Trade and Climate Change ING by Integration and Trade Sector

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Trade and Climate Change Mitigation Measures:

Implications for Latin American Producers Preliminary Version

CMY

www.iadb.org/int

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Trade and Climate Change Mitigation Measures: Implications for Latin American Producers Preliminary Version

Grant Aldonas

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The views and opinions expressed in this publication are those of the authors and do not necessarily reflect the official position of the Inter-American Development Bank.

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Table of Contents Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vii I. Setting the Context . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 A. The Science of Climate Change. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1. Implications for the Economics of Climate Change . . . . . . . . . . . . . . . . . . 3 B. The Economics of Climate Change. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 1. Estimates of Global Warming’s Economic Impact . . . . . . . . . . . . . . . . . . . 5 2. Development Dimensions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 3. Implications for International Trade. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 C. The Search for a Global Response to Climate Change. . . . . . . . . . . . . . . . . 10 II. Mitigating the Effects of Climate Change. . . . . . . . . . . . . . . . . . . 17 A. Market-Based Measures. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 1. Emissions Trading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 2. Emissions Taxes, Carbon Taxes, and Taxes on Fossil Fuels . . . . . . . . . . . 22 B. Command and Control Measures. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 1. Direct Regulation of Emissions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 2. Product and Performance Standards. . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 3. Product Labeling. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 4. Investment Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 C. Incentive Programs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 1. Subsidies for Biofuels and Alternative Sources of Energy. . . . . . . . . . . . . 33 2. Research and Development and Technology Diffusion Incentives. . . . . . 35 3. Tax Incentives for Abatement Purposes. . . . . . . . . . . . . . . . . . . . . . . . . . 36 D. Carbon Tariffs and Other Offsets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38 1. Carbon Tariffs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 2. Carbon Trading Emissions Abatements. . . . . . . . . . . . . . . . . . . . . . . . . . 41 E. Other Measures with Implications for Latin American and Caribbean Producers. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42 1. Regulation of Imports Containing GMOs. . . . . . . . . . . . . . . . . . . . . . . . . 42 2. Impact of Production Subsidies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43

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III. Climate Change Mitigation Measures Adopted or Proposed . . . . 45 A. European Union. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 1. EU-wide Action. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 2. Implementation at the National Level . . . . . . . . . . . . . . . . . . . . . . . . . . . 51 B. United States. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54 1. Legislative Action. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55 2. Potential Regulations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59 3. Sub-Federal Initiatives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61 4. Other Measures. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62 C. Canada. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63 D. Japan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66 E. China. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69 F. Private Sector Initiatives. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72 1. Creating Effective Carbon Accounting Standards. . . . . . . . . . . . . . . . . . 73 2. Private Voluntary Reporting Codes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74 3. Private Product Labeling Initiatives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76 4. Voluntary Emissions Trading Regimes . . . . . . . . . . . . . . . . . . . . . . . . . . . 77 IV. Impact on Producers in Latin America and the Caribbean. . . . . . 79 A. Climate Change from a Producer’s Perspective. . . . . . . . . . . . . . . . . . . . . . . 80 1. Thinking in Terms of Emissions and Energy Intensity. . . . . . . . . . . . . . . . 82 2. Analyzing Industry Structure. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87 3. Rethinking Market Access in Light of Globalization . . . . . . . . . . . . . . . . 90 4. Examining the Effects on Transactional Costs. . . . . . . . . . . . . . . . . . . . . 95 B. Implications for Four Industries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98 1. The Cement Industry in Mexico. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99 a. Energy and Emissions Intensity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100 b. Structure of the Mexican Cement Industry and Its Primary Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102 c. Implications of Climate Change Mitigation Measures for Market Access and Growth. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104 d. Effects on Transaction Costs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .106 2. Plastics in Colombia. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 108 a. Energy and Emissions Intensity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 108 b. Industry Structure. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110 c. Implications of Climate Change Mitigation Measures for Market Access and Growth. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111 iv Trade and Climate Change Mitigation Measures

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d. Effects on Transaction Costs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113 3. Agriculture and Forestry in Uruguay. . . . . . . . . . . . . . . . . . . . . . . . . . . 115 a. Energy and Emissions Intensity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 117 b. Industry Structure. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 119 c. Implications of Climate Change Mitigation Measures for Market Access and Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 121 d. Effects on Transaction Costs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .125 4. Mining in Peru. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .127 a. Industry Structure. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 128 b. Energy and Emissions Intensity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 129 c. Implications of Climate Change Mitigation Measures for Market Access and Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 131 d. Effects on Transaction Costs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .133 V. Implications for Policymakers. . . . . . . . . . . . . . . . . . . . . . . . . . . 135 A. Key Elements of a Climate Change and Trade Agenda. . . . . . . . . . . . . . . . 137 1. Global Participation and the Region’s Role in Multilateral Institutions . . 138 2. Regional Cooperation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 143 a. National Strategies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 147 B. Integrating Trade and Climate Change Goals. . . . . . . . . . . . . . . . . . . . . . . . 149 1. Building a participatory process. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 150 2. Engaging the Private Sector. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 151 3. Building Institutional Capacity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 157 C. Clarifying Objectives for Future Negotiations. . . . . . . . . . . . . . . . . . . . . . . 159 1. Negotiations on Climate. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160 2. Negotiations on Trade. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 164 Bibliography. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 167

Table of Contents v

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Introduction

limate change represents a significant challenge for development in the region and elsewhere.1 How Latin America and the Caribbean governments and private firms in the region manage the transition to a lower carbon regional and global economy will, in many respects, determine whether their broader efforts at development succeed. In a recent report, the World Bank stresses that, left unaddressed, “climate change will reverse development progress and compromise the well-being of current and future generations.”2 That logic applies with equal force to the mitigation measures adopted by governments and private entities to cope with climate change (or global warming, as the two terms are often used interchangeably). Serious concerns regarding the impact of climate change have led governments to adopt or propose a number of fiscal, regulatory, and/or market-based measures to mitigate the effects of a global warming. Private firms that operate on a global basis have, either on their own motion or in response to the demands imposed by governments, introduced measures designed to measure and reduce their carbon footprint. A number of the measures under consideration could affect the access that Latin American and Caribbean producers currently have to the affected markets or the supply chains of globally-organized firms. Such measures include carbon tariffs and other border measures, renewable energy policy targets, carbon standards, product standards, rules governing intellectual property and technology transfer, subsidies designed to address climate change, product labeling schemes and a variety of other measures. What that suggests is the need for the countries of Latin America and the Caribbean to be developing trade and climate change strategies that address the potential effects of such mitigation measures even while they are designing strategies to cope with climate change itself. The mitigation measures currently in place, as well as those under consideration, present a unique set of challenges to both the public and private sectors in Latin America and the Caribbean. That is precisely why both governments and the private sector throughout the region must play an active role in developing and implementing 1 2

World Bank, World Development Report 2010 – Development and Climate Change (“WDR 2010”). Ibid. vii

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a successful trade and climate change strategy – one designed to facilitate the region’s3 transition to a low carbon economy, while, at the same time, improving the prospects for trade, economic growth and development. This report focuses on the form and direction that an integrated trade and climate change strategy should take. That integrated strategy must, of necessity, start with the existing international framework for cooperation on climate change. Article 3.5 of the UN Framework Convention on Climate Change (“UNFCCC”) cautions that “measures taken to combat climate change, including unilateral ones, should not constitute a means of arbitrary or unjustifiable discrimination or a disguised restriction on international trade.”4 In addition, industrialized countries and economies in transition (Annex 1 countries under the UNFCCC) agreed to “strive to implement policies and measures . . . in such a way as to minimize adverse effects, including the adverse effects of climate change, effects on international trade, and social, environmental and economic impacts on other Parties,” especially developing countries. While those protections would apply to producers in Latin America and the Caribbean, the discussions under way in a number of countries have raised serious concerns regarding the potential of the existing or proposed measures to restrict market access for Latin American and Caribbean producers, either directly or indirectly. Of equal concern, implementation of controls on carbon dioxide emissions in export markets of importance to Latin American and Caribbean producers—whether through the direct regulation of emissions, carbon taxes, or carbon markets—will necessarily impose compliance burdens that will raise the implicit cost of exporting to the affected markets as they flow through to Latin American producers. We must understand that the impacts of climate change are not specific of a country or even of a region; climate change is a global threat that must be confronted in unison. The countries of Latin America should join forces against climate change and confront this growing threat thought-out a regional strategy. Integration must be the key in designing this regional strategy.

The Convention on Climate Change entered into force on March 21, 1994. Over 190 countries have ratified the accord. It sets the over-arching framework for efforts to meet the challenge posed by climate change, requiring governments to gather and share information on greenhouse gas emissions, national policies and best practices; develop national strategies for addressing greenhouse gas emissions and adapting to expected impacts; provide financial and technological support from developed nations to developing countries; and otherwise cooperate in preparing for adaptation to climate change and its affects on the environment. The Convention should be distinguished from the Kyoto Protocol, which operates under the framework of the Convention. The Kyoto Protocol represented the first attempt to negotiate legally-binding commitments to reduce greenhouse gases. 4 Ibid. 3

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Recent economic analyses have examined the impact of trade measures and carbon markets on manufacturing output and exports in Latin America and other regions. There is, as yet, little information on the impact of mitigation measures at the firm level in key sectors of the region’s economies. That lack of information on the impact at the firm level makes it difficult for policymakers in the region to assess the actual impact and to develop strategies that would minimize the effect on exports and output. One of the main challenges of the region will be to implement a low carbon integration infrastructure that aims to encourage trade in the region without raising the current levels of deforestation and land degradation. LAC region has a large potential to develop sustainable and low or non-GHG emitting energy technologies taking advantage of the renewable recourses of the region including wind, solar, hydro, geo-thermal and bio-energy. This could mean a significant advantage to trade by lowering the region’s carbon footprint in the export sector. Latin America and the Caribbean, furthermore, can become key players in the transition to a low carbon global economy by seizing the opportunities that the transition will create for innovative firms in the region. The current lack of information about the impact of climate change and related mitigation measures, however, hampers the ability of policymakers to identify new opportunities that may arise for the region’s producers from that transition. Little work has been done to date to help Latin American and Caribbean policymakers identify impediments that would inhibit their producers’ market access or prevent investment and trade in low carbon goods and technologies that might yield new opportunities for Latin American and Caribbean producers. That is due, in large part, to the fact that the response of many countries and global firms to climate change remains in flux, particularly after the U.N.-sponsored “conference of parties” in Copenhagen this past December failed to produce a globally acceptable approach. The following discussion is designed to begin filling the gap in terms of our understanding of the impact not just of climate change, but of proposed mitigation measures as well. It does so by a very different approach – one that examines the potential impact from the perspective of individual producers in Latin America and the Caribbean and the industries of which they are a part. The analysis is divided into five sections. Section I briefly provides the necessary context for the analysis that follows. It provides an overview of the science of global warming and then examines the underlying economics of climate change—the costs of adaptation and mitigation, the development dimension, and the implications for international trade. It also describes the search for a global response and what that Introduction ix

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implies for the operating environment Latin American and Caribbean producers will confront in global markets. In brief, section I underscores why coordinated action would be preferable to unilateral steps by individual countries in confronting the challenge of global warming. At the same time, it highlights the challenges involved in reaching a legally-binding international agreement on emissions of carbon dioxide (“CO2”) and other “greenhouse gases” (“GHG”), which make it far more likely that any steps taken in the short run to address climate change will be unilateral, raising the risk that such actions will incorporate potentially-trade distorting measures or otherwise impede market access. Section II develops a taxonomy of mitigation measures that have been implemented or proposed, either in furtherance of the global effort or unilaterally. That taxonomy includes an explanation of the potential impact each measure might have on producers in Latin America and the Caribbean, as well as the opportunities such measures might create. Section III provides an overview of the climate change mitigation measures in place or under consideration among select Organization for Economic Cooperation and Development (“OECD”) member countries. It also highlights similar measures proposed by what is the most significant emerging economy, China, as well as initiatives undertaken by private firms, either on their own initiative or in conjunction with non-governmental organizations. Just as important, section III also details the increasing focus of private firms on measuring CO2 and other “greenhouse gas” emissions and its implication for Latin American and Caribbean producers. Whether taken in response to government regulation or on their own motion, the efforts of private firms to measure the “carbon footprint” of their enterprise will necessarily flow through to suppliers throughout their global value chain, with important implications for the suppliers’ cost of production. Section IV of the report outlines the implications of the mitigation measures adopted in the European Union and those under consideration elsewhere for producers in Latin America and the Caribbean. It draws on four case studies of producers in the region – the cement industry in Mexico; agriculture and forestry in Uruguay; mining in Peru; and plastics in Colombia—to suggest the factors that both producers and policymakers should focus on in developing their own response to climate change and the related mitigation measures. In the process, section IV develops a paradigm that could be used to examine the impact of climate change mitigation measures on other industries in Latin America and the Caribbean. It looks at the individual industries and their position in supply chains serving global markets, as well as the market structure and market relevance of x Trade and Climate Change Mitigation Measures

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firms, to identify the potential impact of climate change mitigation measures on their operations and their access to global markets. Section V of the report discusses the implications of this analysis for policymakers in the region, as well as recommendations for developing an integrated regional strategy on trade and climate change. The over-arching objective of those recommendations is to reinforce the work of the Inter-American Development Bank in support of governments in Latin America and the Caribbean as they devise policies to ensure that the adjustment to a low carbon global economy does not negatively affect the most vulnerable part of the regionâ&#x20AC;&#x2122;s population. Antoni Estevadeordal Alexandre Meira Rosa Manager Manager Integration and Trade Sector Infrastructure and Environment Sector

Introductionâ&#x20AC;&#x192; xi

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CHAPTER

Setting the Context

efore turning to the individual measures that countries have adopted or proposed to address climate change, it is helpful to understand the economic dynamics driving the introduction of such measures. Understanding the underlying market failure that such measures are designed to address helps clarify the extent to which they are well designed to achieve the intended results. Correspondingly, it also helps isolate those instances in which measures adopted by governments go further than what is needed and begin to impede legitimate trade, with all that implies for producers in Latin America and the Caribbean. The following discussion is divided into three parts. The first provides a brief overview of the science of climate change as a predicate for the economic analysis that follows. The second discusses the economics of climate change, including its development dimension and its implications for international trade. The third part describes the efforts to craft a global response to climate change and what that means for the environment that Latin American and Caribbean producers will confront in global markets.

A. The Science of Climate Change5 The greenhouse effect is a naturally occurring phenomenon. The earth’s atmosphere traps heat from the sun. Certain gases and aerosols—water vapor, carbon dioxide (CO2), methane (CH4), ozone (O3), and nitrous oxide (N2O), all of which are naturally present in the atmosphere—impede the escape of infrared energy into space.

For a well-written and accessible introduction to the science surrounding the climate change debate, see Houghton (2004). The World Bank’s most recent World Development Report (World Bank 2010) also contains an excellent summary of the science.

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Climatologists refer (World Bank 2010) to the warming effect caused by the naturally occurring levels of these greenhouse gases (GHGs) as the “the natural greenhouse effect.” There is broad agreement within the scientific community on the fact of global warming and on the contribution that human activity has made to the concentration of CO2 and other GHGs in the atmosphere (World Bank 2010).6 The working hypothesis of climatologists is that man-made emissions of CO2 and certain other gas emissions contribute to the “greenhouse effect,” and amplify the effects of rising temperatures. There is little doubt about the connection between GHG concentrations and temperatures (World Bank 2010). Greater concentrations of GHGs such as CO2 will tend to trap greater amounts of heat radiated by the Earth that would otherwise exit the atmosphere into outer space. There is also little doubt that the average concentration of CO2 in the atmosphere has increased since the beginning of the Industrial Revolution, particularly in the past 50 years. That increase in the concentration of GHGs broadly correlates with the rise in global average temperatures over the same period; temperatures today are 0.8°C higher than pre-industrial levels (World Bank 2010).7 The remaining debate is over causation, that is, whether the human contribution to those GHG concentrations is the primary cause of the recent rise in global temperatures. To put that in perspective, the atmosphere contains roughly 824 gigatons (Gt) of carbon (World Bank 2010). As of 2007, human activity accounted for 10 Gt of that total, of which 7.7 Gt were from the combustion of fossil fuels; the remaining amount was largely attributable to changes in land use (World Bank 2010). While the quantity of GHGs resulting from human activity is small relative to the total carbon

The fact that there is a broad consensus about certain aspects of climate change does not mean that the central hypothesis, as well as many of its implications, is beyond dispute. Perhaps the most trenchant criticism of both the science and the economic analysis that has driven much of the global debate over climate change and the pursuit of a variety of means of mitigating global warming’s effects can be found in Carter et al (2006). There, the authors summarize their critique of the science and economics captured in Lord Stern’s review, discussed below, as follows: “The scientific evidence for dangerous change is, in fact, far from overwhelming, and the Review presents a picture of the scientific debate that is neither accurate nor objective…” The recent revelations regarding the reports of the Intergovernmental Panel on Climate Change have, unfortunately, further undermined its presumed objectivity and the value of its work. See, e.g., Telegraph (2010) and Guardian (2010) 7 Temperatures would, in fact, have risen further but for the offsetting effects of certain other pollutants associated with burning of fossil fuels like coal and for the lag in time it takes for the oceans to reach a higher equilibrium temperature after the initial increase in surface and air temperatures. (World Bank 2010). 6

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content of the Earth’s atmosphere, it is that portion of the total that has been rising along with temperatures. The potential effects of climate change on the environment and, ultimately, on the global economy, are diverse and widespread. They include rising air and ocean temperatures; melting snow and ice globally (which has contributed to a rise in sea level); fewer cold days, cold nights and frosts; more frequent and more intense heat waves; and more frequent floods and droughts. In terms of its geographic effect, the changing climate has brought greater droughts in the interior of continents, even while total precipitation has risen. The intensity of storms and tropical cyclones has increased. As the World Bank’s most recent World Development Report highlights, these effects are not distributed evenly around the world. They vary significantly by latitude, as does the source of increased GHG emissions, with all that that variation implies for the economics of climate change and the ability to craft a global solution to the challenges it presents.

