Tim Groser
8 December, 2009
Trade and Climate Change: A Negotiator's Perspective

Over the next two weeks at Copenhagen, starting at official level, and culminating with the arrival of some one hundred Heads of Government, including both the British and New Zealand Prime Ministers, we hope to see the shape of an agreement emerge to counter the threat of anthropogenic induced climate change for what is called the ‘second commitment period', which is set to begin on 1 January 2013.

Since I am within spitting distance of Whitehall, allow me to use the wonderfully understated language of the British Civil Service. At the very least, it will be an "interesting" meeting.

Copenhagen: the Outlook

There will be literally thousands of international civil servants; hundreds of harassed security guards; a phalanx of the world's media interviewing delegates initially and finally interviewing each other. There will be businesses, lobbyists, a diverse range of NGOs with a vast universe of demands and agendas, some of which will be only loosely related to climate change.

There will be film stars, vegans, people running around in polar bear suits.

This is, ladies and gentlemen, international diplomacy in action. Is it likely to lead to anything useful?

It is a high risk strategy, so where is the smart money?

Well, in my opinion, the smart money is, thank heavens, no longer either on a complete train wreck or, more realistically, a complete diplomatic fudge with not much decided behind the facade. That was, in my view, where things were heading until the Danish Prime Minister, Mr Rasmussen, wisely recalibrated expectations at the APEC Leaders Meeting in Singapore a few weeks ago from the totally unrealizable objective of a ‘complete and ratifiable agreement' at Copenhagen towards a ‘one agreement, two steps' negotiating scenario.

I have spent thirty years negotiating international economic agreements. Most of them, contrary to popular opinion, and after massive political frustration and delays, do end up getting done - never perfectly of course, but usually in the right direction.

But this is never achieved in one step and seldom in conformity with agreed ‘road maps', or time-lines to which solemn Brownie oaths have been earlier pledged. A successful negotiation is always done incrementally by building up convergence and consensus first at the general, then increasingly specific, levels of detail.

Thanks to the leadership shown by the Danish Prime Minister, the formal negotiating draft legal text - with its hundreds of pages and thousands of square brackets representing different opinions - will be formally set aside. That is as bogged down as a medieval swamp somewhere in Wales. But that is no longer intrinsically a problem, now that we have the outline of a realistic scenario.

Highly experienced and astute Secretariat officials, working closely with experienced negotiators from a number of countries, will be developing a text covering the key issues contained in the unmanageable draft legal text and on which firm political decisions are required - mitigation targets, financing in both the short and long term, capacity building and other key elements of the earlier Bali Action Plan.

We do have a problem however: the recalibration of expectations as to what could be realistically achieved at Copenhagen has been left terribly late and there is high confusion out there as to what the real negotiating scenario for Copenhagen is.

Extremism, or gross tactical misjudgments by certain Delegations, can still torpedo what could be a highly constructive step towards a full and ratifiable agreement at a subsequent point. This is not a time for people to start throwing their toys out of the cot. And if finally wisdom prevails, and we do get a solid set of politically binding decisions on key issues, our professional negotiators will then be able to re-engage in 2010 to complete the second, and one hopes, final step towards a far more solid agreement than Kyoto ever was.

Let us be clear about one thing: an agreement for the second commitment period that simply replicates Kyoto is a non-starter. It is not a question about ‘killing Kyoto', as the incendiary rhetoric of recent negotiating meetings has it. In fact, any conceivable agreement for the second commitment period will build on key Kyoto concepts. But another Kyoto? No. It won't do the job.

Building a post-Kyoto agreement that has any political or environmental integrity has to be based on the primacy of domestic policy to counter climate change and an appreciation of the hard facts about the sources of future emissions growth. Let me start with the first before moving to the deeply controversial and uncomfortable second element.

The Primacy of Domestic Policy Base

To someone like me, coming from a trade negotiating background, the underlying approach taken by Kyoto negotiators is simply mysterious. Having set out targets for emissions reductions which they were bound to meet in terms of international law, and with over a decade lead-in time before the start of the first commitment period in 2008, until recently, Governments did little. What were they thinking? That this would be achieved by magic?

