The EU’s technical tangle in making carbon border measures WTO-legal

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Hello from Brussels, where the last big policy event of the summer (the drenching rain making “summer” a largely theoretical concept) was yesterday’s launch of the climate package Fit For 55.

My Brussels colleagues have the detail on the last-minute wrangling and dissent here and a rundown of the big issues here. Today’s main piece looks at the main trade bit, the carbon border adjustment mechanism (aka CBAM, the kind of noise we think Batman might make while despatching an arch-villain with a swift right to the jaw) and whether the EU can proof it against World Trade Organization litigation. Today in Geneva — actually by videoconference from around the world — trade ministers will try to make a substantive breakthrough on the WTO talks on reducing fisheries subsidies. Will it happen? No. “Important divisions persist,” according to WTO director-general Ngozi Okonjo-Iweala. We predicted this and explained why recently.

Charted waters looks at the impact of Fit for 55 on the auto industry.

Finally, some housekeeping. From Monday, Trade Secrets will arrive in your inbox half an hour earlier.

The challenge of making discrimination fair

There didn’t seem to be any big surprises as far as we could tell in yesterday’s published CBAM proposal: details of the plans have been trailed and leaked for months. Brussels is obviously at pains to say it’s WTO-compatible, as do the industry associations that are calling for it. It’s clearly not in the EU’s interest to release an idea that will be shot down in volleys of litigation if it’s trying to use it to push other governments towards the use of carbon pricing measures.

It seems pretty clear the EU has decided to defend CBAM using environmental exceptions written into the WTO agreement — most likely Article XX (g) about the conservation of “exhaustible natural resources”, if you’re following at home — which can justify putting border measures on certain imports and not others. 

It’s logical enough on the face of it: breathable air certainly fits that description. But here the fun stuff starts, and the lawyers, climate scientists, economists and other good wholesome folk start earning their money. As Jim Bacchus, former chair of the WTO Appellate Body, notes in this nice summary, in order to use that exception the EU has to prove that CBAM isn’t a means of “arbitrary or unjustifiable discrimination”, or a “disguised restriction on international trade”.

That’s a tricky thing to do. It’s entirely possible to win the argument on principle but lose the case on methodology. Famously, the US did so in some of the big WTO disputes in this area, such as the shrimp-turtle case that started in 1997. The Appellate Body said the US was allowed in theory to ban the sale of wild shrimp caught without special nets designed to allow sea-turtles (the “exhaustible natural resource” in this case) to escape, but that in practice the implementation of the US law favoured some foreign countries and producers over others.

In a similar way, as this very interesting thread by a Brussels lawyer argues, in order to justify CBAM as an environmental measure the EU will have to show that carbon leakage (emissions-heavy industries moving abroad) is a real thing. This will be hard, because there’s no agreed methodology to prove leakage: the EU talks about risks rather than certainty. It’s also going to be fiendishly difficult to work out what the implicit cost of emissions is for a country that has some form of regulatory carbon control rather than an EU-style emissions trading scheme with an explicit price.

As we have said all along, it’s down in the detail that the EU gets on to uncomfortable ground. As Bacchus points out, WTO obligations apply to individually traded products, not just to the policy orientation of an entire trading partner. A clean producer from an economy with weak official environmental standards should not be penalised. Assessing carbon content by product and producer will involve a vast amount of monitoring and assessment. The EU’s plans make provisions for that, but it’s an unfamiliar way of doing things, at odds with the typical Brussels state-to-state mindset that all global problems will be fixed if other governments just do what the EU does.

Lorand Bartels, a University of Cambridge law academic and counsel at the law firm Freshfields, says: “Creating a WTO-compatible carbon border measure involves the EU letting go of one of its instincts, which is to deal with entire countries as part of a legal order rather than individual products and producers.”

Two other things could foul up the EU’s case for WTO compatibility. One would be indefinite, or even prolonged, free allowances of carbon credits to parts of EU industry, which would make it easier for other countries to argue that this is indeed a “disguised restriction on international trade”.

The other is money. CBAM will raise revenues in the form of tariffs. But according to the EU’s own logic, the optimal amount of revenue is nil, because this is supposed to be an environmental measure that encourages everyone to adopt an EU-equivalent carbon pricing mechanism.

If the European Commission goes round giving the impression that the EU is banking on CBAM revenues as a significant ongoing contribution to so-called “own resources” — money raised centrally rather than by the member states — it’s going to hand ammunition to opposition lawyers in any future WTO action. Assuming he was talking about carbon border measures — it’s not 100 per cent clear — internal markets commissioner Thierry Breton might be advised not to repeat his boast about import tariffs being brought in to repay the EU’s new centrally issued bonds.

We stand by what we’ve always said about carbon border measures. Economically solid in theory, legally and technically tricky in practice. We continue to wish the EU luck. Someone has to be pushing the debate about trade and climate. But this remains a project with an awful lot of unanswered questions that stand at odds with other EU policy goals and orientations.

Charted waters

Another aspect of the Fit for 55 package that has caught a lot of attention are the measures that ban the production of vehicles with internal combustion engines, including hybrids, by 2035.

With auto manufacturers one of the region’s most important exporters, this will have ripples beyond the EU. Figures in the chart below also highlight why the ban was necessary, with carbon emissions in newer passenger vehicles actually creeping up over the past couple of years in several member states. Claire Jones

Line chart of annual figures for emissions of CO2 per km for new passenger cars showing Emissions from new cars in the EU have crept up

Trade links

It appears western brands’ condemnation of alleged human rights abuses in Xinjiang province is having an impact on Chinese spending habits. Nikkei reports ($, subscription needed) that young people are snubbing foreign brands in favour of guochao, or “China chic.” Meanwhile, from solar panel producers to apparel retail giant Uniqlo, Japanese businesses increasingly fear US sanctions on their suppliers over alleged forced labour in Xinjiang.

Differences in opinion over China feature high on the agenda for Angela Merkel’s farewell trip to Washington, DC as German chancellor. The excellent Europe Express newsletter gives an insider take on the Green deal proposals.

Economists look at the relationship between container shipping and the US business cycle. Chad Bown of the Peterson Institute charts how medical shortages in the early days of the pandemic triggered extraordinary shifts in trade policy.

And finally, some good news on the semiconductor chips front. TSMC has said it believes the global shortage may soon ease. Happy weekend all! Claire Jones

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