1. Implications for the Economics of Climate Change The nature of the problem global warming presents has significant implications both for understanding the economics of climate change and for shaping any useful response. Greenhouse gas emissions and the potential impact they have on the environment and human wellbeing represent a classic example of market failure. Individual producers have little incentive to invest in production processes capable of lowering CO2 emissions because their individual action will do little to address the problem of climate change, while absorbing the cost of installing a production process capable of lowering emissions would put the producer at a competitive disadvantage in global markets—unless their competitors are obliged to make similar investments. In the same way, the individual consumer has little incentive to purchase goods and services from a producer using methods that yield lower CO2 emissions when goods or services of similar quality are available at a lower price from other producers that do nothing to reduce emissions. Indeed, unless producers and consumers bear the full cost of the externalities their actions create, there is little incentive to improve production methods in ways that are environmentally sound, as well as economically efficient. Quite the opposite, in fact: because of the implications for their cost competitiveness with rival producers, producers have a significant incentive to avoid such costs and force others to bear the expense of cleaning up the environment. Setting the Context 3

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It is worth underscoring that, while the discussion above treats climate change as a type of “market failure,” it is, in fact, a problem that suffers from multiple market failures. It is not only that the price of goods and services produced do not reflect the full environmental cost of CO2 emissions. The lack of viable markets for pricing the environmental cost of emissions of carbon dioxide and other greenhouse gases makes the task of correcting for market failure through adjustments to price doubly difficult. Just as significantly, other aspects of climate change cannot be addressed merely by changing prices and correcting for market failure. As highlighted above, both the production of carbon emissions and the geographic effects tend to vary by latitude. While the production of GHGs over the past century has largely been the province of industrialized countries closer to the poles, the extremes in weather tend to have a greater effect on the less developed countries that populate the regions closer to the equator. What that means in terms of the political economy of crafting a solution to the challenge of climate change is obvious. Those countries facing the most significant potential adjustments to climate change are those that are, in general, the least responsible for the rise in GHG emissions, as well as those least likely to be able to afford the costs of either adaptation or mitigation. What that means in practical terms is that requiring producers to internalize environmental externalities and getting rid of subsidies for the use of carbon represent necessary, but not sufficient conditions for limiting the potential environmental and economic damage from climate change. Progress will require some resolution of who bears the costs of adaptation through government-to-government negotiations. In truth, while the negotiations to craft such a resolution are often led by environmental ministries, the actual subject matter of the talks often devolves to issues that are more often the province of trade negotiators, and there is an important interplay between any agreement on climate change and the existing rules governing global trade. That alone highlights the compelling need for Latin American and Caribbean policymakers to be thinking in terms of an integrated trade and climate change strategy.

B. The Economics of Climate Change While there is a broad consensus on the science of climate change, there is considerable uncertainty regarding the magnitude of climate change’s economic impact. The changes wrought by global warming could be significant (World Bank 2010; see also Stern 2007, Part II). As they have in the past, sharp changes in climatic conditions 4 Trade and Climate Change Mitigation Measures

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could affect the planet and human welfare in a number of ways, including significant changes in agricultural yields, coastal flooding, increased incidence of tropical diseases in more temperate climes, damage to critically important ecosystems (such as the Amazon Basin) and a variety of other effects (World Bank 2010; Stavins 2000). Having said that, both the estimates of potential economic impact and the resulting estimates of the costs of mitigation depend heavily on the methodology employed and the assumptions made about the future course of the Earth’s climate. Neither the economics nor the estimations of the impact of climate change are an exact science (von Below and Persson 2008). The economic estimates depend on simulations run on different climate models that “typically rely on a small set of common and deterministic emissions scenarios.”Those models do not incorporate the assumptions that drive economic models of energy usage and economic growth in any structured way, making the incorporation of the results of the climate models into economic modeling difficult at best (von Below and Persson 2008).

1. Estimates of Global Warming’s Economic Impact The uncertainty surrounding the effects of climate change is reflected in economists’ assessments of the potential costs. As a consequence, estimates of the economic impact vary widely (World Bank 2010).8 Comparing the costs of inaction against the costs of mitigation is particularly complex, given the uncertainty surrounding the development of new cleaner technologies, the adaptive ability of both societies and ecosystems, and the extent of damages that higher temperatures might cause (World Bank 2010). One of the most comprehensive studies was done by Lord Nicholas Stern, former Chief Economist of the World Bank, for the Government of the United Kingdom. The Stern Review (2007) suggested that doing nothing could result in future economic damages on the order of 20 percent in global gross domestic product (GDP). In Stern’s view, that demanded immediate action in the form of a hefty carbon tax of 1 percent of global GDP. Stern also recommends what would ultimately involve an annual expenditure of 2 percent of GDP by richer, more industrialized countries to assist the poorer countries of the world with the costs of adaptation.

See, e.g., Dasgupta (2008); Sunstein and Weisbach (2008). The World Bank’s most recent World Development Report reinforces the same point regarding uncertainty but highlights other research that suggests that the cost of mitigating climate change may be more modest than is conventionally assumed (World Bank 2010).

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By contrast, one of the most respected U.S. leaders in the field of environmental economics, William Nordhaus of Yale, has argued for a more graduated response. In Nordhaus’ view, adapting to a steep increase in the price of energy overnight is likely to impose adjustment costs out of proportion to the benefits (Nordhaus 2008). He favors a slow but steady change in the energy prices and in energy supply more generally, which implies the need for a much lower carbon tax as a result. Nordhaus also suggests that it would be both more equitable and more efficient to invest in the productive base of economies, particularly developing economies and especially investments there in human capital, than to impose significant adjustment costs on either developed or developing countries that would impede that process. The two approaches illustrate the problem highlighted above in terms of their choice of methodology and their assumptions. Despite the widely disparate estimates and recommendations between the authors, the basic difference between their estimates rests largely on their choice of discount rates (Sunstein and Weisbach 2008).9 Given the variations in estimates of the economic impact of climate change, it is best to think of them not as concrete depictions of reality but as a range of possibilities that ought to shape the response of governments and businesses throughout Latin America and the Caribbean. Thus, it makes sense to incorporate the basic framework that Lord Stern outlined in terms of the region’s negotiating positions over who will bear the ultimate cost of adjustment and mitigation. At the same time, it would certainly make sense to inform that negotiating position with Nordhaus’ suggestion that the effort to address climate change should not come at the expense of economic growth and development, and that the incentives in the global economic system ought to encourage investments in productive capacity and human capital in Latin America, rather than introducing barriers to market access, for example, that would directly impede the region’s ability to achieve its economic goals.

2. Development Dimensions The World Bank’s most recent World Development Report offers a useful overview of the development dimensions of climate change. The Report highlights the fact that, in the past 30 years, half of the developing world lived in extreme poverty, while today that number is only 25 percent. Per capita income among the world’s middle-income

Stern also applies discounting in a manner that is difficult to justify (i.e., discounting the cost of reducing emissions over the next 50 years, while discounting the benefits over several hundred years), but the more important difference is the discount rate itself (Weyant 2008).

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countries, many of them in Latin America and the Caribbean, has doubled. Fewer children are malnourished; more individuals have access to modern infrastructure (World Bank 2010).10 The Report also details how climate change may put that progress at risk, with all that that implies for the roughly 1 billion people who remain in extreme poverty. To the extent that the progress of the last 30 years has been driven by strong economic growth, based on technological change, domestic institutional reform, and greater openness to the world economy, anything that would discourage continued economic growth would represent a significant setback in development terms. Climate change might affect the prospects for growth in multiple ways. Most directly, the impact of climate change on agricultural production will have a significant impact on growth in countries where greater than 50 percent of the population remains engaged in near-subsistence agriculture. While agricultural policies in India have undoubtedly played a role in diminishing the returns from the Green Revolution (Anand 2010), annual harvests on Indian farms are driven far more by the annual monsoon. In other words, the implications of climate change for the monsoon may have more far-reaching effects for development and reducing poverty than improvements in domestic agricultural policy choices in India. Climate change will also affect the prospects for development indirectly. To the extent that development depends on global economic growth, either Lord Stern’s or William Nordhaus’ estimates of the impact of climate change raise troubling questions. On the one hand, if Stern is correct in his estimates of the potential loss in global GDP attributable to climate change under a business-as-usual scenario (upwards of 20 percent), that reduction in growth will affect developing countries most. The effects of the recent global economic crisis illustrate the potential problems—the reduction in growth in the world’s leading economies has sharply diminished the opportunities for trade. While emerging markets like China, India, and Brazil have weathered the economic storm well, their success has not translated into equally strong growth among other developing countries, even within their own regions. On the other hand, if Nordhaus is right about the risks inherent in imposing significant adjustment costs to address climate change, resulting in slower global growth, developing countries will suffer to a greater extent than their counterparts in the developed world. To remain a step ahead of a rapidly growing (and urbanizing) population, developing countries as a group will require significant investments in energy,

Ibid. Setting the Context 7

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transport infrastructure, urban systems, agricultural production, health care, education, and a variety of other sectors. In a carbon-constrained future, the cost of those investments will rise if governments and private firms in developing countries employ existing technologies that yield significantly greater GHG emissions. In other words, a rising cost of carbon will raise the cost of investments needed to drive development. In short, the interests of developing countries, including those of Latin America and the Caribbean, are best served by a climate strategy that improves energy and emissions efficiency, but also fosters stronger economic growth.

3. Implications for International Trade The need for a pro-environment, pro-growth climate change strategy underscores the importance of continued access to global markets for goods, services, capital, and technology. Greater openness to the global economy has proved to be one of the most important drivers of economic growth in the developing world over the past 30 years. Properly understood, there is no conflict between expanding trade and economic growth, on the one hand, and, on the other, meeting the challenge that climate change represents. In fact, expanding trade and encouraging economic growth in Latin America and the Caribbean and other regions of the developing world can contribute to meeting the challenge of climate change: the response to climate change and the rules governing global trade can be crafted in ways that ensure both greater economic opportunity and a healthier environment. While often overlooked, one important extension of the principle of comparative advantage is that specialization through expanded international trade can yield a more efficient use of resources.11 Trade raises productivity by encouraging specialization, which implies the ability to expand production while employing fewer resources. Furthermore, by encouraging greater competition, trade drives efficiency gains throughout a producer’s supply chain, with the same potentially beneficial effect

11 This basic point is often overlooked even by ardent advocates mounting a defense of trade in the face of criticism by environmentalists. See, e.g., Bhagwati (1993). Bhagwati does allude to the fact that trade restraints, which hinder the full play of comparative advantage, can yield damaging environmental results, noting that “the imposition of restraints on Japanese automobile exports to the U.S. during the 1980s shifted the composition of those exports from small to large cars,” as the Japanese attempted to increase their revenues in the face of the restraints. Id. The net effect, environmentally, was to encourage U.S. consumption of energy and increase the toxins emitted by passenger automobiles. Needless to say, the critics do not highlight this potentially beneficial effect, opting instead to argue the second-order effects of specialization (e.g., the potential creation of pollution havens). See, e.g., Daly (1993).

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in environmental terms. The shift toward a nation’s comparative advantage can also bring changes in the mix of goods and services that it produces, with the net effect of reducing the environmental impact even in the face of economic growth (See Krugman and Obstfeld 2009, 280–281). Liberalizing trade can, as a consequence, encourage a smaller environmental footprint for any given level of output.12 By the same token, the introduction of climate change mitigation measures can reduce the opportunities for trade and thereby have the opposite effect on environmental impact, unless the countries of the region ensure that the concerns those measures raise are adequately addressed (World Bank 2010). Just as important, to the extent that trade yields economic growth and rising per capita income in the region, it contributes to rising demand for a cleaner environment (Frankel 2008).13 Trade and economic growth can also help provide the wherewithal for societies to adopt cleaner technologies and afford the remediation that is needed to restore habitat and improve the environment generally (Frankel 2008). The introduction of climate change mitigation measures that impose direct constraints on trade will have an obvious impact on trade flows. Inarguably, the imposition of “carbon tariffs” or “carbon dumping duties” that would directly affect the region’s exports would have serious consequences for Latin American and Caribbean exporters, as it would for developing country producers elsewhere. The same could be said of trade distorting effects of subsidies offered by the United States and China, for example, to their domestic producers to encourage the production of biofuels and new “green” technologies, to help overcome the arguments regarding competitiveness. Such subsidies can impede market access of existing products from the region, as is the case with Brazilian ethanol, and also limit the prospects for producers in the region to develop green technologies of their own.

12 This conclusion holds even though specialization does not always represent an unalloyed good in environmental terms. Indeed, most economists’ analyses of the economics of trade and the environment skip past the potential benefits and shift directly toward a discussion of the negative effects of specialization (e.g., the potential specialization of certain countries in the production of environmentally hazardous goods or services). See, e.g., Frankel (2008, 19) (offering a succinct discussion of the extent to which trade liberalization, in the face of significant differences in environmental regulation, might lead to the creation of pollution havens); see also Batabyal and Beladi, (2001, 2). 13 Among the most frequently cited studies to make the point is an early one by Gene Grossman and Alan Krueger of Princeton University, who found that sulfur dioxide pollution in cities around the world fell as per capita income rose. Grossman and Krueger (1995) found that, initially, increased economic growth could yield rising environmental damage, but that the achievement of higher levels of per-capita income was strongly correlated with improvements in the environment. Id. The resulting relationship between per-capita income and environmental damage is best depicted as an inverted U-shaped curve, now commonly referred to as the “environmental Kuznets curve.” See Krugman and Obstfeld (2009, 280) The World Bank has made the same point in the context of development (World Bank 1992).

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Less obvious, but just as important, new product standards and labeling requirements introduced either by governments or by private firms will raise producer costs and may well cause producers in the region and elsewhere in the developing world to lose their foothold in the global supply chains that increasingly dominate world trade. New standards that oblige firms to measure carbon along their entire supply chain, either to avoid carbon leakage or as a condition of participating in carbon trading, will require producers in the region and elsewhere in the developing world to adopt carbon accounting standards in order to continue to participate in the firm’s supply chain. Where the cost of adopting those standards becomes prohibitive for smaller producers in the region, they risk raising a new set of practical barriers to trade. In either instance, the loss of market opportunities will ultimately affect the developing country producers’ access to capital. Rising capital costs translate into limits on their ability to expand, raise their productivity, and take advantage of greater economies of scale, with all that those imply for the multiplier effect that those firms would otherwise have on production and employment in their own supply chains locally in developing countries. These consequences suggest a compelling need to develop an integrated strategy on trade and climate change—one that ensures continued, if not expanded access to global markets and one that helps producers in the region satisfy the requirements and standards that climate change mitigation measures will likely impose.

C. The Search for a Global Response to Climate Change The dynamics highlighted above have driven the effort to negotiate a global agreement on climate change. The proponents of such an accord argue that, in the absence of rules that force producers to absorb the full environmental cost of production (i.e., capture the negative externalities their production processes create), there is little hope of mitigating either the environmental or economic costs that will flow from global warming.14 In this instance, the negative externalities created by CO2 emissions are global; they cannot meaningfully be addressed by a single nation acting alone. In that sense, “[c]climate change is truly a global commons problem.” Reducing CO2

Indeed, what many fear is that competition in a more globalized world economy will impel both governments and producers to “race to the bottom,” as industries manufacturing internationally traded goods pressure their governments for fewer environmental rules on the grounds that they hinder industrial competitiveness. Frankel (2008, 2–3). 14

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emissions requires action on a global basis in order to eliminate the economic incentive that more ad hoc arrangements offer to potential “free riders” who can avoid internalizing the environmental costs of their production or consumption choices (Stavins 1997). Just as important, for some countries, the cost of mitigation will exceed the benefits. To the extent that countries like Canada or Russia would stand to gain from rising temperatures in terms of agricultural production, they have less incentive to participate in any global agreement and may actually have to be induced to join by incentives offered in other areas (Stavins 1997). This distribution of costs and benefits suggests the need for a global agreement designed to align the incentives in the global economy in ways that ensure that producers and consumers worldwide do, in fact, bear the full environmental cost of their choices (World Bank 2010).15 Unfortunately, as will be discussed in greater detail below, neither the UNFCCC nor the decade-old Kyoto Protocol negotiated under the UNFCCC’s auspices met that basic test. The current negotiations on a global agreement designed to replace the Protocol when it lapses in 2012 have also foundered, most recently at the 15th meeting of the UNFCCC’s Conference of Parties in Copenhagen this past December. Given the underlying economics and the political tensions they create, that result should come as no surprise. In broad outline, the model established by the UNFCCC and the Kyoto Protocol sought to set an overall cap on carbon dioxide emissions as a predicate for negotiation of individual country commitments. The ultimate objective was to establish global emissions trading that would set a global price for carbon and, thereby, offer a basis for competition that would fully internalize the environmental costs of production. Despite efforts under the Kyoto accord to constrain carbon dioxide emissions on a global basis, the gaps in coverage have done little to alter the economic equation facing producers and consumers globally.16 Indeed, it is precisely the problem posed by potential “free riders” under the Kyoto accord that has led to opposition from producers in OECD countries that would be subject to constraints on CO2 emissions,

15 This makes the point that, for all the reasons alluded to above, “collective action is needed to effectively tackle climate change and reduce the costs of mitigation”. 16 What the Kyoto approach created, unfortunately, was a negotiation over individual country commitments to lower emissions. Those negotiations were and are, in fact, negotiations over who will bear the burden of adjustment to a low-carbon global economy. That dynamic creates a zero-sum game that has disabled the effort to reach a global accord.

