The carbon tax that Brussels hopes will catch on


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Hello from Brussels. By now there seems to be a reasonable degree of confidence here that there will actually be a Joe Biden administration to deal with at the end of January rather than an alt-right paramilitary junta. Attention has turned away from the aftermath of the Capitol Hill insurrection and towards what the forthcoming policymakers are actually saying.

As we noted in Trade Secrets yesterday, the maiden speech of Katherine Tai, the US trade representative-elect, was interesting if not breathtakingly radical. (Not radical is fine, as far as the EU is concerned.) In fact, it echoed a lot of the thinking over here, that enforcement of existing trade rules will be the big thing rather than racking up shiny new agreements. Whether the EU and US can collaborate on said enforcement is the open question.

Today’s main piece looks at an EU initiative that might either be a source of tension or co-operation with the US: its plans for a carbon border tax. Tall Tales continues to mine the rich vein of told-you-sos arising during the implementation of Brexit. Our chart of the day covers the boom in Chinese goods exports.

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An incremental way to save the planet

On Monday we looked at the digital services tax, a prominent document in the “Potential trade battles with the US” folder on the EU’s computer desktop. A similar item in the “Potential trade battles with everyone” file is the proposed carbon border adjustment mechanism, or CBAM.

A CBAM, which the EU hopes to introduce in the next couple of years, would mean that the carbon emissions of imports are charged the same cost as their EU equivalents. Such a system would be economically efficient and intuitively fair: it prevents carbon leakage by internalising the cost of carbon emissions to the EU’s trading partners, as well as to its own producers. Unfortunately, its economic and ethical attractiveness is in inverse proportion to the ease of designing a mechanism that could both achieve these desired ends and stay within World Trade Organization rules. 

The European Commission’s finest have beavered away since 2019 to produce a proposal by this year. There are two particular reasons why it’s a lot harder than it sounds to come up with an effective CBAM. For one, a blanket tariff on all imports from a particular country erases the difference between relatively carbon-light and carbon-heavy producers. Second, assessing a product arriving at the EU border depending on its last export destination glosses over carbon emitted earlier in the supply chain. Detail matters in the design of a CBAM. Ignoring technicalities is both inefficient and potentially opens the measure to legal challenge at the WTO.

An obvious way to do a carbon border measure, as we’ve described before, is in effect to incorporate foreign producers into the EU’s emissions trading system, its carbon market and also the most important tool Brussels has right now for reducing greenhouse gas emissions. This would require them to buy the permits that European producers must now use to be able to compete with them in the EU market.

Implemented properly, this ought to be OK under WTO law, if necessary by invoking the right to impose tariffs to conserve “exhaustible natural resources”. A paper commissioned by the European Parliament offers a very clear analysis of the WTO legality of carbon border measures. The policymaking connections of its authors, David Kleimann and Joost Pauwelyn, are worth noting. Kleimann is former adviser to the chair of the European Parliament’s trade committee and now a fellow at Georgetown University in Washington: Pauwelyn is Brussels’ nominee to sit on the EU-designed stopgap WTO appeals mechanism, and probably a future appellate body member, if it ever gets revived. He also helped to design border measures in a carbon pricing proposal presented to the US Congress more than a decade ago.

However, using the emissions trading system limits the measure’s scope. The scheme covers only some industries, and to start with the CBAM will similarly be limited to a small range of basic energy-intensive commodities — perhaps cement and steel. For finished goods rather than raw materials, the question remains whether the costs of inputs can be calculated. To assess emissions by product and by producer will require a complex emissions certification, granted by external inspectors working to an EU benchmark. 

Finally, there’s the issue about what to do with those EU industries (including steel and cement manufacture) at present given free allocations for emissions under the emissions trading system. It would make sense to abolish those allocations simultaneously with introducing the CBAM. The US already regards 100 per cent-free allocations as trade-distorting subsidies that can be met with anti-subsidy duties. But industries that receive free allocations are resisting.

If and when the EU launches a CBAM, it will start it off narrow in coverage and address as many of the technical and legal complexities as possible while being prepared to adjust it as it goes along. It’s quite likely that there will be WTO litigation: indeed, you might well conclude that if China hasn’t brought a case within a few months, then the scheme wasn’t ambitious enough. Through a process of trial and error, in the same way that the Airbus-Boeing litigation has gradually pointed the way to an enduring aviation subsidies regime, perhaps the EU’s carbon border mechanism will bed down enough that it can at least start to make a measurable difference to relative carbon prices worldwide, which at the moment offer far too little incentive to reduce emissions.

