The European Union’s Proposed Carbon Equalization System: Can it be WTO Compatible?

Biswajit Dhar, Kasturi Das
JEL codes: 
Discussion Paper # 156

Numerous political statements by the world leaders on the urgency of reaching an ambitious climate deal in Copenhagen notwithstanding, the actual discussions at the UNFCCC (United Nations Framework Convention on Climate Change) continue to be shrouded by daunting North-South divide, dimming the hope of sealing a deal in December 2009. The negotiating climate has been further queered by the European Union (EU) and the United States (US), which have, in the recent past, made attempts to include certain unilateral trade measures in their domestic climate change regimes. Among the issues that have fuelled the debates on the climate-trade interface in the run-up to Copenhagen, perhaps the most contested one is the proposed use by developed countries of border measures on imports from countries (read major-emitting developing countries) not implementing comparable GHG (green house gas) emissions reduction policies on the grounds of addressing the risk of what has been coined as carbon leakage. The issue of carbon leakage has its origin in the purported apprehension in these developed countries that in the energy intensive, trade-exposed sectors, the carbon costs imposed by their domestic climate policies (e.g. carbon tax or cap-and-trade scheme) will put domestic producers at a competitive disadvantage vis-a-vis producers in countries not imposing similarly strict carbon constraints. It is argued that if stringent domestic climate action causes their firms to relocate to other countries with less stringent or no carbon constraint, or to lose market share to firms from countries having low emission standards, then the emission reduction achieved in countries imposing stringent measures will be offset to a great extent by an increase in emissions elsewhere. According to the developed countries, such carbon leakage could end up undermining the environmental integrity of the carbon constraining domestic policy measures. In keeping with the above arguments, law makers in both the US and the EU have proposed introduction of carbon tariffs in order to obviate the disadvantages that their domestic products may face vis-a- vis imports as a result of emission reduction measures being adopted by them. While the inclusion of such onerous proposals in the American Clean Energy and Security Act of 2009 (the Waxman-Markey Bill), as approved by the US House of Representatives in the end-June 2009, has generated significant furore over the past several months, somewhat similar provisions were already included in the post-2012 climate change and energy package finalized by the EU in December 2008. It is widely argued by developing countries that such carbon tariffs on imports would be akin to protectionism in the guise of preventing global warming. Concerns have emerged among the so-called major-emitting developing countries (such as, China and India), who are the main target of such measures, that these measures could act as a discriminatory market access barrier affecting their exports to the developed countries concerned in energy intensive sectors that may come under the purview of these measures. Hence, it is apprehended by them that the proposals to impose such carbon tariffs may act as an effective threat to induce them to undertake binding emission reduction commitments in the ongoing climate negotiations. It is this tacit protectionist intent allegedly underlying the proposed border measures that has triggered a huge furore among the developing countries. Another controversial issue pertaining to such carbon tariffs is whether they could be compatible with the WTO (World Trade Organization) commitments of the countries introducing such measures. This concern has found reflection not only in the post-2012 climate-energy package of the EU itself, but also in the debates on the domestic climate legislations in the EU and US. Against this backdrop, this paper makes an attempt to analyze the WTO compatibility or otherwise of the border measure proposed by the EU in its post-2012 climate- energy package. The analysis focuses on two sets of issues: (i) whether the proposed border measure could conform to the border tax adjustment provisions and the Most Favoured Nation (MFN) clause of the GATT (General Agreement on Tariffs and Trade), and if not then (ii) whether the EU could justify it under the General Exceptions provisions included in Article XX of the GATT that allow WTO Members, subject to certain conditions included in its chapeau, to deviate from their GATT obligations to serve certain legitimate policy objectives, including environmental objectives. The analysis presented in this paper indicates that the EU could face significant difficulties in establishing that the proposed border measure would be WTO-compliant. However, the devil would finally lie in the details.