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and has led them to request either government subsidies or higher protective tariffs to offset the effects on their competitiveness in global markets.17 Efforts to find a globally acceptable response to climate change have been under way for over three decades. The UNFCCC sets a basic outline for international cooperation on climate change. The Convention was concluded in 1992 and entered into force since 1994 (UNFCCC 1992). As of December 2009, 192 countries are party to the Convention. The Convention’s stated goal is the “stabilization of greenhouse gas concentrations in the atmosphere at a level that would prevent dangerous anthropogenic interference with the climate system.” Toward that end, the accord provides a structure under which nations work cooperatively to address climate change. It provides for such things as national reporting of anthropogenic GHG emissions, sharing and dissemination of practices and/or technologies for reducing GHG emissions, and full cooperation in scientific, technological, and socio-economic research on climate. In addition, developed nations (listed in Annex 1 of the Convention) pledged to adopt national policies to limit GHG emissions and enhance and preserve GHG sinks and reservoirs, and to provide resources for certain climate-related activities in less developed nations (UNFCCC 1992). What the UNFCCC does not do, however, is set specific limits on GHG emissions or otherwise oblige producers and consumers to internalize the environmental cost of their economic choices. There are a number of ways an international agreement could be designed to mitigate the effects of climate change through marketbased policies. They include, variously, a globally harmonized level of taxes imposed by each nation equivalent to the estimated environmental cost of GHG emissions; a uniform international tax on GHG emissions with the revenue allocated among participating countries per agreed rules; a system of internationally-tradable emissions permits subject to an agreed global cap; or “joint implementation,” a concept akin to emissions trading which involves bilateral trade in emissions on an ad hoc basis (Stavins 1997). The UNFCCC framework does not fully embrace any of those four solutions. Nor does the Convention contain an enforcement mechanism to ensure compliance

17 The potential under the Kyoto model for free riders has led to pressure for trade protection by domestic industries that fear a loss of competitiveness. The clearest example involves the current discussion in Europe and the United States of so-called “carbon tariffs.” Proponents argue that goods exported from countries where producers are not subject to similar constraints in terms of emissions should be subject to higher tariffs in order to eliminate the competitive disadvantage that domestic producers fear they would face.

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even with those limited obligations that states assume under the agreement (UNFCCC 1992). It instead establishes a coordinating secretariat and a Conference of the Parties to regularly review implementation of the convention and to develop any legal instruments necessary for its effective implementation. All of which of which serves as a reminder that there is, as yet, no international institution “capable of administering, monitoring, and enforcing truly international instruments” designed to mitigate the effects of climate change (Stavins 1997). The UNFCCC Conference of Parties process did, however, prove successful in creating a forum for negotiations over the Kyoto Protocol, which was designed to establish specific limits on GHG emissions. The Protocol was adopted by the third Convention of the Parties to the UNFCCC in Kyoto, Japan in December 1997. Its entry into force was, however, delayed until February, 2005, due to the inability of a number of signatories, most importantly, the United States, to ratify the agreement. The Protocol has now been ratified by 184 countries; the United States, however, is not a party to the Protocol. The Kyoto Protocol created a framework for controlling emissions of GHGs by establishing binding emissions reduction targets for certain parties. The Protocol assigns greater responsibility to developed nations in light of their more advanced levels of industrialization and greater historic emissions under a principle of “common but differentiated responsibilities” established by the Protocol. As a result, the Protocol includes binding emissions targets for 37 industrialized countries and the European Union amounting to an average emissions reduction of 5 percent from 1990 levels by 2012. The protocol does not establish targets for the developing country signatories, but does encourage their efforts to reduce GHG emissions as well. Significantly, while the Kyoto Protocol established reduction targets, individual signatories may achieve those goals through “national action.” What that means in practical terms is that each of the signatories is free to adopt the policy instrument or instruments of their choice, provided that they ultimately satisfy the reduction targets established by the Protocol. The signatories can also utilize one of the market-based mechanisms provided for under the Protocol to satisfy their commitments. The first involves emissions trading, where nations with a surplus of emissions credits can trade or sell credits to nations exceeding their target. The second is the clean development mechanism (CDM). Under the CDM, nations subject to binding emissions reduction targets can get credit for financing emissions reduction or carbon sink promotion projects in a developing country. The third mechanism is known as joint Setting the Context 13

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implementation (JI). Under JI, a country that is subject to a binding target can undertake an emissions reduction or removal project in another country with a target in exchange for credits towards the first country’s emissions reduction goal (Kyoto Protocol 1997). The Kyoto Protocol will terminate in 2012 by its terms; hence the push, as recent as the meeting in Copenhagen to develop a framework governing GHG emissions beyond 2012. That is where things stood in December 2009 as delegates from over 190 nations convened in Copenhagen for the latest round of negotiations on international action to address climate change (New York Times 2010). The meeting represented the fifteenth Conference of the Parties (COP) that are a part of the UNFCCC. Advocates for strong international action had hoped that the meeting would conclude with a new, legally binding international agreement on reducing GHG emissions as a successor to the 1997 Kyoto Protocol, set to expire in 2012. But, well before delegates had convened in Copenhagen, negotiators began downplaying expectations for the meeting, indicating that a new binding agreement on emissions reductions would not be possible at this time. (Charbonneau 2010) Those predictions proved accurate. The only agreement to emerge from the December meeting was a non-binding arrangement known as the Copenhagen Accord. That arrangement was concluded following extended negotiations by the heads of state of the United States, China, Brazil, South Africa, and India. Although non-binding, the Copenhagen Accord does include emissions-control targets for a number of developed and developing nations who “associate” themselves with the arrangement, including the United States and China. The accord also contains pledges of financial aid for developing countries undertaking climate-related initiatives. In what may ultimately prove to be the most important aspect of the arrangements, the Accord includes a general commitment to transparency in the reporting of emissions and emission reductions in developed and developing nations (UNFCCC 2009a). There is, as yet, no agreed-upon standard for reporting emissions or measuring them, but the need to comply with the transparency provisions of the Accord signals the possibility that greater reporting on emissions will be required of private firms. Looking beyond Copenhagen, the prospect for a new, legally binding international agreement on emission reductions remains highly uncertain. Negotiators have already begun preparations for the next COP meeting to be held later this year in Mexico, but few observers at this stage expect that meeting to produce any greater progress than was achieved in Copenhagen. 14 Trade and Climate Change Mitigation Measures

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Some observers have questioned the effectiveness of the UNFCCC, both because of its inability to enforce the targets that it created, and because its cumbersome decision-making structure complicates the effort to negotiate a successor to the Kyoto Protocol. They point to the Copenhagen Accord negotiations among a more limited number of high-GHG-emitting nations as a more effective framework for the future. Having said that, most developing nations, including many of the signatories to the UNFCCC from Latin America and the Caribbean, have signaled their continued support for the Convention. They are unwilling to forfeit the special status that the UNFCCC affords developing countries, and sense that their interests would not be fully represented in a negotiation among a smaller group of countries outside the framework the U.N. agreement provides. What this state of affairs portends is a continued stalemate in the search for a global response to climate change. It also suggests that, although a globally-agreed plan of action on emissions is to be preferred, any steps taken to address climate changeâ&#x20AC;&#x201D;at least in the short runâ&#x20AC;&#x201D;are likely to be unilateral. As will be discussed in greater detail below, the resort to unilateral measures will create strong pressures within the countries or jurisdictions implementing such unilateral actions for trade-distorting measures that could harm Latin American and Caribbean exporters.

Setting the Contextâ&#x20AC;&#x192; 15

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CHAPTER

Mitigating the Effects of Climate Change

s noted above, while a global solution would be far preferable to the enactment of disparate, potentially conflicting unilateral measures, even a global accord must be implemented through instruments adopted at the national level. Individual nations will determine the policy instruments they employ to comply with their international obligations (Nordhaus and Yang 1996). That would hold true even under the proposed agreement designed to replace the Kyoto Protocol, which was the focus of intense negotiations prior to the UNFCCC COP 15 meeting in Copenhagen in December 2009. The discussion below provides an overview of the sorts of measures that climatologists, environmental experts, economists, and policymakers have focused on to date. It develops a taxonomy of climate change-related measures and highlights their potential effects on producers in Latin America and the Caribbean. Before turning to an examination of the various instruments and their impact on producers in the region, however, two important caveats are in order regarding the discussion of effects of the various measures listed below. The discussion does not take into account the potential movement of exchange rates, which could alter the terms of trade that Latin American and Caribbean producers might face.18 Nor does

18 While a fuller treatment of the impact of climate change and climate change mitigation measures is beyond the scope of this study, the basic implications are, nonetheless, relatively clear. Plainly, where domestic currencies appreciate relative to the currency in the producers’ main export markets as a result of global warming’s impact or the effects of climate change mitigation measures in the export market, Latin American and Caribbean producers will find their products less competitive and may well face greater competition in their home markets as well. The reverse is also true—to the extent that the currencies in the region’s principal export markets appreciate relative to the currency in which the particular Latin American or Caribbean producer normally operates, the producers will find their goods and services more competitive in the export market and will face less competition in their home market. Where a particular

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the discussion address economic effects other than those faced by the region’s producers, such as the public finance implications of national emissions or carbon taxes.19 It is nonetheless worth considering how the countries of the region might address those issues as part of an integrated trade and climate change strategy. There are, in fact, a number of different policy instruments that would promote reductions in emissions of greenhouse gases that countries might employ.20 Those instruments can usefully be grouped in one of five categories. The first involves market-based mechanisms designed to overcome the market failure that presents the most significant challenge (i.e., ensuring that producers and consumers internalize the environmental cost of their economic choices). The two policy instruments most frequently discussed in connection with climate change mitigation—carbon taxes and carbon emissions trading—fall within this category. The second category—command and control measures—involves the direct or indirect regulation of activities that emit GHGs. Direct limits on emissions by power plants, product standards, and product labeling all fall in this category. The third category involves the use of monetary or fiscal incentives to encourage behavioral change or induce technological change. This category includes a variety of different measures from tax credits for creating carbon sinks to subsidies for

Latin American or Caribbean country has pegged its currency to that of its principal export market or adopted that nation’s currency as its own, the appreciation of that currency will not affect the competitiveness of producers relative to their competition in that particular export market. They will, however, find their goods and services more or less competitive in world markets based on the appreciation or depreciation of their currency along with the currency to which it is pegged. 19 While the taxes imposed by importing nations on the carbon content of goods may ultimately reach producers in Latin America and the Caribbean, the revenues will not end up with the region’s governments, whether in general revenues or in funds designed to help those countries implement climate change strategies of their own. Properly understood, the point of a carbon tax is to oblige producers to internalize the environmental cost of their production. That does not necessarily imply that the revenue or economic rents created by such taxes should necessarily accrue to the consumer market in which the goods are sold. Those are really two separate questions in economic, environmental, and equitable terms. There is an obvious welfare benefit to the country from the expansion of its export base and the income that it generates for workers locally. To the extent that it expands the country’s tax base, which it may well do since most export firms tend to be in the formal sector of the economy, the net effect of the tax revenue accruing to the country imposing the tax may well be offset. A much deeper look at the implications, however, is beyond the scope of this report. That is, for example, one reason why Canada in its various disputes with the United States over softwood lumber has always chosen to impose an export tax rather than subject its exports to a higher import tariff. Under the export tax, Canada benefits from the revenue, if not the market access. Similarly here, Latin American and Caribbean policymakers may be better off bargaining for a result that ensures that the revenue flows in their direction to aid in their own adjustment and adaptation to climate change. 20 See, e.g., Goulder and Pizer (2005). 18 Trade and Climate Change Mitigation Measures

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the production of biofuels and other alternative forms of energy to government grants and tax incentives for research and development on energy-efficient engines, battery technology, and a variety of other technologies. Tariffs on imported ethanol, which act much like a subsidy for domestic production in this instance, are also included in this category. The fourth category of policy instruments is designed to address the competitive effects of first-order climate change mitigation measures. This category includes such items as carbon tariffs designed to prevent “carbon leakage” and carbon emissions trading abatements designed to limit the competitive disadvantage that firms subject to first order measures might face from competitors in countries that do not impose similar costs on their producers. There is, in addition, a fifth category of policy instruments that is relevant for the analysis below. This category includes measures that are not designed to mitigate climate change, but may nonetheless have an impact on the ability of Latin American and Caribbean producers to adjust to competing in a lower lower-carbon regional and global economy. One example would be national regulations on the sale of genetically modified crops (GMOs), which may limit the utility that GMOs could otherwise provide in improving the carbon efficiency of agriculture in the region. Another example would be the grant of production subsidies that have the effect of relieving firms of the obligation to internalize the environmental costs of their production, even though that was not the intent behind the grant of the subsidy. The recent bailouts of automobile manufacturers in the United States and elsewhere would fall in this category. The following discussion develops this taxonomy of climate change-related measures and summarizes their potential effects on Latin American and Caribbean producers in general terms.21

A. Market-Based Measures As noted above, the two policy instruments that have gained the most attention in discussions of climate change both involve market-based mechanisms for addressing the market failure that lies at the heart of the economics of climate change. Those instruments—emissions trading and “carbon taxes”—are discussed below. 21 The taxonomy outlined here is largely taken from Stavins (1997); U.S. Congressional Budget Office (2008); and Duval (2008).

Mitigating the Effects of Climate Change 19

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1. Emissions Trading Emissions trading involves the establishment of an overall limit on emissions of certain GHGs, the grant of permits to sources of such emissions (e.g., power plants, steel mills, etc.), and the permission to buy and sell these permits. The most basic challenges involve setting an appropriate overall limit on emissions and creating a means of distributing the permits. Those challenges are not insuperable, but they do raise serious questions about what a given level of restraint implies in terms of foregone economic growth. Since market access ultimately depends on the existence of a market in which consumers have the income to actuate their demand, the risks of a government in a market of interest to regional producers getting the limits wrong and choking off economic growth is every bit as important for Latin American and Caribbean producers as it is for their local counterparts. The distribution of permits raises a separate set of issues, both for the administration of the system and for Latin American and Caribbean producers. Discussion of emissions trading has generally focused on two paths: (1) the grant of permits to firms based on their historical share of emissions in the past, or (2) auction of the permits to the highest bidder. Both mechanisms have significant distributional consequences (e.g., the historical share approach tends to reward those that were among the worst emitters of GHGs in the first place; auctions tend to reward the largest and most profitable entities, regardless of whether those profits are earned through efficiencies, particularly in their use of energy and their GHG emissions). To date, the governments have focused on the first of the two alternatives for reasons of political economy (i.e., the ability to ensure that important constituents benefit from the process or are at least not harmed by its operation). In practice, the distribution systems have not worked, both because governments were unwilling to set an overall restraint level that actually reduced emissions to any significant extent (the EU’s initial experience) or because the process that was supposed to distribute the emissions allowances could not craft a politically sustainable solution (the current U.S. circumstance). From the perspective of Latin American and Caribbean producers, emissions trading have both direct and indirect effects. To the extent that emissions trading took hold, effectively reduced emissions, and yielded something akin to a true price for carbon, the most direct effect on the region’s producers would be rising prices for fossil fuels and products, such as fertilizer or plastics, that use such fuels as a feedstock.

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Significantly, because goods are normally priced at the margin, it would not take universal participation in a carbon-trading regime to establish an effective global price for carbon. In other words, Latin American and Caribbean producers might face those effects even in the absence of a truly global system of trading carbon emissions allowances. The indirect effects of emissions trading raise the most serious questions regarding market access and competition in the region’s principal export markets. Properly understood, the constraints imposed by government on emissions create a set of rights and economic rents that go with them. The distribution of those rights on a historical basis involves a transfer of wealth to the recipient—a transfer that would undoubtedly fall within the WTO’s definition of subsidy. From the perspective of Latin American and Caribbean producers competing head to head with those firms that receive emissions allowances, that subsidy provides the recipient with a material competitive advantage in its home market and, potentially, creates new competition for Latin American and Caribbean producers in theirs. There is one final effect on Latin American and Caribbean regional producers that will receive a more complete treatment in a succeeding section of this report. That involves the potential imposition of carbon accounting standards that are essential to the measurement of GHG emissions by enterprises in any emissions trading system. Any firm subject to an emissions trading system will be obliged to determine whether it is in a net credit or deficit position in terms of GHG emissions in order to know whether it can sell allowances or must buy them to meet its prescribed emissions target. Whether or not the firm is in a net credit or deficit position depends on how its target is set under the emissions trading rules. If the target is set on a business unit or enterprise basis, it may well be that the firm need only adopt carbon accounting standards for that part of its operations that falls within the jurisdiction implementing the emissions trading regime. Where, on the other hand, the rules of the emissions trading system require that the firm measure its net emissions position on the basis of its supply chain, the firm will necessarily be obliged to ask its suppliers to account for their emissions as well. It is this cascading effect of carbon accounting standards through the global supply chain of firms subject to emissions trading that could pose a challenge for the region’s producers. Given the overwhelming importance of being able to determine whether the firm at the hub of the supply chain has met its emissions target, it is highly likely that the requirement for carbon accounting will radiate outward along

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the spokes of the supply chain to suppliers abroad, including those in the region. The ability to satisfy the accounting standards set by the firm in order to meet emissions targets set in the downstream product market could, in fact, become an insuperable additional barrier to the participation of regional firms in such global supply chains.