This gradualist approach is no doubt the sensible one, but it does raise the question of whether such an incremental measure is worth the hassle. An independent study commissioned by the Finnish government concluded that a CBAM might well end up being more symbolic than substantive, and indeed counterproductive if it provokes retaliation from the likes of China.

The real prize would be for the mechanism to have an impact on international political economy. If the US enacts its own form of domestic carbon pricing and adopts a similar border measure, the global balance of power could change. It would no longer be Green Europe against the world but that fabled transatlantic alliance we keep hearing about holding China to its promises to cut carbon emissions to net zero by 2060. That’s a project for the medium term, to say the least. But at least a working EU CBAM, even a limited one, might nudge the world gently in the right direction.

Charted waters

Trade tensions? What trade tensions? China’s trade surplus hit its highest ever monthly level in December, as the country’s exports continued to boom during the pandemic, Thomas Hale writes. Exports grew 18.1 per cent in dollar terms last month, while imports rose 6.5 per cent, pushing the trade surplus to a record $78bn. Here’s what has happened to goods exports since the pandemic went global in March last year:

Line chart of year-on-year change in exports (%) showing China's trade surplus has soared

Exporters have benefited from higher demand for medical products and lockdown-related goods at a time when global trade has come under intense pressure and other big economies have struggled to cope. China is the only one of the world’s major economies that is expected to have grown in 2020.

Tall tales of trade

Goods confiscated by Dutch customs officers from ferry passengers arriving in the EU from the UK
Goods confiscated by Dutch customs officers from ferry passengers arriving in the EU from the UK © Sander Koning//EPA-EFE/Shutterstock

We can see that the implementation of Brexit is going to keep us in Tall Tales, which we might temporarily rename Told You Sos, for months to come.

This week’s involves the comic sight of Dutch customs officials gently relieving a British lorry driver of his ham sandwich at the border under EU food hygiene rules. Cue spluttering from Brexiters that the UK hasn’t diverged from EU regulations in this area, or not yet, so there’s no need to treat them differently. Forgive us while we do a few eye-rolling exercises.

The point, as some of us have explained only about a billion times, is that as soon as you leave the single market and its enforcement mechanisms, including the European Court of Justice, the EU no longer has oversight of your inspection and regulatory processes and so will not take them on trust. It’s not about having the same regs: it’s about having different legal regimes to enforce them.

Bad news for the UK economy, to be sure, but at least the Dutch catering industry can see brighter days ahead, assuming of course there will be any British lorry drivers left to sell sandwiches to.

Don’t miss

  • Michel Barnier has warned that many of the new regulatory frictions hampering cross-Channel trade will be impossible to smooth over, as the inevitable consequences of Brexit begin to manifest themselves for businesses across Europe. 
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  • On the topic of frictions, German logistics group DB Schenker on Wednesday became the latest major parcels operator to suspend cross-border delivery services because of new red tape and customs paperwork imposed by Brexit. In a note issued to customers, the company said it was suspending shipments from the EU to the UK blaming the “enormous bureaucratic regulations” created by the post-Brexit trading arrangements that had left recipients in the UK unable to handle shipments in a “legally compliant manner”.
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  • Amsterdam is already showing potential to eat into London’s pre-eminence as a European capital markets centre. Trading in EU shares fled London for EU centres, including the Dutch city on the first day outside the single market at the start of 2021, while Polish ecommerce group InPost picked the city for its stock listing on Wednesday. The announcement by the parcel locker business suggests that initial public offerings may also gravitate towards where trading in European stocks is more lively.
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Tokyo talk

The best trade stories from Nikkei Asia

  • The US company behind The North Face and Vans will relocate its Asia-Pacific headquarters to Shanghai and Singapore, the latest high-profile corporate exit from Hong Kong. 
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  • Even business travel bubbles with 11 neighbouring countries will be closed as Japan restricts entry once again to curb the spread of coronavirus. 
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  • Indian government data show imports from China fell 19.5 per cent in the first 10 months of 2020, as a border dispute stoked bilateral tensions and spurred a build-up of domestic industries. 
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