Chapter 6: Trade and Investment

Critical Issues: The Impact of Trade and Investment on Climate Change Efforts

There are three main ways in which trade and investment policy objectives might influence the ability and inclination of nations—particularly developing countries—to collaborate on effective climate change efforts in a post-2012 context:

• trade and investment liberalization can provide the means, and the necessary goodwill, for developing countries to address mitigation and adaptation;

• trade and investment rules can act as aids or obstacles to climate change efforts; and

• trade and investment relations can constitute a platform for wider cooperation.

The primary linkage between trade policy and climate change is in the potential of trade policy to affect the means of the trading states to address mitigation and adaptation objectives. Trade liberalization has the potential to increase the efficiency with which the international basket of goods and services is produced and delivered, allowing countries to specialize in those areas in which they have some comparative advantage. When this works, it increases the economic strength of nations, among other things potentially increasing the government revenues available for addressing mitigation and adaptation objectives related to climate change. (There are important caveats; some are discussed in the next section.) Increased efficiency of production can also directly contribute to resource-saving and reduced GHG emissions.^[1]

An important caveat is worth noting. The potential benefits of trade liberalization depend crucially on the integrity of many governmental and non-governmental institutions in the affected sectors. Particularly relevant to the present discussion is the need for a strong regime of environmental regulatory protection. If, for example, a rainforest-rich state has a poor regime for protection of forests, indigenous peoples and biodiversity, liberalized trade might induce deforestation to produce cash crops for export—a trend that will aggravate climate change.

A linkage related to this primary connection is the international goodwill or hard feelings that can be engendered by good faith or bad faith negotiations. The now-stalled Doha Development Agenda has been criticized by many developing countries as failing to live up to its name^[2]. If it were to be concluded in a way that left key developing countries dissatisfied, it would likely create a less fertile ground for cooperation on other policy fronts, climate change included.

A second sort of linkage is based on the impacts of trade and investment rules themselves, and their potential for good or harm in fostering post-2012 efforts on climate change. A number of ongoing and planned negotiations cover issues that have a direct impact on countries ability to undertake such efforts:

• WTO negotiations on lowering tariff and non-tariff barriers to environmental goods and services could, if they are successful—many are skeptical at this point—create better markets for goods and services that directly contribute to combating climate change, including environmental technologies such as wind power, in which Denmark has strong comparative advantages.

• WTO negotiations on rules related to subsidies might conceivably reinstate the lapsed “Article 8” carve-outs that allowed for subsidization of R&D and for subsidies to compliance with environmental regulations^[3].

• WTO negotiations on the interaction between the WTO and MEAs such as the UNFCCC and the Kyoto Protocol have, with their current mandates, little prospect for reducing the potential for legal clashes, but in fact carry some downside risk^[4].

• If the talks were to result in a substantial decrease in OECD domestic support to agricultural producers and increased market access for Southern producers, they would thereby increase the value of farming as an activity and farm land as an input for millions of Southern producers^[5]. This might encourage policy-makers and producers to more heavily invest in measures aimed at increasing the sector’s adaptive capacity.

• Negotiations on the liberalization of services in the WTO, the EPAs and other fora might end up improving the provision of various climate-relevant services in developing countries: energy services, water services and transportation services (including areas in which Denmark has particular expertise). The manner of liberalization, and the capacity of the developing country partners to manage investment (writing adequate concession contracts, imposing regulatory oversight, etc.), will determine whether the final impacts of such negotiations are positive or negative from a climate change perspective^[6].

A final linkage is based on the tendency of trade and investment agreements, particularly regional agreements, to act as platforms or facilitators for cooperation that goes beyond the economic, to areas such as environment and development. The Euro-Med Agreements, for example, are much more than trade agreements, and encompass a broad range of cooperation and capacity building. As such, properly elaborated association agreements can significantly boost the capacity of partner states to address climate change objectives, instill a more complete understanding of climate change imperatives, and bolster the motivation for such states to participate in international efforts to combat climate change.