2. Emissions Taxes, Carbon Taxes, and Taxes on Fossil Fuels The use of tax policy to address the market failure that drives the economics of climate change is generally lumped under a single heading: carbon taxes. In fact, these tax measures come in different forms, all of which vary in terms of their effectiveness and practicality. Emissions taxes impose a charge direction on emissions, usually in the form of a charge per unit emitted of a particular GHG, such as CO2. From the perspective of the effect of different tax measures discussed as mitigation options, emissions taxes are the most targeted and, as a consequence, the tax most likely to reduce emissions themselves, as opposed to the use of carbon or certain fossil fuels. Applying a tax directly on emissions, however, presumes a means of measuring the emissions of both products and processes. It also raises significant definitional and administrative questions, such as defining the person, real or juridical, that should be subject to tax and the basis on which the taxpayer’s emissions should be measured (e.g., on a unit, enterprise, or supply chain basis).22 Carbon taxes are taxes applied to the carbon content of a product or to the carbon burned in the process of manufacturing and marketing a product or service. Carbon taxes are less directly targeted on CO2 emissions than an emission tax, which leaves open the possibility of creating an incentive to reduce the use of carbon-based fuels but not necessarily to reduce emissions.23 Having said that, carbon offers a more practical basis for assessing a tax than emissions for the reasons alluded to above. Fossil fuel taxes are closely related to carbon taxes, but work even less directly on emissions. They generally involve imposing a charge per unit of a fuel such as gasoline, based on its carbon content or on the GHG emissions it would yield. Practical challenges reduce the ability to apply a tax directly to emissions as well. Given the difficulties of reducing CO2 directly through some form of “scrubbing” of emissions and disposal of the resulting CO2, for instance, there are few practical examples, apart from those that might be applicable in the case of coal-fired power plants, that could be used to test such a tax. They may, however, become more prevalent in the future as technology evolves. See Stavins (1997). 23 Duval (2008) highlights the fact that carbon taxes do not represent a “perfect proxy for a tax on GHG emissions, since only the latter provides incentives to reduce GHG emissions through ways other than reducing the use of carbon-based inputs”). 22

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While emissions taxes arguably apply only to processes, carbon taxes could be imposed on both product content and on the process by which the product is made and marketed, including the cost of transportation. From the perspective of Latin American and Caribbean producers, if those taxes were, in fact, borne by their competitors and did not apply to exports from the region to the jurisdiction levying the tax, regional producers would gain a material competitive advantage over their competitors that were subject to the tax. Not surprisingly, that outcome has led advocates of such taxes to think in terms of how the tax might be collected on imports as well as on locally produced goods. To the extent that the tax takes the form of an indirect tax on income (i.e., a direct tax on the good itself, rather than on the income derived from its sale), current trade rules under the WTO would allow the importing country to apply a tax on imports equivalent to that borne by locally produced goods. From the perspective of Latin American and Caribbean producers, such a charge would offset the advantage that imports from Latin America and the Caribbean might otherwise enjoy. The region’s producers are likely to find that they are obliged to pay the tax when their goods enter markets where competing products are already subject to such taxes. At that point, whether that tax ultimately adds to their costs and inhibits market access will depend, to a large extent, on whether the elasticities of demand facing the individual supplier allow them to pass the tax on to consumers in the export market. Such taxes may, to a certain extent, also be “border-adjustable” consistent with current WTO rules,24 meaning that firms subject to the tax could potentially receive an exemption when exporting their goods or services out of the taxing jurisdiction, and that imports would be obliged to bear the tax when entering the customs territory 24 The WTO rules allow for the border adjustability of indirect taxes on income (i.e., taxes applied to goods, rather than to income). To understand the impact of those rules on emissions taxes, it helps to start with the WTO treatment of a tax imposed on carbon. A tax imposed on the carbon content of a product would, on its face, fall within the type of taxes the WTO allows to be adjusted at the border. Having said that, to the extent that the tax applies to the carbon emitted in the process of manufacture or marketing of the good (e.g., emitted in the process of transporting the good from the home market to the export market applying the tax on carbon), the issue is much less clear. Rulings under the WTO rules and the WTO’s predecessor, the GATT, draw a sharp distinction between taxes as the regulation of the content of goods, on the one hand, and attempts to tax or regulate a good’s access to a WTO member’s market based on the process by which the good was made, on the other. The former are permissible; the latter have generally been found in violation of the WTO rules. There has been some movement in the WTO Appellate Body’s decisions that a number of commentators (most often those interested in environmental regulation of production processes) suggest allow such taxation or regulation in the furtherance of environment objectives. A fairer reading of the WTO rulings would indicate that the basic distinction between the regulation of goods and the regulation of production processes has not been altered by the WTO decisions, and that any such measures adopted unilaterally by a WTO member would be subject to challenge by their WTO trading partners. Applying that logic to emissions taxes leads to the

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of the country imposing the tax. Latin American and Caribbean producers could confront competition in their home markets from producers that benefited from the rebate of the carbon taxes upon export. Emissions taxes, if broadly applied by a number of countries, could also affect the price of CO2, carbon, and fossil fuels generally in global markets. Latin American and Caribbean producers would see that effect in the form of higher costs of production. Thus far, however, most governments have favored other policy instruments, suggesting that no such effect is foreseeable in the near future—at least not in any dimension that would not be overwhelmed by other factors affecting energy prices. The discussion of the implications of taxing emissions, carbon, or fossil fuel for LAC producers would be incomplete if it focused on the impact of the taxes alone. Tax policy can obviously be used to create incentives as well as constraints on emissions. This aspect of tax policy will be addressed below in the general discussion regarding subsidies. As was true of the emissions trading rules discussed above, the tax schemes examined here would also require that firms subject to the tax measure their emissions of GHGs, their combustion of carbon, or their purchases of fossil fuels. Once again, much will depend on the nature and scope of the tax actually imposed. If the tax were imposed on a territorial basis, there would be no need for the firm to account for the emissions or carbon consumed in the process of manufacturing imported inputs. That, of course, would also undermine the effectiveness of the tax as an environmental measure and, potentially, encourage shifts in production toward jurisdictions with fewer such constraints (i.e., “carbon leakage”). For that reason, the far greater likelihood is that the taxes will require a firm to account for its emissions or carbon along the entire reach of its supply chain in order to assess effectively the actual emissions or carbon content of products sold in the taxing jurisdiction. The alternative, as noted above, would be to impose a tariff on imports equivalent to the tax charged on domestic goods. In either event, the importing firm at the hub of the supply chain would be obliged to account for the emissions or carbon content of the goods it imports. That, in turn, will lead the firm to look to suppliers that are capable of satisfying the carbon accounting standards needed to comply, either with the tax or customs rules governing the transaction (Stavins 1997). In other words, just as was true above, Latin conclusion that such taxes would face a stricter scrutiny than a carbon tax, in the sense that, apart from farm animals, few products in international commerce “emit” CO2 or other GHGs. Emissions are generated by combustion, which isa process, rather than a commodity in an inert state. In that sense, emissions taxes can only be applied to processes, and, as such, clearly fall on the process side of the product/process distinction drawn by previous WTO rulings. 24 Trade and Climate Change Mitigation Measures

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American and Caribbean producers may find they need to be able to account for the emissions or for the carbon burned in their operations in order to qualify as suppliers, even though they are not directly subject to the emissions or carbon tax.

B. Command and Control Measures As highlighted above, “command and control” measures refer to policy instruments that regulate the activities of firms and individuals, rather than creating incentives that overcome the market failure that climate change represents. In that, these measures are both less efficient and more costly than the alternatives discussed above.

1. Direct Regulation of Emissions Attempts to regulate emissions directly have generally been thought of in two ways (Stavins 1997). One route—conventionally thought of as “technology based”—involves prescribing the specific equipment or processes that producers must use in their production (e.g., prescribing energy efficiency standards for production equipment or combustion processes). Scrubbers on coal-fired power plants in the United States represent one example of this approach. The other approach—commonly thought of as “performance-based”—prescribes certain allowable levels of emissions for production process, but leaves the choice of technology to the individual producer. Thus, setting a maximum allowable level of CO2 emissions for an integrated steel mill that burns coke and smelts iron ore would represent one example of a performance-based standard. The direct regulation of emissions can also involve an outright ban on the emission of certain GHGs or other pollutants. A relevant example here is the ban on aerosol sprays that contain ozone-depleting substances (Stavins 1997.25 The most relevant example of such regulation in the context of climate change is the recent steps taken by the U.S. Environmental Protection Agency (EPA) to regulate GHG emissions. In December, 2009, the EPA issued an “endangerment and cause or contribute finding” for GHGs under the Clean Air Act, which will allow the EPA to craft rules that directly regulate GHG emissions.26 As of January 1, 2010, the

Ibid. U.S. Environmental Protection Agency, Endangerment and Cause or Contribute Findings for Greenhouse Gases Under Section 202(a) of the Clean Air Act, Docket ID No. EPA-HQ-OAR-2009–0171, 74 FR 66496 (December 15, 2009). 25 26

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EPA rules require large emitters of GHGs to collect and report data with respect to their GHG emissions—a requirement that will cover roughly 10,000 facilities and 85 percent of the United States’ GHG emissions.27 Efforts to regulate emissions, using either technology-based or performancebased standards, could have a number of direct and indirect effects on Latin American and Caribbean producers exporting to the jurisdiction imposing the rules. While limits on the prescriptive jurisdiction of states under international law preclude the direct regulation of the activities of firms in the region, states have, in the past, found a variety of ways to ensure that products imported from other countries comply with the regulations that apply to local firms. The impact of command-and control-mitigation measures on Latin American and Caribbean producers will generally flow from those alternatives, rather than from the regulations themselves. There are instances, however, when regulations will have a direct effect on regional producers. Plainly, an outright ban on the production and sale of particular products, like aerosols, would eliminate any market access that regional producers of those products previously enjoyed. That ban would not be discriminatory, in that it applies with equal force to domestic producers and would, therefore, satisfy the national treatment requirements under WTO rules.28 Less directly, but more importantly, local producers will face compliance costs that Latin American and Caribbean producers will not face unless they are subject to similar rules at home. That could give the region’s producers an advantage relative to their competition, most immediately in head-to-head competition on the basis of prices, but also in terms of access to capital to the extent that their competition does not find ways to improve their productivity in the face of the regulatory constraints. The problem, of course, is that this sort of competitive effect is precisely what drives producers in many of the region’s principal export markets either to seek an

27 See Mandatory Reporting of Greenhouse Gases, Docket No. EPA-HQ-OAR–2008–0508, 74 FR 56260 (October 30, 2009); and EPA (2009). 28 Article III of GATT 1994, the core set of WTO rules applicable to trade in goods, requires that WTO members afford imports a treatment “no less favourable” than that afforded domestically-produced goods. General Agreement on Tariffs and Trade 1994, Art. III. For that reason, much of the WTO litigation in the trade and environmental arena has focused on Article III’s requirement of “national treatment,” since the question that environmental regulation most often raises is whether differences in the rules applicable to imported goods make them more burdensome than those borne by domestic producers, in violation of Article III. The broad scope of Article III generally means that even seemingly rational approaches to regulation and enforcement of domestic rules will run afoul of the WTO rule. For that reason, the cases most often involve both an assessment of whether a measure violates Article III and, if it does, whether it is otherwise saved by the general exceptions of Article XX of GATT 1994, which provide substantial scope for environmental regulation. (See General Agreement on Tariffs and Trade 1994, Art. XX).

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exemption from the local rules, a subsidy to offset the costs of compliance, or import barriers that would insulate them from competitors that do not bear the same regulatory costs in their home markets. An exemption from the local rules would leave both the Latin American and Caribbean producer, and its competitor in the market imposing the regulations, on the terms they faced ex ante. Based on past experience, however, the more likely result will be the adoption of regulations that attempt to exceed the reach of the regulating state’s jurisdiction and impose rules on activities in other countries. These rules will likely differ from those applied to domestic firms because of the enforcement questions that attempts to regulate extraterritorially always generate. Such questions would lead, as in the past, to WTO litigation under Articles III and XX of GATT 1994, where past rulings do not offer a solid basis on which to determine the likely outcome of such a dispute as a matter of law. Lastly, the nature of what the regulations purport to measure will require us to revisit the question of carbon accounting here as well. Much will depend on the extent to which regulators oblige enterprises subject to their rules to account for emissions by point source (the way most other air pollutants are currently regulated in the United States under the Clean Air Act, for example) or whether they, instead, require firms subject to their jurisdiction to account for emissions on an enterprise or supplychain basis. In the case of the regulations that apply solely to point sources within the jurisdiction of the regulating state, the reach of the rules would not compel a firm to demand that its suppliers account for the emissions or carbon burned in their own operations. The same would hold true if the regulations applied on an enterprise basis, but the definition of enterprise was limited to the operations of a firm within the territory of the regulating state. Where, however, the regulations purport to regulate emissions on the basis of the firm’s entire supply chain, it will necessarily be obliged to require an accounting of its suppliers, including those in Latin America and the Caribbean. In that instance, regional producers would confront the same costs they would under either of the market-based mechanisms discussed above.

2. Product and Performance Standards Product standards regulate emissions indirectly by defining the maximum emissions that can be produced by certain products; examples are automobile fuel efficiency standards or energy efficiency standards for household durables such as refrigerators. Mitigating the Effects of Climate Change 27

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The most direct effect of product standards on Latin American and Caribbean producers would be the obligation to ensure that their products satisfied the standards set in the jurisdiction to which they were exporting. That said, it is often the case that when a market of sufficient size introduces product standards on a unilateral basis, these standards often become the de facto global standard, meaning that producers in the region would be forced to meet the standard even if they were exporting to thirdcountry markets. One example of the use of standards to mitigate climate change involves fuel economy standards. Such standards can take the form of direct regulation of carbon content in a particular class of fuels, or requirements to include a set percentage of a cleaner alternative form of energy such as ethanol. In terms of the impact of such rules on Latin American and Caribbean producers, they could have an impact on the price obtained by producers of fossil fuels unless that cost can be fully passed on to refiners. For producers of automobiles, trucks, and other transport or construction equipment, these products will be obliged to comply with the fuel economy standards set in their principal export markets. In Europe, for example, automobile manufacturers must ensure that overall, their fleets achieve an efficiency standard of 130 grams of CO2 per kilometer. In the United States, new vehicle efficiency standards, effective as of 2007, require that automobile manufacturers achieve fleet efficiency standards of 35 miles per gallon by 2020, up from 27.5 miles per gallon for cars and 22.2 miles per gallon for sport utility vehicles. In January 2008, Canada announced its intention to match the new U.S. standards. Governments may also impose performance standards that influence market access indirectly. One example involves the increasing inclination of local governments to build environmental conditions into their land-use planning requirements and zoning rules. Those generally take the form of restraints on the use of land for certain industrial purposes, but can and often do prescribe standards for the energy efficiency of homes and other buildings, and may go as far as identifying acceptable building materials. Those conditions can become de facto standards for the market as a whole when producers find they gain economies of scale by serving the market with a single product capable of complying with the highest standard set by individual local zoning requirements.

3.â&#x20AC;&#x201A; Product Labeling Another form of regulation involves product labeling. The purpose of labeling requirements is to allow consumers to make an informed choice about the products they buy. 28â&#x20AC;&#x192; Trade and Climate Change Mitigation Measures

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One pertinent example is the U.S. government’s Energy Star program, administered by the EPA. The purpose of the program is to provide a trusted, governmentbacked symbol for energy efficiency on which consumers can rely to reduce GHG emissions and other pollutants caused by the inefficient use of energy (Joiner, Jr. and Laux 2008).29 EPA establishes the requirements for eligibility based on a number of factors, including, inter alia, the extent to which the product »» contributes significant energy savings nationwide; »» offers features that satisfy consumer demand; »» ensures consumer savings over the life cycle of the product even though the initial purchase price may be higher than less energy-efficient alternatives; and »» a basis on which improvements in energy efficiency over competing alternatives can reasonably be measured. To date, there have been few studies of the actual competitive benefit of qualifying for the Energy Star label. Where the issue has been studied, data constraints prevent any broad conclusion about the competitive effect. The results do, however, point to some positive commercial benefit (Joiner, Jr. and Laux 2008). From the perspective of Latin American and Caribbean producers, the limited advantage represented by the Energy Star label is unlikely to present a significant commercial hurdle in entering the U.S. market. Participation in the program is voluntary. The region’s producers do not need to qualify for the label in order to sell into the U.S. market. The EPA’s Energy Star program is, moreover, open to foreign firms intending to enter the U.S. market and is, in that sense, non-discriminatory, implying less of a competitive disadvantage to Latin American and Caribbean producers. A trend in labeling with far more serious potential consequences for Latin American and Caribbean producers involves carbon labeling, particularly as it relates to the carbon content of various food products. Because a significant percentage of the region’s exports involve agricultural commodities or processed food products, the concept of labeling food based on “food miles” or other similar measures presents a particular problem. Carbon reduction labels are intended to show consumers the amount of CO2 and other GHGs emitted as part of a product’s manufacture, distribution, use, and 29 Joiner, Jr., T. and Laux, J., “Energy Star: A Competitive Advantage?” Journal of Business Case Studies Vol. 4, No. 10 (October 2008).

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disposal (i.e., the product’s “carbon footprint”). The goal is to allow consumers to make an informed choice. That said, the label implicitly favors local production over imported goods, regardless of the methods used in local farming, simply because it includes the carbon expended in the process of preparing the goods for market, transportation, and cold storage, all of which add considerably to the product’s “carbon footprint” by the time it reaches the consumer. Thus far, Sweden (Rosenthal 2009)30 and the United Kingdom31 have adopted such labeling requirements. Japan has introduced a pilot program involving labeling by 30 large consumer goods firms and Taiwan is considering similar rules (McCurry 2008; Taiwan News Agency 2010). While the U.S. federal government has not enacted similar rules, legislation has been introduced in the California state legislature that would create a label applicable to goods sold in the California market—an important market for Latin American and Caribbean producers. The notion of carbon labeling, particularly as reflected in the calculation of “food miles,” has come under criticism from a variety of sources. These include nongovernmental organizations that are otherwise in sympathy with the broader goal of reducing GHG emissions, such as the Institute for International Environment and Development and Oxfam International (Chi, MacGregor, and King 2008; EdwardsJones et al. 2009), and, increasingly, development economists.32 There is, nonetheless, a growing trend toward their adoption in both the public and private sectors. Those efforts generally involve the development of standards by non-governmental organizations (Stancich 2008).33 The private sector’s interest is

30 See further The National Food Administration’s environmentally effective food choices – Proposal notified to the EU May 15, 2009. The Swedish proposal has sparked a good deal of controversy among European farmers and there are early indications that the European Commission will find the Swedish labeling proposal inconsistent with the rules regarding trade in Europe’s internal market. 31 The U.K. system is a product of collaboration between the U.K. Department of Environment, Food and Rural Affairs (Defra), the British Standards Institute (BSI) and the Carbon Trust, a quasi-public corporation established by the U.K. government to facilitate the shift toward a low-carbon global economy by introducing market mechanisms designed to aid in that process. “Plan for carbon footprint on every label,” Telegraph (May 31, 2007). Defra has also published a broader analysis of methods to measure the carbon footprints of public entities which offers some further insight into the methodology behind the food labels (United Kingdom Department of Environment, Food and Rural Affairs 2008). Britain’s largest food retailer, Tesco, has already implemented the guidelines. See Finch (2008). 32 See, e.g., Brenton, Edwards-Jones, and Friis Jensen (2008); Edwards-Jones et al. (2009). 33 In France, for example, the supermarket chains Casino and E. Leclerc have introduced voluntary carbon labeling. Switzerland’s top supermarket chain, Migros, introduced carbon labeling in 2007 based on a calculation done by MyClimate, a carbon offset company. In the United States, wholly apart from the EPA’s Energy Star program, the Washington-based Carbon Fund has developed a Certified Carbon Free label in collaboration with the Edinburgh Center for Carbon Management that incorporates the work previously done by the International Standards Organization, the Carbon Trust, and the GHG

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driven both by cost and environmental concerns. Retailers already employ the concept of “food miles” as a basis for improving supply chain efficiency. The fact that a tool that retailers already use for business reasons can be converted to a measure of environmental improvement is likely to ensure the broader adoption of the measure and product labels that result from it.