There is one honorable exception: the EU. The EU at least started to put a price on carbon, via its ETS, some six or seven years after the completion of the Kyoto negotiation. OK - it is a partial scheme that exempts for the time being around 40% of Eurozone GDP, but at least the EU provided a lead and is now starting to address the excluded sectors with complementary measures.

However, from about the start of the First Commitment Period, I would have to change this narrative. Things have started to move - far too late of course, but decisively in the right direction.

It is no longer just the EU that is putting domestic policy in place to transit to a lower carbon growth path. In the developed world, the political process is messy, because democracy is intrinsically a messy process.

In NZ, we have completed the design of the worlds only fully comprehensive, all gases, all sectors Emissions Trading Scheme.

Amongst developed countries, few if any face the same difficulties in finding low cost mitigation strategies as NZ. One of the complications of the nation-based approach to emissions reduction strategies is that the worse you were in the base period, the better placed you are to effect low cost emission reduction strategies.

The key difficulties for NZ are that some 70% of our electricity is already from renewables - the comparable figure in the UK is 2%
. But most problematic is that 48% of our gross emissions come from agriculture, where there are only limited abatement options - unless of course, you are prepared to reduce food production, which we are not.
Frankly the world will need vastly efficient food exporters like NZ to increase, not decrease food production. The world needs to increase food supply by 50% over the next 20 odd years. We have put agriculture into our ETS - the only country to do so. It is not a popular decision among our farmers, who cannot understand why NZ alone should put a carbon price on its agriculture output. But we have done it.

Longer term, we believe it will be essential to develop research breakthroughs in agriculture to ensure that the world does not face an impossible choice between food security and climate change.

This is why, incidentally, NZ has proposed a ‘Global Alliance' amongst the world's leading agricultural research institutions. The intention is to develop new technologies to reduce the linkage between food production and emissions growth. We are extremely optimistic, given the highly favourable responses we have attracted already, that this initiative will start to take shape soon, starting next week at Copenhagen.

Across the Tasman, Australia too is confronting the absolute need to put in place a price on carbon through the proposed CPRS, or Carbon Pollution Reductions Scheme. The scheme has twice been voted down in the Senate. If anyone believes that getting climate change friendly policies in place is just a matter of politicians showing ‘political will', I suggest they study the dramatic Australian political developments in the last two weeks. It is extremely difficult in any democracy to establish the political consensus required to turn an economy around towards a lower carbon future.

Most importantly, the United States is similarly mid-way through its democratic procedures to put a price on carbon. The Waxman-Markey Bill has gone through the House; the Kerry-Boxer cap and trade bill is making its way through the US Senate. US negotiators are adamant that this time, they will not make the mistake that was made in Kyoto: agree to targets without having a domestic policy base, or at least the very clear prospect of one, in place.

This is not an international beauty contest where some emissions reduction figure is picked out of the air and doubled to international applause from rock stars and other glitterati, only to find later that no-one had a clue how to effect it.

It is instructive that on the first day of Copenhagen, three independent climate change think-tanks, all on the side of a strong collective response to climate change and led by the European Climate Foundation, published their analysis of countries' offers. They gave each offer one of three grades: inadequate, satisfactory and medium. The assessment is, of course, based on comparability of effort.

NZ, with its offer of -10% to -20%, is assessed as ‘medium' (only Switzerland is also rated ‘medium' along with NZ). We are not top of the class - only Japan and Norway are assessed as ‘satisfactory' - but we are clearly in respectable territory and this is completely consistent with the position our Prime Minister took to the NZ electorate - namely, that NZ, with its unique carbon footprint, would not strive to ‘lead the world', but would ‘play its fair share'. Below NZ, the EU, by contrast but with a higher nominal offer of -20% to -30%, is assessed as ‘inadequate' - along with the others.

This is not ‘breaking news'. There is nothing remotely surprising here to people who go beyond superficial headlines to the substance. This latest finding is, totally consistent with earlier OECD and other serious modeling work around the issue of ‘comparability' of offers. It demonstrates yet again the extreme naivety of making a comparison based on nominal numbers alone.