There is another sort of linkage between climate change policy and trade policy related to competitiveness. Strong national commitments to action on climate change will have negative impacts on the competitiveness of some trading sectors vis-à-vis their competitors in countries that undertake no such commitments. The impacts will vary considerably from sector to sector^[7]. This is actually a negative linkage, in that it will motivate some states not to collaborate on international efforts to combat climate change—to “free ride” on the efforts of others. To counter this negative incentive, countries with emission reduction commitments might consider measures to neutralize the incentive for carbon-intensive industries to outsource to “free riding” countries, from where goods are produced at lower cost for western markets. Measures of this nature would involve careful consideration within the MEAs, based on a full understanding of the economic impacts of the various policy options^[8].

Private investments through Export Credit Agencies (ECAs) can have important implications for climate change in developing countries, offering investment support in such sectors as power generation, oil and gas development, and energy-intensive manufacturing^[9]. ECA investments are generally concentrated in seven countries (Brazil, China, India, Indonesia, Mexico, the Philippines and Turkey) that are major contributors to global GHG emissions, and much of the investment in the power sector has gone to coal-fired and gas-fired plants^[10]. While the ability of ECAs to finance sustainable projects is somewhat limited by the international norms that govern their operation^[11], there is opportunity to encourage coherence of these activities with global climate change goals through selectivity in the projects they support, the use of common approaches for evaluating the environmental impacts of projects and the introduction of energy efficiency and carbon intensity standards. ECAs respond to directives and policies from finance ministries and foreign ministries responsible for international negotiations, where the debate on improved standards for climate change issues should be addressed.

Opportunities for Integration

The previous section briefly surveyed the major linkages between trade policy and climate change, in an analysis that suggests several opportunities for trade and investment policy efforts to help achieve international climate change objectives.

First, there is a need to focus on the prerequisites to developing countries benefiting from trade and investment liberalization. That is, while liberalization offers opportunities, they can only be exploited by states with the capacity to increase exports, to attract investment, to cushion and facilitate the necessary economic restructuring, to recoup lost tariff revenues, and so on. There is wide agreement that this involves not only the traditional technical assistance for implementing trade law obligations, but goes further to strengthen the domestic institutions and infrastructure that makes these things possible, such as an efficient bureaucracy; rule of law; functioning financial sector; energy and communications infrastructure; functioning regulatory institutions; etc^[12]. This is the new “aid for trade” agenda, which has substantial—but not complete—overlap with the traditional development assistance agenda. (See section 7.2.5 for further discussion of the trade for aid agenda.)

In the overall conduct of trade negotiations, there is a need to pull back from the traditional mercantilist mode of negotiations, focused on reciprocity and narrow definitions of national interest. The EU EPA negotiations, having at the outset promised a different kind of trade agreement, are wrestling with finding the right balance in this regard^[13]. The Doha Development Agenda, many charge, has underperformed on the development front, and the EU’s aggressive demands for non-agricultural market access and services liberalization (echoed by a number of other OECD countries) may be at odds with a development-centered outcome^[14]. To repeat, the risk is that only those out-comes that truly foster economic development in developing countries will equip those countries with the means and the inclination to be active players in any post-2012 efforts on climate change.

Second, there is a need to reconcile the objectives of climate change action and a wide number of specific ongoing negotiating areas—in particular the WTO negotiations on environmental goods and services, subsidies, agriculture, trade in services and the relationship between the WTO and the MEAs. In the EPA negotiations, the relevant areas are primarily services and investment. In all these areas there is risk and opportunity from a climate change perspective, both in terms of the direct effects of the negotiating results on climate change, and on the prospects for international agreement in a post-2012 context.

Third, in existing and developing bilateral and regional trade agreements (e.g., Association Agreements) there is scope for deliberate efforts to foster capacity and motivation to act on climate change. This can happen in the context of fostering cooperation in the partner region itself (in the Euro-Med and EPA context, region-building is one of the EU’s explicit objectives), or under the aegis of a more bilateral approach to cooperation, such as support in identifying national interests in the area of climate change. Again, such an agenda would overlap strongly with the traditional development cooperation agenda.