4. Investment Regulation Not all forms of regulation that could contribute to the mitigation of climate change are related to the carbon content of goods or production processes. An often overlooked set of mitigation measures involves the rules governing the disclosure of information by public issuers on securities exchanges globally. The introduction of new guidelines regarding corporate reporting of risks associated with climate change in relation to a firm’s current operations or future investments has increased the scrutiny of corporate carbon footprints by investors. Here, the financial services sector plays an important role. The industry’s primary function is the efficient allocation of capital. Performing that task requires financial firms to assess the risks and returns associated with a company’s operations and investments, including the financial implications of global warming (Brimble and Stewart 2009). That assessment, increasingly, requires information regarding a company’s existing carbon footprint and its strategy for operating in alternative business futures (i.e., operating under business-as-usual conditions and being exposed to the economic consequences of climate change or, alternatively, operating in a carbon-constrained environment and being forced to adapt to a higher cost of carbon).

Protocol developed by the World Resources Institute and the World Business Council on Sustainable Development. In addition, the California-based Climate Conservancy, a spin-off from Stanford University, has created a Climate Conscious label that rates products, rather than listing CO2 itself. In Canada, a Toronto-based non-profit organization, CarbonCounted, developed an online database web application, CarbonConnect that allows companies to calculate their carbon footprint, which are then certified by CarbonCounted’s certified auditors. Ten large Korean companies have agreed to participate in a government-backed carbon label pilot scheme akin to that introduced in Japan. The German government has backed a Product Carbon Footprint pilot labeling scheme in cooperation with the World Wide Fund for Nature and three German science institutes, Öko-Institut, Potsdam Institute for Climate Impact Research (PIK), and THEMA1. The China Energy Conservation Investment Corporation (CECIC) is working with the Carbon Trust on feasibility studies designed to measure the carbon footprint of a number of Chinese businesses and products. The European Commission is examining how carbon footprinting can be used effectively, but has not committed to the concept of carbon labeling. The EC has commissioned Life Cycle Engineering, an Italian consulting firm, to develop a Carbon Footprint Measurement Toolkit in cooperation with the Swedish Environmental Management Council, which could be used as a part of the EU Eco label regime. Mitigating the Effects of Climate Change 31

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In that regard, the U.S. Securities Exchange Commission (SEC) recently announced guidelines for the disclosure of information related to climate change (SEC 2010).34 In general, U.S. securities laws require disclosure of “material” information that might reasonably be expected to affect the financial performance of the firm and would, therefore, be relevant to the investing public. The SEC’s guidance expressly identifies “the impact of climate change” as a fact that could require disclosure (SEC 2010). The SEC guidance is extraordinarily far-reaching. The agency, for example, expressly identifies the potential risk to a company’s reputation emanating from the consuming public’s reaction to publication of the company’s GHG emissions as a factor in determining whether the company should disclose that risk as part of its financial reporting (SEC 2010). Given its scope, the SEC’s guidance is bound to expand the requirement for U.S. companies subject to the agency’s jurisdiction to implement effective carbon accounting standards in order to accurately assess their exposure to climate-change-related risk, whether due to global warming itself or to the changing legal environment. There is also an obvious nexus between the SEC’s financial reporting requirements, particularly as they relate to the disclosure of information on a company’s carbon footprint, and the recently published EPA GHG emissions reporting requirements. The possibility that errors in reporting under the EPA rules might translate into serious potential violations of the securities laws will amplify the efforts of companies to implement effective carbon accounting procedures. This could well flow down through their supply chain as discussed above. The SEC’s guidance is pertinent to Latin American and Caribbean producers participating in the supply chain of a firm subject to the SEC’s rules, to the extent that it implies that they too will be required to implement effective carbon accounting rules if they intend to continue to sell to their U.S. customer, even when the goods will not enter the U.S. market.

34 Commission Guidance Regarding Disclosure Related to Climate Change, Interpretation, 75 Fed. Reg. 6290–6297 (February 8, 2010) (to be codified at 17 C.F.R. pts. 211, 231 and 241). The SEC published the guidance in recognition of the increasing interest of corporations in assessing their performance in light of the potential risks associated with global warming. See, e.g., Ernst & Young and Oxford Analytica(2009) reporting on the adoption by the National Association of Insurance Commissioners of a mandatory requirement obliging insurance companies to disclose the financial risks they face from climate change to state regulators). In addition, the SEC felt compelled to act in light of the trend toward publication by companies of their carbon footprints and their efforts to reduce them, given the SEC’s interest in ensuring the accuracy of the information provided to the public that might affect investors’ decisions (SEC 2010). Finally, the SEC was also acting in recognition of the changing legislative and regulatory environment in the United States, which could require firms to make significant capital expenditures to reduce emissions, all of which would affect financial performance (SEC 2010).

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The SEC’s guidance is, of course, also relevant to the ability of the regional producer to tap U.S. capital markets to finance future growth, which would make the SEC’s interpretive guidance directly applicable to the producer as the issuer of securities on an exchange located in the United States and subject to the SEC’s jurisdiction. Because of the breadth of the U.S. securities laws, the SEC’s guidance may also apply to Latin American and Caribbean firms investing in the United States in order to establish a beachhead for marketing purposes.

C. Incentive Programs Governments have adopted a wide variety of monetary or fiscal incentives to encourage individuals and firms to adapt to a lower-carbon economy. These fall into three basic categories: subsidies for the production of biofuels and other alternative sources of cleaner energy; tax incentives designed to encourage research and development on a variety of advanced technologies that would contribute to energy efficiency and/or reductions in GHG emissions; and incentives for other forms of GHG emissions abatement.

1. Subsidies for Biofuels and Alternative Sources of Energy One of the most important measures from the perspective of Latin American and Caribbean producers is the subsidization of biofuels production in Europe, the United States, and elsewhere. Subsidies to biofuel production flow from two separate strands of economic policy. The first involves mandates requiring their use; the second involves specific financial incentives to offset the cost of implementing those mandates and encourage production. Under its Renewable Energy Sources Directive, for example, the European Commission will require that EU members meet 10 per cent of their transport energy needs by using biofuels. Similarly, in the United States, renewable fuel standards established by the Energy Policy Act of 2005, and reinforced by the 2007 Energy Independence and Security Act, dictate the use of 36 billion gallons of renewable fuels, mainly ethanol, annually by 2022. Canada’s Renewable Fuels Bill would require a minimum of 5 percent ethanol in gasoline by 2010 and 2 percent biodiesel in diesel by 2012. Those mandates are bolstered by significant subsidies. The United States, for instance, provides a 51-cents-per-gallon subsidy to producers of bioethanol to offset the fact that the break-even price for ethanol production in terms of the price of oil is $54 Mitigating the Effects of Climate Change 33

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per barrel.35 The break-even price for European ethanol production, which is wheatbased, is still higher at $72 per barrel, leading Germany (the EU’s largest producer and user of biofuels) to offer ethanol producers a 35-percent tax advantage over producers of traditional fuels and to subsidize up to 50 percent of the construction of ethanol production facilities (Larson 2008).36 There are also a number of measures that governments adopt in support of their subsidy programs. The most prominent example involves the tariff that the United States imposes on imported ethanol. The basic U.S. applied tariff (i.e., the most-favored-nation rate applicable to imports from WTO members) on imports of undenatured ethyl alcohol (80 percent volume alcohol or higher) is 2.5 percent ad valorem; the applied rate on denatured ethyl alcohol is 1.9 percent ad valorem (Koplow 2006). Since 1980, however, the United States has also applied a specific-rate tariff on ethyl alcohol imported for use as a fuel—a rate that is currently 54 cents per gallon (Koplow 2006). The United States is not alone in imposing substantial tariffs on imports of ethanol. The European Union, for example, applies a tariff of €0.102 or €0.192 per liter on imports of ethanol, depending on whether it is denatured (Kutas, Lindberg, and Steenblik 2007). In the case of ethanol, the tariffs ensure that the subsidy offered to domestic producers is not undercut by competition from imported ethanol, but it also serves as a subsidy in its own right, as do tariffs generally. Critics have argued, for instance, that the European ethanol tariff provided a price support (i.e., subsidy) to EU producers of an estimated €420 million in 2006 by insulating EU producers from international The panoply of U.S. incentives for biofuels reaches well beyond the subsidy to ethanol producers. The list of federal government programs includes, for example, the Volumetric Ethanol Excise Tax Credit, Biodiesel Blenders Tax Credit, Small Producer Tax Credit, Renewable Fuels Standard, Alternative Fuel Infrastructure Tax Credit, and the Clean Fuels Program (Schumacher 2006). There are also a variety of programs at the state level, including North Dakota’s general incentives for agricultural processing facilities that may apply to businesses; Montana’s tax credits for investments in oilseed crushing facilities, biodiesel production equipment and biodiesel distribution infrastructure; California’s separate state mandates for the use of renewable fuels by investor-owned utility companies; and Wyoming’s incentive for ethanol production. (Schumacher 2006). 36 The significant levels of subsidization have led to trade conflicts among the various states. The United States’ subsidies for biodiesel, for example, allowed U.S. producers to gain considerable market share in Europe relative to their European competitors. That, in turn, led to pressure by European producers on the European Commission to impose anti-dumping duties on imports of biodiesel from the United States. (Guardian 2008). The EU ultimately imposed 5-year tariffs on US biodiesel to counter American subsidies (Bandyopadhyay, Bhaumik, and Wall 2009). The EC imposed a tariff of €237 per metric ton (the equivalent of a 41 percent ad valorem tariff) to offset the American programs, which the EC found to afford a €198 per metric ton subsidy (Bandyopadhyay,, Bhaumik, and Wall 2009). The European tariffs cut off 95 percent of the U.S. biodiesel producers’ export market, sharply reducing their scale economies and, ultimately, their financial viability. The U.S. industry was also affected by the loss of a $1 per gallon for biodiesel tax credit (although a limited extension of the credit is now under consideration by the U.S. Congress). 35

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competition. Arguably, generally applicable tariffs on sugar and corn imports operate in much the same way, even though not offered as a means of inducing the domestic production of alternative sources of cleaner energy. All of these measures create significant barriers to Latin American and Caribbean exports of ethanol and of the products, corn and sugar, that are used as feedstock for ethanol production. For that reason, the measures have come under significant criticism from a variety of sources, most particularly non-governmental organizations concerned with the impact the subsidies may have on the production of food commodities and global hunger generally.37

2. Research and Development and Technology Diffusion Incentives Governments also provide significant subsidies to research and development of other cleaner alternative sources of energy. A recent report by the U.S. Committee on Climate Change, Science and Technology, chaired by then-Secretary of Energy Sam Bodman, listed well over 300 U.S. federal government programs that provide material support to the research and development of technologies capable of contributing to the effort to reduce emissions and improve energy efficiency (Committee on Climate Change, Science and Technology Integration 2009).38 The U.S. federal government programs supporting research and development cover every major sector of the U.S. economy, from its energy supply to transportation to buildings, industry, and the U.S. electric grid (Committee on Climate Change, Science and Technology Integration 2009). They cover 15 technology areas, including everything from carbon capture and sequestration to energy-efficient engines and battery technology, and $1.2 billion to fund research to develop vehicles powered by fuel cells.39 The list also includes a number of cooperative efforts under which the United States provides assistance to other countries in employing these technologies (Committee on Climate Change, Science and Technology Integration 2009). Other OECD governments have made substantial investments in research and development as well, although not on the scale of the United States. China, too, has invested heavily in the development of “green” technologies.

See, e.g., Oxfam (2008). All the more remarkable, the Committee’s inventory focuses solely on U.S. federal government programs supporting GHG-reducing practices and technologies that are currently suitable for deployment; the list does not include investments in longer-term technologies. Ibid. What is more, the list made no pretense of being exhaustive. 39 See also Popp (2006) regarding then-President Bush’s request for subsidies for fuel cell research. 37 38

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The effect of these programs on Latin American and Caribbean producers depends heavily on whether they can benefit either from the funding for research and development or have access to the resulting technology. At least in the case of the United States, the programs for research and development are subject to government procurement rules that are substantially open to foreign competition. That said, the bidding process is complex, meaning the far likelier route for participation would be through partnerships either with existing U.S. private-sector customers or with U.S. research-based universities. As for access to the resulting technology, many of the programs are expressly designed to ensure that the fruits of the research are broadly shared; however, those sorts of requirements also work against the full development of the technologies because of the economics of public goods, which is what the resulting technology would be if fully open to all comers. That form of market failure is not adequately addressed by the structure of the programs, but would, necessarily, be exacerbated by efforts to expand the diffusion further, except as embodied in tradable goods and services. In short, wholly apart from the possible “buy national” requirements that may attach to many of the research and development programs, there are also sound economic reasons for restraints on the public distribution of the product of the research and development efforts. A second-order effect of the programs may have an impact on Latin American and Caribbean producers. Plainly, if governments pursue a series of policies designed to create a lower-carbon economic future, the economic rents generated by the rights to technologies that contribute to energy and emissions efficiency will prove extraordinarily valuable. As is commonly true of any technological change, the first movers also tend to gain an insuperable advantage by virtue of their ability to achieve scale economies before their competition has the opportunity to ramp up production. The net effect for the region’s producers could be technological lockout.

3. Tax Incentives for Abatement Purposes There are a number of proposals extant that recommend the imposition of carbon taxes with the proviso that the revenue generated be used to provide incentives for abatement or research and development of more energy-efficient technologies.40 In practice, governments have skipped the predicate (i.e., imposing a carbon tax) and simply offered a range of fiscal incentives to encourage emissions abatement. 40

See, e.g., Aldy,. Ley, and Parry (2008).

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Multiple programs at different levels of government provide a significant range of incentives. In the United States, for example, the federal government provides a credit of up to $1,500 against a taxpayer’s income tax liability for the purchase of an energy-efficient product or renewable energy system for home use. At the state level, California offers property tax exclusion for certain types of solar energy systems.41 North Carolina offers a tax credit equal to 35 percent of the cost of “renewable energy property” built, purchased, or leased in the state. Pennsylvania effectively exempts wind turbines and related equipment from property tax by barring tax assessors from including them in the assessed value of the property. In Minnesota, solar energy systems are exempt from the state’s sales tax. Georgia provides tax credits of up to 35 percent of the cost of clean energy equipment and also exempts purchases of biomass for energy production from the state’s sales and use taxes. A number of other countries have adopted similar sorts of incentives. Australia was among the first countries to establish an incentive for the creation of carbon sinks. Australia allows taxpayers to deduct the cost of establishing forests for the dedicated purpose of absorbing CO2 from the atmosphere (Government of Australia 2010). Under its energy tax directive, the European Union allows member states to offer total or partial exemptions from tax or tax cuts for energy products used in pilot projects for the development of more environmentally-friendly goods or renewable forms of energy, including biofuels (European Union 2003). The tax directive also permits exemptions for income related to the production of solar, wind, tidal, or geothermal energy, or to energy produced with biomass or waste (European Union 2003). From the perspective of Latin American and Caribbean producers, the main effect is to create a market for energy-efficient goods and services that would not otherwise exist. That said, there is nothing in the programs that would particularly offer the region’s producers a material competitive advantage over local suppliers. The indirect effect of the tax incentives for abatement is much like that identified above with respect to incentives for research and development. The abatement incentives represent the demand-side incentives that correspond to the supply-side incentives discussed above. In creating a broader market for energy-efficient goods and services, the abatement incentives may also encourage the sort of technological lockout the discussion above highlighted. 41 The examples of state incentives listed here are drawn from the U.S. Department of Energy’s Database of State Incentives for Renewables and Efficiency.