Back to the primacy of domestic policy to combat climate change. You can be sure that the United States delegation will be very careful in Copenhagen to endorse negotiating ideas and proposals that will help them get the domestic policy combating climate change in place and will oppose negotiating proposals that will complicate getting a domestic consensus in place. And in my view, they will be absolutely right to take this approach.

There are also unmistakable and positive signs of progress amongst the large developing countries. India, China, Brazil, Mexico, South Africa are all on the page with serious proposals to reduce the relentless growth of their emissions from a ‘Business as Usual' or BAU extrapolation.

There are some fundamentally difficult negotiating issues about how such developing country mitigation strategies might be scheduled, about the compliance regime around them and so forth but it would be churlish not to recognize the shift that is taking place.

So one test of Copenhagen will be as follows: how can we capture this domestic policy momentum in an internationally coordinated way and build on it?

Developing Country Emissions

While we can and must welcome the increasingly positive moves of the large developing countries, we cannot escape the question: are these moves by the large developing countries anywhere near sufficient? In negotiating terms, how are we going to break the outmoded ‘firewall' between so-called ‘Annex 1', or developed countries, and Non-Annex 1, or developing countries?

This is of course a deeply political matter, but finally more importantly, it is a scientific matter.

A simple way of expressing it is that if we do not start a transformation that delinks developing country growth - which must proceed given the poverty that still remains - with relentless emissions growth, we are simply not going to get on top of this global problem.

There are various statistics you can use to portray the problem. Since I am in the UK and the eminent British economist Lord Stern has played such a prominent role in defining the debate - and no-one can accuse Nicholas Stern of being unsympathetic to the developing countries - let me use his characterization. This is from Hepburn and Stern's "The Global Deal on Climate Change", published this year:

"In the next 20-25 years, under business as usual, China alone will emit cumulatively more than the USA and Europe combined over the last one hundred years, driven in large part by its coal consumption".

Another way to express the same conundrum is from the 2009 OECD study on the Economics of Climate Change:

"An incomplete country coverage of GHG mitigation policies would not achieve much. All but the laxest (eg 750ppm of CO2e) of GHG concentration targets are virtually out of reach if Annex 1 countries act alone".

One final way to nail the point. Around 75% of all emissions are from energy-related emissions (all energy generation, every plane, every train, every car, all stationary energy emissions and so forth). So, energy related emissions are three-quarters of the problem. The 2008 IEA annual report calculated that 97% of the increase in these emissions to 2030 would come from non-Annex 1 countries. This year's IEA annual report increased the estimate to 100%.

Another Kyoto - even a Kyoto that included the United States - is not going to do the job. I appreciate that those who see this as a Manichean struggle between the forces of ‘good' poor developing countries versus ‘bad' rich developed countries will have the greatest difficulty absorbing these scientific facts of life, but there you are.

This leads to a rather critical question: how might the large developing countries be encouraged to develop bold pathways to a lower carbon future? This is a highly complicated matter, and any comprehensive treatment would start with the carrot - financing. Most certainly they will require financial assistance from the developed world and, under any conceivable negotiated result, they will get it.

But my purpose today is to look at the ‘stick', trade measures, and the idea of unilateral BTAs, or Border Tax Adjustments in particular.

The Trade/Climate Change Nexus

Let me start by quoting Mencken:

"For every major problem, there is always a solution that is simple, that is direct and that is profoundly wrong".

Unilateral border tax adjustments to counter ‘leakage', or competitiveness at risk considerations, is, at least in my view, a perfect example of Mencken's acerbic wit.

At one level, it seems neat: you do not wish to impose a price on carbon that will simply reduce their relative competitiveness and, ceteris paribus, risk losing jobs and production to other producers in other countries which do not face a price on the carbon they emit. A border tax adjustment, while useless to address relative competitiveness of your exports, could therefore in theory be used to protect you from imports, not subject to a price on the carbon emitted during their production and distribution.

There is a huge and growing academic literature around this. Most of it is highly technical, around core WTO provisions like Article XX of the GATT and associated WTO jurisprudence such as the Shrimp/Turtle case. However, the core points are not technical.

First, if you were going to impose unilateral border tax adjustments that would have any underlying moral or political rationality, you would presumably wish to treat imports from countries that were doing the right thing by climate change - ie were meeting their international commitments - from those countries that were not. You could of course take a different view - just slam everyone regardless whatever they were doing to help address climate change. But I will assume a minimum of sophistication and international civility.

