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Climate Change and International Trade- A Causal Relationship

, February 18, 2022, 0 Comments

The importance that the Climate Change holds is undeniable and is rightly reflected in jurisdictions’ domestic and international policy priorities. On the other hand, International trade is another crucial policy area that allows countries to expand their markets and access the pool of global goods and services.

  As a result, the domestic market of any country certainly becomes more competitive. Interestingly, there exists an important causal relationship between these two most important policy areas wrt the impact each accrues on to the other, not only in negative but also in a positive approach. destiny-climate-change-india-marketexpress-jn

Contrary to the general perception, International trade plays an intriguing role in the emission of greenhouse gasses at each stage of the process (emissions from the international transporting of goods and services) that exacerbate climate change.  Most recent estimates show that around a quarter of all global emissions are linked to international trade flows. 

However, on the other hand, climate change also poses serious threats and damages to free flow of trade. Such threats emanate from disruption of international supply chains and trade flows, alterations to comparative advantages and specialization of respective countries and serious implications on the balance of payments. Climate change also impacts agriculture and tourism drastically specifically in low- and middle income countries. Agricultural and tertiary sector is more important than industrial activities in such countries and any vulnerability to agriculture weighs down not just domestic food security but also the economic development of food-exporting countries.

As has been recognized earlier that trade exacerbates climate change, however, it also acts as a catalyst to deal with it and has the potential to enhance mitigation and adaptation efforts by making available the goods and services that do so. International Trade encourages production in areas with cleaner production techniques, promotes the spread of environmental goods and services necessary for transitioning to low-carbon production that can help reduce emissions and improve environmental management. It may be highlighted that today, global trade in environmental goods is estimated at more than US$1 trillion annually and is rising. Also another aspect of international trade lies in the fact that imports and foreign aids play a critical role in immediate recovery from any natural disaster, when essential items such as food and medicines are in short supply. Trade, in short, is a critical node to mobilize if the world is to achieve green, resilient, and inclusive development.

In the similar manner, Climate Change also opens window of opportunity for sustainable growth and opportunities to promote production in energy efficient products and trade diversification in the transition to a low-carbon world. 

Recently developed countries, especially developed ones, have been in the process of taking and deliberating measures against unsustainable international trade practices. In this context, the latest Carbon Border Tax Mechanism proposed by the EU has been doing quite the rounds. Let us delve into what carbon border tax implies. ‘Carbon border tax’ can be defined as a penalty tax to discourage import of carbon-intensive goods such as steel, aluminum, cement, fertilizers and electricity via the carbon border adjustment mechanism (CBAM). The EU Commission plans to levy the tax in a phased manner from 2026 by imposing additional import duties on certain products in accordance with their carbon content to discourage carbon-intensive imports. 

The carbon tax will essentially be a Pigovian Tax which balances the marginal social costs and benefits of additional emissions, thereby internalizing the costs of environmental damage. The tax aims to ‘incentivize’ greener manufacturing around the world and to protect European industries from outside competitors who can manufacture products at a lower cost as they are not charged for their carbon emission during the manufacturing processes. This is also an attempt by the EU to stop carbon leakage to discourage producers from shifting production outside the EU and importing goods instead. 

So, the carbon border tax is perceived as an indirect attempt to force emerging economies, including India, to adopt cleaner and non-fossil fuel-based practices to manufacture goods.

General consensus of the developed world is that such measures will support climate mitigation objectives by increasing the importance of export and output diversification in countries reliant on exports of fossil fuels and carbon-intensive products. However, opportunities will arise only for countries that can demonstrate carbon competitiveness in the manufacturing sectors such as electronics and other light manufacturing.

However, developing and middle income countries lack appropriate capacities to identify areas of carbon competitiveness and their firms are unable to measure and verify carbon reductions for a given good or service. As a result, exports from low- and middle-income countries will be most heavily affected and may be excluded from global value chains. 

By increasing the prices of Indian-made goods in the EU, this tax would make Indian goods less attractive for buyers and could shrink demand. 

Nonetheless, India is on a path of greening its economic system already with right policies for boosting the renewable energy system. This will go a long way in de-carbonising its manufacturing sector too. Under the Perform Achieve and Trade (PAT) Scheme that was initiated in March 2012, energy-intensive sectors have successfully reduced around 92 million tonnes of carbon emissions in the two PAT implementation cycles running between 2012-19 (the results of third cycle is awaited though). Currently, PAT Cycle IV is under implementation. Energy savings of approximately 26 MTOE are expected to be achieved. Also in the recent COP26 held at Glasgow, India announced ambitious targets that would definitely allow India to stimulate the use of cleaner production processes and technologies.

However, speaking with respect to near term implications, before retorting to such measures, the developed world also should make sure that there is adequate flow of finance and technical support to the developing world which they are committed to. This would help necessitate, if not seamless, then easier implementation of the green transition trajectory.

In a nutshell, the right symphony between trade and environmental policies can offer effective economic incentives to attain sustainable economic growth such as negotiating tariff reductions in environmental goods and services being one. It is recognized that the inclusion of environmental provisions in bilateral and regional trade agreements has also helped harmonize environmental regulations between developed and developing countries. Also the individual capacity and domestic priorities of different jurisdictions cannot be ignored. For this, as mentioned earlier, more advanced economies will have to provide resources and institutions for capacity building to less-developed partners to encourage institutions and strengthen environmental regulations.