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D. Carbon Tariffs and Other Offsets The fourth category of policy instruments of interest to Latin American and Caribbean producers consists of those designed to address the unintended consequences of first-order climate change mitigation measures. This category includes such items as carbon tariffs and carbon emissions trading abatements. The impetus behind the proposals for carbon tariffs and emissions trading abatements flows from the fact that both sorts of measures are motivated by both environmental and economic concerns. From an environmental perspective (Veel 2009), the measures are thought of as a means of preventing “carbon leakage” (i.e., the shifting of production to less environmentally restrictive regimes, which would undercut the intended effect of the regulations originally imposed). From an economic perspective, the primary concern is one of cost competitiveness (Veel 2009). Producers subject to restrictive climate change regimes fear a loss of competitiveness relative to their competition located in less environmentally restrictive systems. Proposals to impose such measures have led to a spirited public debate regarding their efficacy and the extent to which they can be used as a means of disguised protection. They have also raised serious questions regarding the application of WTO rules and the potential need to reinforce those measures in the face of the challenges that both climate change and mitigation measures may raise under the WTO system (Veel 2009). While the discussion below addresses the WTO-consistency of the measures, it does not attempt to provide a complete analysis of the legal issues at work. Rather, it is designed to highlight two points relevant to a later discussion of the implications for policymakers of the challenges Latin American and Caribbean producers will confront in the shift toward a lower carbon global economy. The first is simply to stress that, where other countries impose measures that potentially violate, nullify, or impair the WTO rights for which the nations of the region have bargained, Latin American and Caribbean policymakers do have recourse to the WTO to vindicate those rights. The second, however, is the more important. To the extent that such trade conflicts are foreseeable, they should also be avoided. The discussion above nicely illustrates the extent to which the climate negotiations under way under the aegis of the UNFCCC process are, in fact, as much about trade as they are about the environment; policymakers of the region need to conceive an integrated trade and climate change strategy that acknowledges that fact. 38 Trade and Climate Change Mitigation Measures

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1. Carbon Tariffs A “carbon tariff ” might broadly be defined as a levy on an imported good based on CO2 embodied in the good itself, the CO2 emitted in the production, marketing, and transport of the good to its point of final sale to consumers, and/or on CO2 emissions or CO2 emission reduction efforts of the exporting or producing country (Veel 2009).42 As such, the better analogy is not to normal ad valorem “tariffs,” but something more akin to either a border tax adjustment designed to ensure that the imported good bears the same rate of “tax” as locally produced goods (in this case, the tax being the net effect of the importing country’s climate change policies on producer costs) 43 or a countervailing duty (i.e., one designed to offset the alleged subsidy implicit in the producing country’s failure to ensure that their producers fully internalized the environmental cost of their production).44

The definition used here is slightly broader than that used in the referenced article. As noted above, the WTO rules do allow members to impose border taxes on imports that are coextensive with the taxes born by locally produced goods. Likening an offsetting carbon tariff to the sort of border adjustment permitted under Article III of GATT 1994, the relevant provision of WTO law, would allow the state imposing the tariff to draw on a relatively strong legal foundation where the underlying climate change policy involved a carbon tax. Despite the sanguine statements of a variety of commentators, however, the WTO law is nowhere near so clear as to allow a definitive statement that even a measure designed to adjust for a domestically-imposed carbon tax would absolutely survive WTO scrutiny. The basic distinction between products and processes would still leave plenty of room for the exporting country to insist the measure was, at a minimum, overbroad were it to attempt to impose a carbon tariff on the basis of anything more than the actual CO2 embodied in the imported good itself. The farther the measure moves away from the solid ground afforded by Article III, the more it is likely to be found as an infringement of the WTO rules and would have to be justified on the basis of one of the exceptions in Article XX. That is plainly the case in which such carbon tariffs are imposed not as a border adjustment on imports to equalize the tax treatment afforded imported and locally-produced goods, but rather a penalty to offset the competitive disadvantage created by imposing an overall restraint on carbon in the importing market and then relying on emissions trading as the primary vehicle to mitigate climate change. 44 The analogy to a countervailing duty offers another potential economic rationale for imposing a carbon tariff based on any climate change mitigation policy broader than a border adjustment for taxes actually paid in the importing jurisdiction on the basis of the carbon content of the competing imported and domestically produced goods. In this instance, the rationale would involve defining the producing country’s climate change policies as framed in such a way so as to relieve the producer/exporter of its full cost of production (in this case, the full environmental cost of producing the good and transporting it to the importing country’s market). To that extent, the policies of the producer’s government could be construed as a financial contribution to the producer analogous to other similar government actions that fall squarely within the WTO’s definition of subsidy. The problem with the approach is twofold. First, the attempt to define the absence of any affirmative climate change policy as a “grant” or other financial contribution is difficult at best. Beyond that, the importing country would still have to prove the other elements of their case for a countervailing duty (i.e., that the “subsidy” was not generally available to all industries in the producer’s country, but was, rather, specific to the producer or the producer’s industry and that a domestic industry producing a like product was injured by reason of the subsidized imports). 42 43

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Thinking of carbon tariffs in that context helps illuminate the arguments that are likely to be raised both for and against the WTO consistency of any such measure. But, as a practical matter, it will not escape the attention of any dispute settlement panel or, eventually, the WTO Appellate Body, that the primary rationale for imposing the tariff is not the environmental damage caused by the good itself or even the process by which it is produced, but rather by the unwillingness of the exporting country to join the importing country in imposing equivalent climate change policies. That sort of use of trade policy instruments in pursuit of broader foreign policy goals is precisely what the WTO and its predecessor the GATT were designed to prevent. In terms of the economics, a recent study highlights the extent to which the market access of developing countries exporting to jurisdictions where carbon tariffs are under consideration would be impaired (Mattoo et al 2009). The study suggested that even relatively high-income developing countries like China, India, and Brazil would suffer significant impairment of their access to developed country markets if carbon tariffs were imposed.45 While the study does not address the region as a whole, it does highlight two important facts relevant to the likely impact on Latin American and Caribbean exporters. The first is that the higher carbon intensity of their exports, relative to their competition in developed country markets where the carbon tariffs are likely to be imposed, will amplify the effect of any carbon tariff, even though the LAC countries would ultimately be better off than other developing countries like China or India that are less energy- and emissions-efficient. The second is that a policy of adjusting climate policies at the border, as was discussed above with respect to carbon taxes, would have a less serious competitive effect on the producers in both the developed and developing world, which speaks to the discussion to which we turn next—emissions trading abatements.

45 Under the worst-case scenario (i.e., a carbon tariff along the lines of the one we are discussing here), the study indicates that China’s exports of manufactured goods would decline by as much as 21 percent and India’s would fall by 16 percent, implying a 3.5 percent decline in manufacturing output in both countries. Ibid. In a related study, the same authors suggested that the impact of such measures for Latin America and the Caribbean would be less than on China and India due to the region’s relatively greater energy efficiency (i.e., less total CO2 content subject to the tariff), which suggests that the region might gain an advantage relative to China and India, which would slightly diminish the negative first-order impact of the carbon tariff on their export market access. See Mattoo Et al (2009).

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2. Carbon Trading Emissions Abatements The opposite is the case with carbon trading emissions abatements, both in the sense that there is no WTO rule that would necessarily impede the grant of such abatements and in the sense that the competitive effect of the abatements would be nowhere near as significant as the impact of carbon tariffs. Emissions abatements are a relatively new device created by the European Union to address the concerns of European producers regarding their competitiveness relative to producers in countries without the sort of climate change policies the EU imposes. The abatements consist of exemptions from the constraints on emissions that would otherwise apply under the EU regime. Firms or industry sectors must petition the European Commission for relief from the EU emissions policy based on the likelihood that they would suffer competitive reverses from imports of like products from countries without similar climate change regimes. In terms of Latin American and Caribbean producers’ access to the market offering the abatement, the grant of relief would simply restore the competitive balance that existed ex ante. In effect, the action would likely deny the region’s producers only that additional access they expected to accrue as a result of the decline in the cost competitiveness of European producers.46 A more reasonable question could be raised about the extent to which the grant of the abatements amount to a subsidy offered by the European Union to its producers.47

Thinking of the action in those terms does open the question, in WTO terms, of what the region’s producers could reasonably have expected in terms of market access as a result of the initial implementation, for example, of the EU’s emission trading regime. A WTO claim based on that expectation might prove difficult to sustain. 47 There is little doubt that the point of the emissions abatement is to relieve the qualifying European producers of costs they would otherwise face under the EU’s climate change regime—that is, after all, the purpose of the abatement and the goal of the underlying European Commission review of the European producers’ petition. The subsidy argument could prove availing to Latin American and Caribbean producers in one of three circumstances. They could argue that the abatement acts as a protective device much like any subsidy or like the carbon tariffs discussed above. The United States has prevailed previously against the European Union on just such a rationale in the long-running dispute between the two trading partners over oil-seeds. The region’s producers could also assert that the subsidy implicit in relieving the producers of the costs of complying with the EU’s climate regime has distorted global trade, allowed the European producers to gain an inequitable share of world trade in the particular good they produce, and resulted in serious prejudice to the trading interests of the Latin American and Caribbean countries the producers of which are affected by the abatements. The final alternative would relate to European exports to Latin American and Caribbean markets. In this instance, while the point would undoubtedly be contended, there is little doubt that the relief implicit in the abatement would fall within the WTO’s definition of subsidy and, ironically, the very nature of the process by which the abatements are granted ensures that they are “specific” to the firm or industry concerned. The question would, ultimately, turn on whether or not the Latin American or Caribbean country could prove injury to their producers in their home market. 46

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E. Other Measures with Implications for Latin American and Caribbean Producers There is, finally, a fifth category of policy instruments that is relevant for the analysis below. That category includes measures that are not designed to mitigate climate change, but may nonetheless have an impact on the ability of Latin American and Caribbean producers to adjust to competing in a lower-carbon regional and global economy. The following discussion highlights two examples: the potential negative effects of the regulation of imports based on the possibility that they may include genetically modified organisms and the amplified effect of normal production subsidies in the midst of a transition to a lower carbon global economy.

1. Regulation of Imports Containing GMOs Predictions on many aspects of climate change vary, but there is a general consensus that the impact will be most significant on agriculture, with heat and drought driving global yields down (Battisti and Naylor (2009). As one of the leading agricultural regions of the world, Latin America and the Caribbean producers are uniquely placed to help feed the world. That said, the region’s agricultural sector would face a number of the same challenges in climate change’s impact on harvests. The concern regarding agricultural yields under global warming, as well as droughts in the Sahel and other regions, has led to a renewed focus on the development of heat- and drought-resistant crops (Battisti and Naylor 2009). Although the development of heat- and drought-resistant crops does not come close to offering a complete solution to the challenge of improving harvests in a warmer global climate, applying biotechnological advances to that effort will undoubtedly pay dividends. Even so, applying biotechnological advances to crops to improve yields under global warming will undoubtedly bring a confrontation with those advocates of banning genetically modified organisms. Conflict over restraints on imports of goods, primarily agricultural products, containing GMOs, has been a recurring theme in trade policy and trade politics over the past decade and a half. The dispute is rarely over whether a state has the authority to regulate the importation of such goods or over the power of the state to ensure that such imports comply with applicable standards. Rather, it is over the tendency of certain trading partners, most particularly the European Union, to object to any such imports regardless of the proof of their safety. 42 Trade and Climate Change Mitigation Measures

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The WTO Appellate Body in a series of rulings, with which the EU refused to comply, flatly rejected the initial EU rules on the subject (WTO 2006).48 Over time, however, the EU has implemented an extensive review process that recently led to the authorization of one form of GMO crops for cultivation in Europe, which would suggest an opening for producers of that crop outside the European Union.49 The challenge, of course, is that the European process is lengthy and the outcome uncertain. In that sense, even if it did begin to authorize the cultivation and importation of GMO crops designed to resist heat and drought, the EU’s rules and procedures might dissuade producers in Latin America and the Caribbean from introducing those higher-yielding crops to the extent that they were heavily dependent on the European market for current earnings. The net effect would be to limit the utility that GMOs could otherwise provide in improving the carbon efficiency of agriculture in the region. In other words, there are instances in which government regulation unrelated to climate change could well affect Latin American and Caribbean producers adversely, not in terms of market access, but in terms of their adaptation to global warming and their adjustment to competing in a lower-carbon global economy.

2. Impact of Production Subsidies Another example of government policies that could affect the region’s producers, even though they were not intended as a means of mitigating climate change, involves the grant by governments of subsidies to production. Recalling that the point of climate change mitigation policies is to ensure that producers internalize the environmental costs of their production, any government action that tends to undercut the firm’s or industry‘s obligation to comply has significant competitive consequences. It is important to note in this context that global warming will impose adjustment costs on all producers globally, even those that are not subject to strict constraints on their production of GHG emissions. Any advantage governments offer See, e.g., European Communities – Measures Affecting the Approval and Marketing of Biotech Products – Report of the Panel WT/DS291/R; WT/DS292/R; WT/DS293/R (September 29, 2006). 49 The European Commission authorized the planting of genetically modified potatoes that produce higher levels of starch, which are used in industries like paper manufacturing (Cendrowicz 2010). The Commission’s action marks the first time that Europe has approved any GMO cultivation since the Commission imposed a moratorium 12 years ago. Ibid. That said, it is not clear how significant the approval will be for other crops containing GMOs—the potato was created by German chemical giant BASF (i.e., a European producer of biotechnology) and is not intended for human consumption. (Cendrowicz 2010). 48

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their producers has competitive effects, but the impact of trade-distorting production subsidies will be amplified in a carbon-constrained regional or global economy. Money is fungible. While a subsidy may be granted for reasons other than offsetting the costs of complying with climate change mitigation measures, any subsidy can have that effect. The recent bailout of General Motors and Chrysler in the United States and of Opel and other automobile manufacturers in Europe provides a case in point. To the extent that the United States adopts an emissions trading regime akin to that currently in place in Europe, both the United States and the EU will implicitly rely on the price discipline imposed by competition to drive down emissions. In that setting, actions that lower the automobile manufacturers’ cost of production and/or cost of capital allow them to avoid the discipline that a price for carbon created by emissions trading would otherwise impose. In that sense, the firms are placed in a better position to cope with the changes in their operating environment that climate change or any mitigation measures might bring. The competitive effect on Latin American and Caribbean producers of a like product would be that of any other production subsidy, but for the fact that the region’s producers may be forced to comply with the same product standards as one of the subsidized firms, in which case the effect would be to offer the recipient of the subsidy an advantage both in its home market and in global markets in which it competes with Latin American and Caribbean firms. Thus, although the production subsidies were not granted specifically to address climate change, they could have an important—and negative—effect on the competitiveness of Latin American and Caribbean producers in the face of climate change and the transition to a lower-carbon regional and global economy.

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CHAPTER

III

Climate Change Mitigation Measures Adopted or Proposed

he discussion above outlined a taxonomy of climate change-related measures as a means of identifying the types of measures either employed or under consideration by various countries. This section describes the implementation of those measures by individual countries or regions. It also details the multiplicity of measures being developed separately by the private sector. The actual implementation of the measures identified above varies significantly. They range from the European Union, which has the most comprehensive set of climate change policies, to China, which has only recently signaled its intent to pursue a variety of measures designed to become more energy- and emissions-efficient, although it has expressly rejected the idea of establishing a firm cap on emissions. The implementation of the measures also varies in terms of their compulsory or voluntary character. In the European Union, as is common with European law generally, the implementation of its climate change policies purports to be universal in its application and mandatory in nature; however, there are any number of exceptions and exemptions, as the discussion regarding emissions trading abatements above bears out. On the other hand, Japan has, to date, relied heavily on voluntary compliance by its companies in the pursuit of emissions reductions. While that may change under Japanâ&#x20AC;&#x2122;s new government, the nature of the Japanese system and the structure of the Japanese economy around a number of industry leaders may, ultimately, result in more comprehensive coverage than other countries will achieve. Implementation also varies in terms of its definitiveness. In the United States, for example, the situation is extraordinarily fluid, both in terms of the method and its application. Thus, while virtually any climate change mitigation measure likely to be put in place in the United States is also likely to yield some provision like carbon tariffs â&#x20AC;&#x192; 45

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that is designed to offset the competitive effects of the original mitigation measure, that possibility does not represent a present threat to Latin American and Caribbean trading partners, apart from the uncertainty it creates, because of the political and legal hurdles that implementation of any form of climate change mitigation policy will confront. The European Union, by contrast, has a set of policies that have now been in place for some time. They have been in place long enough for the EU to have revised them in ways designed to improve their performance, which has the benefit of creating greater certainty for Latin American and Caribbean producers. Thus, for example, the resistance to the calls by various European leaders for carbon tariffs, and the decision to opt, instead, for a process that offers individual firms or sectors emissions trading abatements not only eliminates the near-term risk of such measures, but also limits the uncertainty regarding supply relationships that can prove to be as effective a barrier to market access as any outright restraint. The discussion begins with the European Union in order to provide a benchmark against which the varying programs implemented by other countries might be measured. It then covers the United States, a critical market for Latin American and Caribbean producers, just like Europe. The discussion covers Canada and Japan to round out the sampling of OECD countries surveyed here, and then describes China’s recently announced climate change plans. The discussion concludes by setting out the measures that the private sector is taking, either in expectation of future climate change mitigation policies, or on their own motion.

A. European Union To date, only the European Union has implemented what could be called a comprehensive set of policies designed to reduce emissions and otherwise contribute to adjustment toward a low-carbon global economy.

1. EU-wide Action The EU process started well before it ratified the Kyoto Protocol in May of 2002.50 In an effort to best achieve the EU’s emission reduction goals under the Kyoto Protocol, the European Commission in 2000 created the European Climate Change 50 European Commission Communication. (November 20, 2008). Environment – Climate Change – Kyoto Protocol. In Europa. Retrieved February 2, 2010, from http://ec.europa.eu/environment/climat/kyoto.htm.

