Earlier this month, the Parliamentary Budget Officer released a report suggesting that if governments keep sheltering industrial emitters from carbon pricing to protect their competitiveness, consumers will bear a greater burden for Canada to meet its climate targets.
Around the same time, Royal Bank of Canada chief executive Dave McKay told The Globe and Mail that Canada may need a carbon tax on imports to “level the playing field” between foreign and domestic companies.
The two stories were not directly related. But together, they pointed toward a controversial form of trade policy that could soon become more familiar to Canadians. It’s one that represents an intersection of two global shifts: greater prioritization of fighting climate change and declining faith in rules-based multilateralism.
So-called “carbon border adjustments” involve tariffs imposed by countries with carbon pricing on imports from jurisdictions without equivalent policies. Until recently, such tariffs were generally rejected as being at odds with World Trade Organization rules or objectives, but they have swiftly gained international momentum.
The European Union is currently developing a border-adjustment plan, with an aim to apply it to sectors such as steel, cement, aluminum and electricity within the next few years. The United States could follow, because Democratic presidential nominee Joe Biden has expressed support for the idea.
The policy lever has flown under the radar in Canadian politics, even though Annamie Paul, who was elected Green Party Leader in early October, has endorsed it.
That could change before long, however, if Ottawa is serious about besting its Paris Agreement commitments, and carbon pricing is to play a major role.
“It’s a sleeper issue" in Canada, says Aaron Cosbey, a leading expert on border adjustments who recently co-authored a report on implementation for the European Round Table on Climate Change and Sustainable Development. “But as soon as you get serious about your ambition” with carbon pricing, he says, the challenges the tariffs are meant to address become inescapable.
In an interview, Mr. Cosbey – a Canadian who has advised Ottawa on other trade and investment matters while working with the International Institute for Sustainable Development – laid out why the policy has come into vogue, while not glossing over its complications and controversies.
Among several reasons to introduce border adjustments, the one usually cited by proponents, including the EU, is to avoid “leakage” – production shifting away from jurisdictions with strong emissions policies. Per Mr. Cosbey, that’s because it’s likeliest among the possible motivations to meet the WTO’s criteria for exemption from trade rules on the basis of environmental concerns.
A second reason is that tariffs can be a blunt instrument used to exert pressure on other countries to take climate change more seriously.
But what could be the biggest draw for Canada’s government is the possibility of protecting the competitiveness of domestic companies, while allowing more climate ambition than the current practice of shielding them.
The “output-based” carbon pricing system now applied to large industries in effect provides generous exemptions for sectors facing competitive pressures. This means many heavy emitters wind up with just tiny shares of their emissions being priced.
The theoretical advantage of a border adjustment is that domestic industry could be made to pay a meaningful carbon price, because the same price would be applied to foreign competitors sending goods into the country. While domestic firms would also likely get some carbon-price rebates on exports, there would be less escape from emissions-reduction expectations than under current measures.
In practice, things get more complicated fast. In Europe, sectors currently sheltered by exemptions from the continent’s cap-and-trade pricing system for emissions are raising concerns about losing them in favour of the adjustment. Among their fears is that, as Mr. Cosbey puts it, they’ll be “stripped naked in the wind” if they surrender existing protections and then the tariffs are struck down.
That puts pressure on policy makers to ensure the mechanism will be trade-law compliant, without making it toothless. And they have to grapple with myriad related questions: Which sectors should it cover? How can rebates be provided on exports without it being deemed subsidization? How should other jurisdictions' emissions-reduction policies be measured, to determine whether products need to have tariffs applied?
If Canada starts going down this path, it’s unlikely to do so alone. The option is probably a total non-starter if Donald Trump keeps the U.S. presidency, given the prospect of a trade war.
A Joe Biden presidency might quickly change the equation. Canada could conceivably be more willing to target American goods for border adjustments if there is a less adversarial White House. But the stronger prospect is co-operation with a Democratic administration interested in the policy.
“It’s a much more serious discussion if it’s continentally integrated,” Mr. Cosbey says, “and I think if Biden wins, we will probably start seeing the beginnings of those discussions.”
It’s unclear how exactly the Americans would impose a carbon border adjustment. The mechanism is supposed to complement domestic carbon pricing, but the U.S. doesn’t have that, and Mr. Biden is lukewarm on it. Using the policy in combination with other forms of emissions reduction, even regulations that cause competitive challenges for domestic companies, would almost certainly break trade law.
But it remains to be seen, as debate around this form of policy just starts to play out, exactly how much trade-law compliance will weigh on governments' minds.
The U.S. has not been all that preoccupied with staying on the right side of WTO rulings in recent years. And partly because the Americans have gone out of their way to undermine the WTO’s authority, other countries may be willing to push the envelope if they believe the policy is necessary to fight climate change without undermining their competitive interests.
“You have the growing recognition that you’re going to have to do something that’s very ambitious and disruptive,” Mr. Cosbey says, “and the lessening concern about what that means in terms of your trade obligations.”
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