Notes

1. ^For a complete survey of the linkages between trade and environment, including those related to efficiency, see IISD/UNEP, 2005. Trade and Environment: A Handbook (2nd ed.). Winnipeg: IISD (Chapter 4). See also Copeland, Brian R. and M. Scott Taylor. 2003. Trade and the Environment: Theory and Evidence. Princeton: Princeton University Press.
2. ^See, for example, World Trade Organization (WTO), 2005. Reclaiming Development in the WTO Doha Development Round (submission of Argentina, Brazil, India, Indonesia, Namibia, Pakistan, the Philippines, South Africa and Venezuela to the Trade and Development Committee). WT/COMTD/W/145, December 1.
3. ^Note that while this potential exists, it has not yet been actively pursued by any government in the talks. See Ayala, Francisco Aguayo and Kevin Gallagher. 2005. Preserving Policy Space for Sustainable Development: The Subsidies Agreement at the WTO. Thematic research paper produced for the Trade Knowledge Network. Winnipeg: IISD.
4. ^The problem is that if the WTO Members agree to an approach for handling disputes between Parties to an MEA (the current narrow mandate given by the Doha text), it may limit the ability of the WTO’s Appellate Body to appropriately deal with the far more pressing issue of disputes between Parties to an MEA and non-Parties. See Bernasconi-Osterwalder, Nathalie. “Trade and Environment: Where do we stand after Doha?” Paper presented at the conference WTO’s Contribution to Sustainable Development Governance: Balancing Opportunities and Threats, Paris, October 21–22, 2005.
5. ^Note that the increased exports would be concentrated in relatively few large exporting developing countries. Of course, there is nothing automatic about the possibility of increased government spending on adaptive capacity in response to liberalization in the agricultural sector, while such investment would be rational, there might need to be proactive international cooperation to bring it about.
6. ^In the context of water services, for example, see Vaughan, Scott, 2003. Privatization, Trade Policy and the Question of Water. Les séminaries de l’Iddri no.9. Paris: Institut de Développement Durable et des Relations Internationales; Clarke, George R.G., Katrina Kosec and Scott Wallsten. 2004. Has Private Participation in Water and Sewerage Improved Coverage? Empirical Evidence from Latin America. Working Paper 04-02, AEI-Brookings Joint Center for Regulatory Studies; McIntosh, Arthur C., 2003. Asian Water Supplies: Reaching the Urban Poor. London: Asian Development Bank.
7. ^For a survey of the issues and the literature, see Cosbey, Aaron, 2005. “Climate Change and Competitiveness: A Survey of the Issues.” Background paper to an experts’ workshop: Climate Change, Trade and Competitiveness, Chatham House, London, March 30, 2005.
8. ^Such measures would face an uncertain prospect if challenged in the WTO; there is at present little consensus among legal scholars on their consistency with WTO law. For a survey of the debate, see Tarasofsky, Richard, 2005. “The Kyoto Protocol and the WTO.” Background paper to an experts’ workshop: Climate Change, Trade and Competitiveness, Chatham House, London, March 30, 2005.
9. ^ECA financing is not a component of ODA, but is a financial flow that is larger than ODA.
10. ^Maurer, Crescencia, 2003. “Financing Carbon: Export Credit Agencies and Climate Change.” Transition from Fossil to Renewable Energy Systems: What Role for Export Credit Agencies? Washington, D.C.: World Resources Institute.
11. ^For example, ECAs of the OECD countries abide by the terms of the Arrangement on Guidelines for Officially Supported Export Credit that was established in 1978 to prevent ECAs from distorting capital markets and competing with commercial financial institutions.
12. ^Cosbey, Aaron, 2004. A Capabilities Approach to Trade and Sustainable Development: Using Sen’s Concept of Development to Re-Examine the Debates. Commissioned by the Swiss Agency for Cooperation and Development. Winnipeg: IISD. In the context of the EPAs, see Busse, Matthias, et al., 2006. “The Institutional Challenge of EPAs.” Trade Negotiations Insights, 5(3). For a strong statement of this argument in the context of investment in services and infrastructure in particular, see World Bank, 1994. World Development Report 1994: Infrastructure for Development. Washington: World Bank/Oxford University Press.
13. ^For a bleak assessment of the results of EPAs based on reciprocity, see Karingi, Stephen, et al., 2005. Economic and Welfare Impacts of the EU–Africa Economic Partnership Agreements. African Trade Policy Centre Work in Progress No.10, Economic Commission for Africa, March.