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Program (ECCP).51 The ECCP and its successor—ECCP II (launched in 2005)— have led to a variety of planned and implemented policies and measures across all sectors of the economy. The basic elements of the ECCP include: »» establishment of an EU-wide emissions trading program, including credits for clean development mechanism (CDM) projects in developing nations and joint implementation (JI) projects in nations with Kyoto emission targets;52 »» expansion of the energy derived from renewable sources, including, most importantly, biofuels for transportation; and »» strengthening of energy labeling requirements for household appliances and creation of a framework for eco-design requirements for energy-using products. The European Union’s Greenhouse Gas emission trading system (EU ETS) began operation in January of 2005. It is the world’s largest carbon dioxide trading system, currently covering over 10,500 energy-intensive plants, refineries, and factories in the 27 EU member states, as well as Norway, Iceland, and Liechtenstein (these three nations joined in 2007).53 National emission allocations were determined based on National Allocation Plans prepared by each participant and approved by the European Commission based on certain criteria. Among those criteria are efforts to ensure that the country will meet its Kyoto targets based on its own combination of emissions allocations and CDM or JI projects, criteria to prevent discrimination between companies or economic sectors, and criteria that allow for new entrants.54 In the first phase of allocations, emissions allowances were largely provided at no cost to regulated installations. Since this initial allocation was based on historical European Commission Communication. (February 10, 2010). Environment – Climate Change. In Europa. Retrieved February 12, 2010, from http://ec.europa.eu/environment/climat/home_en.htm. 52 European Commission. The European Climate Change Programme. [Brussels]: European Commission, 2006. Europa. European Commission. Web. 3 Feb. 2010. <http://ec.europa.eu/environment/climat/pdf/ eu_climate_change_progr.pdf>. 53 “Environment – Climate Change – Emission Trading System.” EUROPA – European Commission – Homepage. 1 Sept. 2009. Web. 8 Feb. 2010; http://ec.europa.eu/environment/climat/emission/citl_en.htm>; European Commission. Communications. Emissions trading: Commission announces linkage EU ETS with Norway, Iceland and Liechtenstein. Europa. European Commission, 26 Oct. 2007. Web. 3 Feb. 2010. <http://europa.eu/rapid/pressReleasesAction.do?reference=IP/07/1617>. 54 European Commission. Communications. Questions & Answers on Emissions Trading and National Allocation Plans. EUROPA – European Commission – Homepage. European Commission, 8 Mar. 2005. Web. 4 Feb. 2010. <http://europa.eu/rapid/pressReleasesAction.do?reference=MEMO/05/84&format=HT ML&aged=1&language=EN&guiLanguage=en>. 51

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emissions estimates, the allocation “placed no significant overall constraint on emissions levels,” which “led to a collapse in the market price of allowances when the full measure of the cap became evident.”55 For all its purported scope, the EU ETS is not, in fact, an economy-wide emissions trading system.56 Rather, it regulates emissions from the production of iron and steel, cement, glass, ceramics, pulp, and paper, as well as electric-power generation and oil refineries.57 Significantly, transportation is currently exempt (air transport is expected to be covered by 2011).58 It is also important to clarify that the way the system works depends heavily on implementation by the individual member states. Each member country receives an allotment of allowances and must submit its plan for allocating allowances for approval by the European Commission.59 This requirement ultimately proved to be one of the weaknesses of the EU ETS during its first phase, as only Denmark chose to auction its full allocation; the rest of the EU members gave the allowances away gratis to their producers in covered industries.60 In the event, Phase 1, launched in 2005, resulted in roughly $8 billion in trades, growing to $24 billion by the end of 2006.61 To put the EU ETS in perspective, that $24 billion represented 80 percent of all carbon emissions traded globally during the ETS’ second year of operation.62 While significant, that level of trade did not prove sufficient to sustain the market. In 2006 the collapse of prices for emissions credits, along with the decline in oil prices forced the EU to revisit the allocation system as it prepared for Phase 2. The other lesson to be drawn from the early stages of implementing the EU ETS relates to the discussion of carbon accounting highlighted in Section II above. What the EU learned in the process was that the ability of the ETS to establish an effective price for CO2 emissions depended heavily on accurate accounting and Dempsey, Kevin M. “International Trade Rules and Climate Change Policy: Part II.” The Globalist. 12 Mar. 2009. Web. 1 Feb. 2010. <http://www.theglobalist.com/StoryId.aspx?StoryId=7587>. 56 Kopp, R., An Overview of the European Union Emissions Trading Scheme, Prepared for the U.S. Senate Committee on Energy and Natural Resources Roundtable on the European Emissions Trading Scheme (March 26, 2007). 57 Ibid. 58 Ibid. 59 The allocation plans involve three separate elements – (1) the amount of the Kyoto Protocol target assigned to the industry sectors covered by the EU ETS; (2) the distribution of allowances among those sectors; and (3) the ultimate allocation of the allowances among individual companies. The allocation plans implicitly also describe how the allowances will be allocated. Ibid. 60 Ibid. 61 Ibid. 62 Ibid. 55

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reporting systems in order to ensure the possibility of monitoring and enforcement.63 The lack of those accounting systems in many, if not most, of the participating EU members at the launch of the EU ETS contributed heavily to the price volatility and eventual collapse in prices that led the EU to reconsider the basis of allocations in its approach to Phase 2. At the same time, the design of the EU ETS, particularly its application solely to emission sources within Europe, diminishes the likelihood that the accounting measures required to operate the system will flow down to producers in the supply chains of European companies solely for reasons of implementing the emissions trading regime. The Council of the European Union has since adopted a package of measures to help meet its more ambitious environment and energy goals, including changes to the emissions trading system.64 Under the new rules, starting in 2013 increasing percentages of emissions allowances will be auctioned rather than distributed for free in hopes of creating a more efficient and transparent system. Industries determined to be likely subject to “carbon leakage” (instances in which emissions-intensive industries relocate from areas with strict emissions controls to areas with more lax or no controls) will continue to receive free allocations and possible additional support if increased energy costs due to emissions controls prove burdensome.65 Looking beyond the EU ETS, the EU built on earlier ECCP targets for expanding its investment in renewable energy development. The European Council in April of 2009 adopted new rules for the expansion of renewable energy development. The EU now plans that renewable energy will constitute 20 percent of overall energy consumption by 2020. Mandatory targets have been set for each member state; each state will develop a national strategy for meeting that target by June of 2010. A 10 percent target for renewable fuels in the transport sector will, however, be consistent throughout the EU to ensure consistent fuel specifications and availability.66 Ibid. Council of the European Union. Communications. Council adopts climate-energy legislative package. CONSILIUM. Council of the European Union, 6 Apr. 2009. Web. 6 Feb. 2010. <http://www.consilium. europa.eu/uedocs/cms_data/docs/pressdata/en/misc/107136.pdf>. 65 European Commission. Communications. Questions and Answers on the revised EU Emissions Trading System. EUROPA – European Commission – Homepage. European Commission, 17 Dec. 2008. Web. 20 Jan. 2010. <http://europa.eu/rapid/pressReleasesAction.do?reference=MEMO/08/796&format=HTM L&aged=0&language=EN&guiLanguage=en>. 66 Council of the European Union. Communications. Council adopts climate-energy legislative package. CONSILIUM. Council of the European Union, 6 Apr. 2009. Web. 28 Jan. 2010. <http://www.consilium. europa.eu/uedocs/cms_data/docs/pressdata/en/misc/107136.pdf>. 63 64

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The EU’s product labeling and eco-design initiatives under its Sustainable Product Policy embody another important aspect of its broader approach to climate change. The labeling initiative is an effort to identify the relative energy efficiency of different products so consumers can make more informed decisions, while the ecodesign initiative is designed to help promote improved environmental performance of products and consistent standards across the European Union.67 Under the Kyoto Protocol, the 15 EU countries that were members before 2004 have a collective GHG emissions reduction goal for 2012 of 8 percent below 1990 levels. The remaining 12 nations of the Union have reduction goals of 6–8 percent below the 1990 baseline, except for Cyprus and Malta, which have no targets.68 Taken together, the EU’s package of climate change mitigation measures appears almost certain to meet its Kyoto emission reduction targets by 2012.69 As a consequence, the EU became the strongest proponent of further emission reductions at the COP 15 negotiations in Copenhagen. There, EU negotiators reaffirmed their commitment to a 20 percent emission reduction below 1990 levels by 2020, with the possibility of 30 percent reductions if a comprehensive international agreement can be concluded.70 Taken together, the EU’s policies do not present significant new barriers to market access by Latin American and Caribbean producers. Apart from new product labeling rules and the potential that the EU’s regulation of GMOs might incidentally diminish the attraction of planting new strains of the heat- and drought-resistant crops, the EU has largely pursued a course that avoids those direct restraints on trade. While

67 European Commission. “Sustainable product policy – Sustainable and responsible business – Enterprise and Industry.” EUROPA – European Commission – Homepage. European Commission, 12 Dec. 2009. Web. 14 Feb. 2010. <http://ec.europa.eu/enterprise/policies/sustainable-business/sustainable-product-policy/ index_en.htm>. It is worth pointing out that the issues surrounding labeling and standards generally are not limited to energy information, carbon content or other environmental measures. They include labeling requirements for products containing GMOs, which represent a part of the system of restraints on such products discussed above. 68 European Commission Communication. (November 27, 2007). Climate change: EU on track towards Kyoto target but efforts must be maintained, projections show. In Europa Press Releases RAPID. Retrieved February 2, 2010, from http://europa.eu/rapid/pressReleasesAction. do?reference=IP/07/1774. 69 Commission of the European Communities. PROGRESS TOWARDS ACHIEVING THE KYOTO OBJECTIVES. Rep. no. COM (2009)630 final. Commission of the European Communities, 12 Nov. 2009. Web. 3 Feb. 2010. <http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=COM:2009:0630:FIN :EN:PDF>. 70 European Commission. Communications. Climate change: European Union notifies EU emission reduction targets following Copenhagen Accord. EUROPA – European Commission – Homepage. European Commission, 28 Jan. 2010. Web. 2 Feb. 2010. <http://europa.eu/rapid/pressReleasesAction. do?reference=IP/10/97>.

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there are continuing calls for carbon tariffs to offset the impact of the EU climate policies on European industry, the EU has, thus far, avoided taking those steps by implementing other measures to ease the competitive disadvantages that certain European industries perceive. The greatest impact of the EU policies will, instead, be indirect. It is the impact of the EU’s policies in establishing a global price for CO2 emissions that will likely prove to have the most pronounced effect on Latin American and Caribbean producers. Given the global nature of the world economy and the restructuring of global trade around multinational companies operating on a global basis, and given the fact that goods in global trade are priced at the margin, setting an effective worldwide price for CO2 does not require universal participation. In highly competitive markets, such as agriculture and forestry, with multiple participants, virtually all of whom are price takers in markets where prices are set by derived demand for products that are processed further downstream from the producers of the commodities, the pricing of emissions would not have to apply to a very significant share of the global market to ensure that the higher costs associated with those prices flowed back upstream to commodity producers that lacked the market power to avoid their brunt. However, agriculture and forestry are not currently covered by the EU ETS. What that means in practical terms is that one of the most important industries in much of Latin America and the Caribbean—and one that would most likely feel the effects of the establishment of an effective price for CO2 emissions in downstream markets—is unlikely to be affected in the short run.

2. Implementation at the National Level It is important to recognize that, like the United States, the EU operates as something of a federal system. In addition to the climate change mitigation measures implemented at the EU level, individual EU members retain great responsibility and some latitude in implementing a variety of measures at the national level. The discussion below examines how that has been done in one prominent EU member state—Germany. As the nation with the largest population and economy in the European Union, Germany has a central role to play in helping the EU achieve its GHG emission reduction goals. That the EU is likely to meet its Kyoto Protocol reduction target is, in no small part, attributable to Germany, or, more specifically, industrial restructuring in the former East Germany. Due significantly to the collapse of large parts of East Climate Change Mitigation Measures Adopted or Proposed 51

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Germany’s heavy industry after reunification, Germany has reduced its emissions by over 22 percent from 1990 levels.71 Germany has made great progress in other ways, too. Since 1991, Germany has employed something known as a “feed-in tariff ” which requires electric utilities to ensure that anyone who wants to sell renewable energy will have a market. The rates (as amended under the Renewable Energies Act, and costs of which are covered by all electricity customers) are high enough to help producers recoup their costs in less than 10 years while also earning them a profit. The feed-in tariff regime has helped Germany become a world leader in renewable energy technology despite no direct government financial support: it is currently one of the top three producers of both wind turbines and photovoltaic systems, and the renewable energy industry is one of the fastest-growing sources of employment. Germany achieved its own renewable energy goal for 2010 three years ahead of time; renewable energy currently accounts for 15 percent of electricity production. The German government’s goal is to create a diversified and decentralized energy system, with increasingly ambitious goals for renewable energy. By 2020, Germany hopes that renewable energies will account for over 18 percent of total German energy demand; by 2050, over half.72 Germany has pursued other energy matters in a climate-friendly way. Under the Sustainability Ordinance for the Renewable Energies Act (Biomass Electricity Sustainability Ordinance) of August 2009, liquid biomass commodities used for power generation must produce at least 35 percent less greenhouse gases than fossil fuels. This takes into account land displacement issues, with the intention to avoid the destruction of rain forests and wetlands. A similar law is likely for transportation biofuels, too. At the same time, the German government is continuing to

“Germany Climate Change Profile Part 1: A Paler Shade Of Green.” With Knowledge Comes A Responsibility To Act! 17 Apr. 2009. Web. <http://knowledge.allianz.com/en/globalissues/climate_profiles/climate_germany/climate_profile_germany_intro.html>; “European Countries – Germany.” EUROPA – The Official Website of the European Union. 2010. Web. <http://europa.eu/abc/european_countries/ eu_members/germany/index_en.html. 72 Plumer, Bradford. “Clean Break A New Strategy Could Offer the Best, and Quickest, Solution to Global Warming. What’s More, You Might Be Able to Get the Ball Rolling in Your Own Backyard.” Audubon Magazine. Audubon Society, 2009. Web. <http://www.audubonmagazine.org/features0903/pdfs/climateChange-intro.pdf>; “Germany Climate Change Profile Part 2: Fact Sheet.” With Knowledge Comes A Responsibility To Act! Ed. Valdis Wish. Apr. 2009. Web. <http://knowledge.allianz.com/en/globalissues/ climate_profiles/climate_germany/climate_profile_germany_facts.html; “German Missions in the United States – Frequently Asked Questions.” German Missions in the United States – Home. Nov. 2009. Web. <http://www.germany.info/Vertretung/usa/en/06__Climate__Business__Science/01__Gov__Climate__ Energy__Envir/03__GCEE__FAQ/TCB__FAQ.html> 71

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promote greater efficiency in appliances, buildings, and transportation, through various instruments.73 Such an ambitious energy and climate program is a reflection of the concern that most Germans have about climate change—a 2006 study by the University of Marburg found that 93 percent of Germans were concerned about climate. In international negotiations, Germany has been a strong advocate for more ambitious emission reductions targets. Even without an international agreement in Copenhagen, the German government has given itself the ambitious goal of a 40 percent reduction in GHG emissions below 1990 levels by 2020.74 Achieving the intended reduction will not be easy. Germany still depends for over 43 percent of its electricity on one of its few abundant fossil fuel resources—lowenergy and dirty-burning lignite coal. Estimates are that Germany still has roughly 225 years of lignite left at current production levels. Germany also depends on nuclear power for over 23 percent of its electricity. Though nuclear power is not a contributor of GHGs, the former Social Democratic/ Green coalition government had pledged to eliminate nuclear power from Germany’s electricity mix. That decision has been changed, however, by the current Christian

73 “German Missions in the United States – Frequently Asked Questions.” German Missions in the United States – Home. Nov. 2009. Web. <http://www.germany.info/Vertretung/usa/en/06__Climate__ Business__Science/01__Gov__Climate__Energy__Envir/03__GCEE__FAQ/TCB__FAQ.html>; “Projects and Programmes.” Germany’s Climate Initiative. Web. <http://www.bmu-klimaschutzinitiative.de/en/ projects_and_programmes>. “The Climate Initiative.” Germany’s Climate Initiative. German Ministry of the Environment. Web. <http://www.bmu-klimaschutzinitiative.de/en/home_i>.”Germany Climate Change Profile Part 2: Fact Sheet.” With Knowledge Comes A Responsibility To Act! Ed. Valdis Wish. Apr. 2009. Web. <http:// knowledge.allianz.com/en/globalissues/climate_profiles/climate_germany/climate_profile_germany_facts. html. “Germany Climate Change Profile Part 2: Fact Sheet.” With Knowledge Comes A Responsibility To Act! Ed. Valdis Wish. Apr. 2009. Web. <http://knowledge.allianz.com/en/globalissues/climate_profiles/climate_germany/climate_profile_germany_facts.html; “German Missions in the United States – Frequently Asked Questions.” German Missions in the United States – Home. Nov. 2009. Web. <http://www.germany.info/Vertretung/usa/en/06__Climate__Business__Science/01__Gov__Climate__Energy__Envir/03__ GCEE__FAQ/TCB__FAQ.html>; “BBC News | EUROPE | Germany Renounces Nuclear Power.” BBC NEWS | News Front Page. 15 June 2000. Web. <http://news.bbc.co.uk/2/hi/europe/791597.stm>. 74 Deutsch, Klaus. Cap and Trade in America. Issue brief. Deutsche Bank Research, 5 May 2008. Web. <http://www.banking-on-green.com/docs/cap_trade_america.pdf>. Broder, John. “Environmental Advocates Are Cooling on Obama.” The New York Times. The New York Times Company, 18 Feb. 2010. Web. 18 Feb. 2010. <http://www.nytimes.com/2010/02/18/science/ earth/18enviros.html>. U.S. Environmental Protection Agency. EPA Finalizes the Nation’s First Greenhouse Gas Reporting System/Monitoring to begin in 2010. United States Environmental Protection Agency. U.S. EPA, 22 Sept. 2009. Web. 12 Jan. 2010. <http://yosemite.epa.gov/opa/admpress.nsf/d0cf6618525a9efb8525735900 3fb69d/194e412153fcffea8525763900530d75!OpenDocument

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Democratic government of Chancellor Angela Merkel, with nuclear energy now seen as a “bridging technology” to be phased out by reliable renewable in the future. Gradually replacing both sources will be a massive undertaking.75 Examining Germany’s various efforts from the perspective of Latin American and Caribbean producers is illuminating in the following sense. First, it illustrates that taken on its own, even a member state as significant as Germany does not, by itself, alter the fundamentals governing the region’s producers’ market access to any great degree. Those fundamentals are set at the EU level, driven either by the agreement of all European Union states on a particular course of action, or by the international trade arrangements to which the European Union is a party. What Germany’s individual efforts do represent, however, is an opportunity for Latin American and Caribbean producers that are capable of fulfilling the demand for energy from renewable resources. This opportunity is particularly important for the region’s exporters of agricultural commodities.

