to take the lead for good reasons.
Bearing in mind the sensitivity of developing countries to unilateral border measures, the best response, both procedurally and substantively, would be to negotiate new multilateral rules under the WTO or the climate regime. For example, Hufbauer, Charnowitz, and Kim have suggested a number of options under the WTO, including a new climate code, which they admit would be “a difficult venture,” or a revision and reinvigoration of the Doha round of negotiations to include climate issues.Footnote 58 They suggest this could take the form of expanding the negotiations on reducing tariff and nontariff barriers on environmental goods to allow higher tariffs on (presumably emissions-intensive) goods that are not accounted for under national commitments under the climate regime, or, alternatively, international sectoral agreements that restrict trade to countries that have imposed emissions limits. They also suggest plurilateral agreements, or simply an agreement on a Code of Good Practice on acceptable trade measures among like-minded members. However, these proposals are not likely to be acceptable to developing countries, and they are inconsistent with CBDR since their primary focus is to level the economic playing field for developed countries.
An alternative would be to seek multilateral agreement under the climate regime, where negotiations have also been strained, but perhaps less strained and protracted than the negotiations under the Doha round, Copenhagen notwithstanding. Ideally, this should take the form of an amendment to Article 3 of the UNFCCC to provide explicit guidelines for the appropriate imposition of unilateral border measures. These would need to be consistent with CBDR and the combined UNFCCC and WTO requirement to avoid “arbitrary or unjustifiable discrimination or a disguised restriction on world trade.” Such negotiations could also provide an opportunity to amend the Annex I/non–Annex I division to remove anomalies, so that all OECD countries are included in Annex I, and create new annexes that reflect the considerable diversity within the developing country bloc. A separate annex could be created for the major emerging emitters that formed the BASIC group at Copenhagen: Brazil, South Africa, India, and China.Footnote 59 Other rapidly growing developing countries could be added to this list to produce a “BASIC-plus” group. The developing countries outside this group should be exempt from border measures. All Annex I members and the BASIC-plus group should be subject to border measures. This would address carbon leakage, and ensure that consumers in developed countries were paying prices that reflected the emissions associated with their consumption.
The crucial issue from the standpoint of fairness is what happens to the revenue.Footnote 60 It is highly appropriate that the revenue earned from a domestic carbon tax or cap-and-trade scheme should be recycled domestically to assist with the transition to a low-carbon economy (especially for displaced workers and those on low incomes). However, it would fundamentally subvert the differentiated responsibilities laid down by the UNFCCC to require producers in developing countries to subsidize this domestic transition in developed countries through border imposts. Indeed, this further underscores why border adjustments run against both the spirit and the letter of the burden-sharing principles of the UNFCCC. The simple way around this problem is to recycle the revenue earned from carbon tariffs back to the BASIC-plus group to assist in their transition to a low-carbon economy.Footnote 61 The revenue could be recycled via a multilateral fund for technology transfer to developing countries, or sent directly back to the exporter's host country to assist in the low-carbon transition in the relevant sectors that are hit by the border measures. This requirement to recycle the revenue would provide the necessary compatibility with CBDR, while addressing both direct and indirect carbon leakage. That is, the carbon tariff or other carbon equalization measures would raise the price of imports and force consumers to take some responsibility for the emissions associated with their consumption according to the beneficiary pays principle. The border measures would also send a signal to offshore producers to reduce the embodied carbon in their products to avoid the impost, while the recycled revenue earned would assist in this process. We have noted, though, that border measures would not necessarily force all offshore producers to take action; some may simply divert their trade or accept lower profits, so further incentives and assistance for retooling would be desirable.
Export rebates should be restricted to energy-intensive industries that are trade-exposed (and therefore cannot pass on the cost through higher prices) and that are most likely to contemplate relocation as the price of carbon rises. Rebates should not be available if there is free or a significantly subsidized allocation of allowances. In the case of a carbon tax or full auctioning of tradable permits, the rebates should be made available with “green strings” attached, such as a requirement to invest in the best available technology or to introduce continuing improvements in energy efficiency.
If the foregoing principles are the subject of multilateral agreement, then they are likely to withstand a WTO challenge under Article 20 of the GATT. Of course, securing multilateral agreement is always difficult, and any proposal to change the annex groupings is likely to be especially controversial—indeed, it has been something of a taboo subject for developing countries. The second-best solution would therefore be for the United States and/or the EU to apply the same principles to their own unilateral border measures to ensure their consistency with the burden-sharing principles of the UNFCCC. Border measures involving recycled revenue would be much less likely to provoke a challenge from developing countries than the border measures thus far proposed in the United States. Nonetheless, we would expect developed countries with weak climate policies to challenge the provision as discriminatory in the WTO unless the recycling provisions were extended to them, and unless they could also be defended as measures to enforce climate leadership rather than disguised protection.
Of course, domestic political obstacles abound. In the case of the United States, the amendment to the UNFCCC would require Senate ratification. Any multilateral or unilateral initiative to recycle abroad the revenue from border measures would require an appropriation from the U.S. Treasury, and therefore require the support of the powerful House Appropriations Committee, which is unlikely to welcome limits on its decisions on how to spend general revenue. However, even putting the proposal before Congress might help to stimulate a deeper debate about the fairness of border measures and possibly generate other initiatives that may be more compatible with CBDR than current unilateral proposals.
It is possible to devise alternatives that can avoid or minimize such congressional obstacles. For example, instead of imposing a carbon tariff and then recycling the revenue back to developing countries under certain conditions (which may cause affront to the recipient countries), the border measure could simply stipulate that importers could obtain an eligible exemption if their relevant country of origin imposed a comparable export tariff.Footnote 62 Indeed, during 2006–2008 the Chinese government imposed export taxes on a variety of energy- and resource-intensive products (such as iron, steel, cement, and aluminum) to encourage greater energy savings in domestic production. Such taxes would have been sufficient to warrant an exemption if the scheme proposed here were in operation in the EU since, according to ZhongXiang Zhang, they were in the same range as the average price of EU emission allowances during the same period.Footnote 63 They also significantly reduced any competitive disadvantage and risk of direct carbon leakage from the European Union.
CONCLUSION
I have argued that unilateral border measures, insofar as they merely seek to level the competitive playing field, are fundamentally incompatible with the climate regime's burden-sharing norms of CBDR. I have also argued that direct carbon leakage is a legitimate concern for policy-makers because it undermines the purpose of climate regulation, but that efforts to address both direct and indirect leakage must still be compatible with CBDR. Recycling the revenue from border measures back to the developing countries from which the imports arose is one means of preventing perverse outcomes in terms of climate justice by avoiding a direct conflict with CBDR. However, this may still not be enough to demonstrate leadership, exert leverage on other countries, and win developing country agreement for an amendment to the UNFCCC. In the final analysis, the short-term costs of direct leakage are likely to be insignificant when set against the immeasurable longer-term advantages that would flow from the imposition of aggressive domestic carbon constraints by developed countries. Exemplary climate leadership by developed countries, designed to facilitate a rapid transition to a low-carbon economy, is ultimately the best means of acquiring the necessary know-how that can be shared with developing countries to enable them to leapfrog over the emissions path taken by developed countries and not remain late developers.