Houston, we have a problem. The core problem is how would you distinguish between compliant and non-compliant countries?

Of the Kyoto concepts that are highly likely to survive into any conceivable second commitment period, one stands out: the principle that a final audit of your compliance or non-compliance will need to await the end of the commitment period. NZ for example is highly likely to meet its Kyoto obligations. That is because the obligation is expressed in net emissions and the latest satellite data suggests we had underestimated the sequestration of our forests. But we will not know for certain until 2014, when the definitive audit of all those who have ratified Kyoto will have been completed.

Think about the implication. A unilateral border tax adjustment would be like an anti-dumping or CVD investigation on steroids - a bureaucratic monster, given the complexity of modern supply chains, with armies of officials trying to calculate the carbon-equivalent tax to impose on imports made from components produced in perhaps 20 different countries. It would be like the Politburo on a bad hair day. It conjures up Bertolt Brecht's limerick:

"Saw civil servants, green with mildew, keeping their huge manure contraption on the move. So badly paid for all their bullying and creeping, I only hope their salaries improve".

That massive administrative complexity aside, if a unilateral BTA regime were to rest on the political distinction that you would not wish to hit those who were doing the ‘right thing' by the planet, as it were, you would not know whether country X or Y was or was not compliant until two years after the end of the second commitment period, say 2020 or 2022, depending on what is finally negotiated. As a political response to the problem, that is, as the Australians say, about as useful as a back pocket on a singlet.

Second, and even more to the point, it would be likely to spark a trade war and the world today does not need a trade war. Certain Europeans have already said they would retaliate against imports from the US if the US ever tried to do this to Europe's exports to the US. China has made it clear not only that it would immediately retaliate but even told us how - a retaliatory regime based on per capita emissions. This idea, to put it mildly, ain't looking too flash at this stage. The day has long passed when the world can unilaterally impose its will on China, thank goodness.

Broader Trade/Climate Change Issues

There are other complex issues in the WTO/UNFCCC interface. Let me address just one further large political management issue.

The WTO is caricatured in certain circles, very largely on the Left, as some type of monster that is inhibiting countries from tackling the problem of climate change. Pascal Lamy, the Director General of the WTO and EU Trade Commissioner before Peter Mandleson, has responded vigorously to this caricature. Essentially, he has said this - don't use the WTO as an excuse for not getting down to the task of negotiating a coherent climate change regime. Go off and complete the negotiation and then come back to the WTO with an agreed deal and we will iron out any differences.

I think Pascal Lamy is absolutely right and NZ has taken his thinking a step further to try to operationalise the concept. We have proposed informally the idea of a moratorium of say 5-7 years after the completion of negotiations under the UNFCCC to hold off using WTO dispute settlement procedures challenging certain core climate change policy tools. This moratorium would provide policy space to implement climate change friendly policies while a more considered review and negotiation would take place to make the two regimes coherent.

Our Moratorium proposal would explicitly rule out unilateral border tax adjustments - a very bad idea, even if superficially popular in certain political quarters. But there are issues such as: are free allocations of emissions units a subsidy? If so, are they actionable? Are they a prohibited subsidy? At the end of the day, we need both to advance the Climate Change agenda and the trade agenda and we need a practical solution to iron out inconsistencies. This is one way to do it.

Conclusion

Ladies and Gentlemen, international agreements do not emerge easily. When they do emerge, there can be a vast difference in their effectiveness. A good agreement - it will never be perfect - is achievable at Copenhagen and there are many aspects to a good agreement which I have not touched on - such as the issues of ‘peaking' of emissions, the need for massive investments in green technologies and research, the highly sensitive matter of its final legal form or forms and so forth.

The best outcome we can attain from Copenhagen will not be the agreement people were seeking until very recently. But that objective - a full and ratifiable agreement - was unobtainable. I remain convinced that if a set of firm political decisions can be taken on the key elements - and there is no mystery about what are the key elements - we will, by the end of this month, have taken a decisive step forward.

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Centre for European Policy, 2009, page 3.

ENDS

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