The European Union (EU) appears ready to move ahead with plans for a carbon border adjustment mechanism (CBAM). It might work, but then again, it might lead to a trade war. The new director general of the World Trade Organization (WTO), Ngozi Okonjo-Iweala, recently proposed a coordinated approach with a better chance of success.
While it is yet to be finalized, leaked documents indicate that a new EU mechanism would subject imports to a carbon-related fee to mirror the costs that the EU’s emissions trading system imposes on its own producers. Initially only electricity, iron and steel, cement, aluminum and some fertilizers would be directly affected. These sectors go first because the EU envisions a “high risk of carbon leakage” or production shifting to countries with laxer emission constraints.
In other words, the EU is going to try to put a price on carbon, and exports from countries that are not doing the same thing will be subject to a purportedly equalizing tariff.
What does this mean for U.S. exporters? Overall, not as much as you might think. According to a paper by Elisabetta Cornago and Sam Lowe, the countries with the greatest exposure to the tariff are Russia, Turkey and China. U.S. exposure, which ranks 12th on the list, would be concentrated in a few sectors such as iron, steel and aluminum.
We should not be surprised by the Europeans’ move. This year, for the first time, the G20 ministers agreed on language “to preserve the global climate and ensure a clean and inclusive energy transition” in its adopted joint final communique. The G7 used even stronger language, stating that “urgent and concrete action is needed” to mitigate and adapt to climate change. That means Brussels may merely be first out of the gate. Whatever inevitable action is taken is bound to have major trade implications, because carbon content and production vary across sectors and countries.
It just might work. After all, if you want to achieve change, you incentivize the good behavior and disincentivize the bad. It’s economics 101. But it won’t be easy.
If the price is too high, adjustment will be sharp and costly. If the price is too low, it will be ineffective. Getting the implementation just right is really hard, especially when the actions of one country or trading bloc have implications for others. If history is a guide, expect revisions over time.
How the Biden administration and Congress respond will be key. Special interests such as the U.S. steel sector may argue that CBAM is a subsidy to their European competitors, and that EU products should be subject to countervailing duties in the United States. We could see numerous cases coming forward against EU imports, which would lead to even more retaliatory tariffs on U.S. imports from the EU. This has all the makings of a trans-Atlantic trade war.
Enter Director General Okonjo-Iweala (often referred to endearingly as Dr. Ngozi in the trade policy community). She is a U.S.-trained economist and Nigerian ex-finance minister. Last week, she called on the world’s leading international economic organizations – including the WTO, World Bank, International Monetary Fund and Organization for Economic Co-Operation and Development – to put their heads together and come up with a global carbon price.
Far from a typical Geneva schmoozer, Dr. Ngozi’s track record is practical-minded and solution-oriented. On trade and climate, she clearly sees different countries on the verge of pursuing different solutions, with bitter disputes on the horizon. The international organizations she called out are creators and repositories of valuable data. They are also where economists from member countries come together and conduct economic analysis to support informed policy discussions. If they can do that, we might be able to avert a trade war at a time when the world economy needs trade the most.
Policymakers need only remember the basics. First, treat all trading partners equally. Second, don’t discriminate between imported goods and domestically produced goods. These are among the first articles of the 1994 General Agreement on Tariffs and Trade (GATT).
In principle, the Biden administration should be on board. In a recent talk about the WTO and the future, U.S. Trade Representative Katherine Tai acknowledged new challenges and said we need to work together. The real challenge will be resisting special interests that may call any effort to price carbon, collaborative or not, a subsidy.
The United States should offer its best minds to these international organizations and be a productive participant in Dr. Ngozi’s efforts. These are the challenges of the day. This is how America can lead and help ensure that new problems don’t emerge. For Biden, averting a trade war with a key ally while contributing to effective solutions on trade and climate would be a win-win.
Christine McDaniel is a senior research fellow with the Mercatus Center at George Mason University.