B. United States As reflected in the discussion in Section II above, the United States has introduced a number of different approaches to climate change mitigation, but does not yet have anything that could be described as a comprehensive approach. Indeed, current climate change policy in the United States is an uneven mix of legislative proposals, voluntary and compulsory federal regulation, and state and regional initiatives. To date, the most significant steps the United States has taken lie in the area of funding research and development on energy and emissions efficiency. As noted above, even before President Obama took office, the United States had over 300 different government programs that supported a variety of different approaches to encouraging innovation on energy and emissions efficiency. President Obama came to office pledging aggressive U.S. action to address climate change and move the country toward cleaner sources of energy, action that would go further than funding research and development. He advocated steep GHG

75 Broder, John. “House Passes Bill to Address Threat of Climate Change.” The New York Times. The New York Times Company, 26 June 2009. Web. 12 Feb. 2010. <http://www.nytimes.com/2009/06/27/ us/politics/27climate.html?_r=1>. “Climate Action Tracker – United States.” Climate Action Tracker. 2 Feb. 2010. Web. 23 Feb. 2010. <http://www.climateactiontracker.org/country.php?id=1332>.

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emissions reduction targets, implementation of a cap-and-trade system for control of GHG emissions, and substantially increased support for research, development, and deployment of clean energy technologies.76 Much like the Bush administration had done, the Obama administration enjoyed early success in pursuing these goals, increasing the funding for research, development, and deployment of new technology. The $787 billion economic stimulus package requested by the administration and passed by Congress in February, 2009, included roughly $80 billion dollars in funding for clean energy initiatives.77 The EPA also acted, initiating a formal assessment of the threat posed by excessive GHG emissions, and instituting a GHG reporting rule for large emitters, an important prerequisite for a cap-and-trade or regulatory framework.78 However, the Obama administration has made less progress in its efforts to implement any form of actual restraint on GHG emissions, meaning any impact on Latin American and Caribbean producers, apart from the uncertainty the current fluid political situation creates, is not a near-term prospect.

1. Legislative Action Congress began work on climate change and energy legislation early in the Obama administration’s first year. By June of 2009, the U.S. House of Representatives passed the American Clean Energy and Security Act. It provides funding for new energy projects such as “clean coal” research, and sets a renewable electricity standard of 20 percent by 2020.

Broder, John. “Obama Opposes Trade Sanctions in Climate Bill.” The New York Times. The New York Times Company, 28 June 2009. Web. <http://www.nytimes.com/2009/06/29/us/politics/29climate.html>. Janzen, Bernd. “Waxman-Markey Bill Border Adjustment Measures Face Revision as Senate Takes Up Climate Bill Deliberations.” ClimateIntel.com. Akin Gump Strauss Hauer & Feld LLP, 31 July 2009. Web. <http://climateintel.com/2009/07/31/waxman-markey-bill-border-adjustment-measures-face-revisionas-senate-takes-up-climate-bill-deliberations/>; Lawrence, Mackinnon. “Biomass Blunder: Cap-and-Trade and Carbon Leakage | BIOMASS INTEL.” Biomass Intel. 30 Nov. 2009. Web. <http://www.biomassintel. com/biomass-blunders-cap-and-trade-carbon-leakage/>. In this one respect, the World Bank’s recent World Development Report misstates the actual situation in the U.S. Congress. The Report claims that “[a]ll the recent energy and climate policy bills introduced in the U.S. Congress provide for trade sanctions or tariffs . . . on countries that do not impose controls on carbon emissions.” In fact, while the Housepassed bill and the Senate vehicles for moving climate change legislation do raise significant concerns in terms of trade policy, they do not all contain carbon tariffs or trade sanctions as the World Development Report states. 77 Cowan, Richard. “Senate weighs final push to move climate bill.” Reuters. REUTERS, 21 Feb. 2010. Web. 22 Feb. 2010. <http://www.reuters.com/article/idUSTRE61K13620100221>. 78 “Cap and Trade” Loses Its Standing as Energy Policy of Choice, The New York Times (March 26, 2010). 76

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The true centerpiece of the legislation was a cap-and-trade system for GHG emissions and an overall GHG emissions reduction target of 17 percent below 2005 levels by 2020.79 This same target would later serve as the U.S. emissions reduction pledge at the COP 15 climate negotiations in Copenhagen.80 In order to pass the House, the legislation was obliged to include a variety of exemptions, the most important of which involves a significant share of American agriculture. The comprehensive climate and energy legislation, passed by the U.S. House of Representatives and under consideration by the U.S. Senate, contains provisions to address potential carbon leakage. The provisions only apply to industries deemed eligible based on a sector-specific formula involving their energy, greenhouse gas, and trade intensities. Under the House-passed legislation, eligible industries would be granted an initial two-year exemption from the cap-and-trade regulations in the bill. After that, these industries would be eligible for an “Emissions Allowance Rebate Program” that would compensate them to a specified degree for costs of compliance with the U.S. emissions caps. The second provision was added only shortly before passage in the House. Though subject to a variety of contingencies and qualifications, this provision could require, beginning in 2020, that importers of energy-intensive products from nations with less stringent or no GHG emissions controls acquire “international reserve allowances” to permit entry of their products. The provision would only be required if no international agreement on climate change is reached by 2018, though the President and Congress could waive the requirement if it is determined to be not in the national interest. Ibid. CEOs seek firm signal on US climate change policy, Reuters (March 2, 2010). Greenhouse, Linda. “Justices Say E.P.A. Has Power to Act on Harmful Gases.” The New York Times. The New York Times Company, 3 Apr. 2007. Web. 11 Jan. 2010. <http://www.nytimes.com/2009/10/01/ science/earth/01epa.html?_r=1&hp>. U.S. Environmental Protection Agency. EPA: Greenhouse Gases Threaten Public Health and the Environment / Science overwhelmingly shows greenhouse gas concentrations at unprecedented levels due to human activity. United States Environmental Protection Agency. U.S. EPA, 7 Dec. 2009. Web. 10 Jan. 2010. http://yosemite.epa.gov/opa/admpress.nsf/0/08D11A451131BCA585257685005BF252. 81 Most recently, the EPA announced that it would expand its mandatory GHG reporting program to include the oil and natural gas sector, industries that emit fluorinated gases, and facilities that inject and store carbon dioxide (CO2) underground for the purposes of geologic sequestration or enhanced oil and gas recovery. EPA Proposes to Add Sources to Greenhouse Gas Reporting System/Requirements target potent and persistent greenhouse gases, Environmental Protection Agency Media Release (March 23, 2010). The EPA indicated that the new requirements for the energy sector were necessary to “provide a better understanding of where GHGs are coming from,” with a view to developing more effective policies to reduce emissions. Ibid. 79 80

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President Obama and several lead senators have indicated that they do not support this provision.81 The leading climate bill in the U.S. Senate contains the first provision, but has only a placeholder for the second.82 Nonetheless, a number of senators from the President’s own party have advocated the imposition of carbon tariffs or other restraints on trade from countries that do not impose equivalent constraints on GHG emissions and ensure that their producers bear costs similar to those imposed on U.S. producers. They have stated that their support for the climate change bill was contingent on some means of ameliorating what they perceive are the competitive effects of the U.S. adopting climate change legislation in the absence of a global accord.83 While those threats raise serious concerns about the potential imposition of carbon tariffs or similar trade restraints in a critically important market for Latin American and Caribbean producers, the possibility of those threats becoming law in the near future is relatively small. Since the passage of the House bill, the U.S. Congress has made little progress toward establishing a GHG cap-and-trade system. Efforts have stalled in the U.S. Senate on climate and energy legislation despite some limited bipartisan cooperation on the leading bill.84

82 U.S. Environmental Protection Agency. New EPA Rule Will Require Use of Best Technologies to Reduce Greenhouse Gases from Large Facilities/Small businesses and farms exempt. United States Environmental Protection Agency. U.S. EPA, 30 Sept. 2009. Web. 13 Feb. 2010. <http://yosemite.epa. gov/opa/admpress.nsf/0/21ACDBA8FD5126A88525764100798AAD 83 U.S. Environmental Protection Agency. EPA: Greenhouse Gases Threaten Public Health and the Environment /Science overwhelmingly shows greenhouse gas concentrations at unprecedented levels due to human activity. United States Environmental Protection Agency. U.S. EPA, 7 Dec. 2009. Web. 10 Jan. 2010. <http://yosemite.epa.gov/opa/admpress.nsf/0/08D11A451131BCA585257685005BF252>. Doggett, Tom. “EPA C02 endangerment finding to White House.” Reuters. REUTERS, 9 Nov. 2009. Web. 12 Feb. 2010. <http://www.reuters.com/article/idUSTRE5A84FN20091109>. Bravender, Robin. “16 ‘Endangerment’ Lawsuits Filed Against EPA Before Deadline.” The New York Times. The New York Times Company, 17 Feb. 2010. Web. 21 Feb. 2010. <http://www.nytimes.com/gwire/2010/02/17/17greenwire-16-endangerment-lawsuits-filed-against-epa-bef-74640. html?pagewanted=print>. Eilperin, Juliet. “Senators try to thwart EPA efforts to curb emissions.” The Washington Post. The Washington Post Company, 22 Jan. 2010. Web. 21 Feb. 2010. <http://www.washingtonpost.com/wp-dyn/ content/article/2010/01/21/AR2010012104512.html>. 84 “CALIFORNIA’S CLIMATE PLAN.” California Climate Change Program. State of California, Jan. 2010. Web. <http://www.climatechange.ca.gov/publications/factsheets/2010-01-27_FACT_SHEET_ SCOPING_PLAN.PDF>. Burtraw, Dallas. “Regional, State and Local Climate Policy in the U.S.” Washington Dialogue Series Trade and Climate Change: Development Aspects of Climate Change Policies of OECD Countries. Proc. of Washington Dialogue Series Trade and Climate Change: Development Aspects of Climate Change Policies of OECD Countries, International Centre for Trade and Sustainable Development, Washington, DC. International Centre for Trade and Sustainable Development, 4 May 2009. Web. <http://ictsd.org/i/ events/dialogues/48173/?view=documentation>.

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Senators of both parties, particularly from regions of the country with economies most dependent on energy production, refining, or manufacturing, express considerable concern about the potential negative impacts of such legislation on an already weakened U.S. economy. Other senators draw different conclusions, instead promoting the job creation potential of a new energy economy. At this stage, the bill’s supporters may well separate the energy and environmental measures and attempt to pass the energy provisions of the bill separately. That measure would presumably incorporate the proposed tax credits or other incentives for renewable energy production and the possibility of a renewable portfolio standard for electricity. Either course of action (i.e., continuing to hold the package of measures together or dividing them between energy and environmental measures) promises further delay in the implementation of a cap-and-trade system in the United States—or of anything else resembling a comprehensive legislative response to climate change. Further delay would also be the case with the current attempt by a group of senators to craft an entirely different approach to climate change. The effort would limit the scope of any emissions trading regime essentially to the power generation sector (admittedly one of the most important sectors of the U.S. economy from the perspective of GHG emissions, but far short of universal coverage or even the scope of the original House legislation).85 In addition to a much more limited reliance on cap-and-trade, the proposal includes a modest increase in the current excise tax on gasoline, diesel fuel, and aviation fuel, as well as new incentives for oil and gas drilling, nuclear power plant construction, carbon capture and storage, and renewable energy sources like wind and solar— akin to those originally advocated by the Obama administration.86 In one respect, the renewed effort to shape a climate change bill represents a step toward a comprehensive set of policies that even U.S. businesses agree is needed at this stage to reduce the uncertainty they face in making operational and investment decisions.87 On the other hand, from the perspective of Latin American and Caribbean Regional Greenhouse Gas Initiative (RGGI) CO2 Budget Trading Program – Welcome. Web. 10 Feb. 2010. <http://www.rggi.org/home>. 86 “Current and Near-Term Greenhouse Gas Reduction Initiatives | Climate Change – U.S. Climate Policy | U.S. EPA.” U.S. Environmental Protection Agency. U.S. EPA, 14 Oct. 2009. Web. 24 Feb. 2010. <http:// www.epa.gov/climatechange/policy/neartermghgreduction.html>. 87 “US completes energy efficiency standards for electrical appliances |.” Energy Efficiency News. 9 Sept. 2009. Web. 24 Feb. 2010. <http://www.energyefficiencynews.com/i/2385/>; U.S. EPA. “Renewable Fuel Standard Program | Fuels and Fuel Additives | US EPA.” U.S. Environmental Protection Agency. U.S. EPA, 3 Feb. 2010. Web. 12 Feb. 2010, <http://www.epa.gov/OMS/renewablefuels/#regulations Broder, John. “S.E.C. Adds Climate Risk to Disclosure List.” The New York Times. The New York Times Company, 28 Jan. 2010. Web. 28 Jan. 2010. <http://www.nytimes.com/2010/01/28/business/28sec.html>. 85

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producers, what it suggests is further delay in any measure that could threaten their access to the U.S. market.

2. Potential Regulations President Obama had signaled early on that, if climate change legislation was delayed, he would pursue an alternative course involving the direct regulation of GHG emissions under the authority granted the EPA by the Clean Air Act (CAA). Toward that end, on December 7, 2009, the EPA issued a final “endangerment finding” regarding the emissions of six GHGs—carbon dioxide, methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons and sulfur hexafluoride—that had been under consideration since April. Relying on a 2007 U.S. Supreme Court ruling, which found that GHGs meet the definition of air pollutant under the CAA,88 the EPA triggered the authority of the CAA by formally finding that excessive emission of GHGs due to human activity represented a threat to public health and welfare, clearing the way for the direct regulation of GHG emissions.89 Even before the endangerment finding was finalized, the EPA had announced plans to regulate emissions from large facilities such as power plants, refineries, and factories emitting at least 25,000 tons per year of GHGs, by requiring construction and operating permits for these emissions. The EPA estimates that this will involve roughly 14,000 large sources across the country, with an additional 400 sources up for consideration each year.90 By setting the permitting threshold at 25,000 tons (instead of the 100 or 250 tons for other regulated air emissions), The EPA hopes to avoid regulation of smaller emitters.91 But the proposed rules, when issued, will nonetheless be subject to legal challenge. The EPA is likely to face lawsuits questioning its authority to establish such

88 Government of Canada. 2006 Canada’s Fourth National Report on Climate Change. Rep. Government of Canada. Web. 4 Feb. 2010. <http://unfccc.int/resource/docs/natc/cannc4.pdf>. 89 Blatchford, Andy. “Canada to align climate-change policy with U.S. – no more, no less – Yahoo! Canada News.” Yahoo! Canada News – Breaking News, Top Stories and Daily News Coverage. Canadian Press, 4 Dec. 2009. Web. 10 Feb. 2010. <http://ca.news.yahoo.com/s/capress/091204/national/ climate_summit_cda>. 90 Pieper, Derek. “Canada changes targets to match US pledges: will convergence lead to more action? | Climatico.” Climatico – Independent Climate Research Group. Climatico, 12 Feb. 2010. Web. 13 Feb. 2010. <http://www.climaticoanalysis.org/post/canada-changes-targets-to-match-us-pledges-willconvergence-lead-to-more-action/>. 91 The Canadian Press. “CBC News – Politics – Charest: Prentice bowing to U.S. on climate change.” CBC. ca – Canadian News Sports Entertainment Kids Docs Radio TV. CBC News, 3 Feb. 2010. Web. 13 Feb. 2010. <http://www.cbc.ca/politics/story/2010/02/03/quebec-charest-prentice-environment.html>.

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a permitting threshold. The agency will also likely face opposition from up to 3,000 facilities that were not previously subject to CAA permitting requirements. Those sources primarily consist of municipal landfills, which raise questions of both federalism and political support for the administration’s moves. One alternative under discussion would create a very different approach. It would involve the creation of a more limited, EPA-designed and implemented capand-trade program for utilities, with permitting for refineries and factories. Its proponents view that approach as a potentially useful laboratory where the EPA could learn to avoid many of the failures that beset the EU program at the outset. Wholly apart from the potential direct regulation of emissions, the EPA’s endangerment finding under the CAA was also a necessary prerequisite to finalizing new regulations proposed by the EPA under the Act and by the U.S. Department of Transportation under the Energy Policy and Conservation Act, concerning vehicle fuel economy standards. Originally proposed in May of 2009, the new regulations would raise corporate average fuel economy standards for light-duty vehicles to 35.5 miles per gallon by 2016.92 EPA’s new regulations have been officially promulgated, so automakers must, barring delays due to challenges, begin to implement necessary changes starting with the 2012 model year.93 The EPA’s endangerment finding and proposed regulatory actions have, as expected, proven very controversial. Sixteen lawsuits have been filed challenging the EPA’s right to regulate GHG emissions, including suits by industry trade associations, the U.S. Chamber of Commerce, and the state governments of Texas, Virginia, and Alabama (at the same time, 16 other states and New York City are set to weigh in on EPA’s behalf).94 In addition, at least 39 U.S. Senators, including four members of President Obama’s own party, have introduced a resolution under the Congressional Review Act to overturn the EPA’s endangerment finding and its ability to impose GHG regulation.95 Though almost certain not to pass, the resolution reinforces the

92 Environment Canada. Canada’s Action on Climate Change. Government of Canada, 1 Feb. 2010. Web. 12 Feb. 2010. <http://www.climatechange.gc.ca/default.asp?lang=En&n=D43918F1–1>. 93 Friedman, Lisa. “Looming Election Could Strengthen Japan’s Climate Policy.” The New York Times. The New York Times Company, 28 Aug. 2009. Web. 15 Feb. 2010. <http://www.nytimes.com/ cwire/2009/08/28/28climatewire-looming-election-could-strengthen-japans-cli-98784.html>. 94 Embassy of Japan in Germany. “Japan’s Association with Copenhagen Accord.” Letter to Secretariat of the UNFCC. 26 Jan. 2010. United Nations Framework Convention on Climate Change. United Nations, 26 Jan. 2010. Web. 14 Feb. 2010. <http://unfccc.int/files/meetings/application/pdf/japancphaccord_app1.pdf>. 95 Hughes, Llewelyn. “Climate Change and Japan’s Post-Copenhagen Challenge.” Brookings Northeast Asia Commentary. Brookings Institution, Dec. 2009. Web. 13 Feb. 2010. <http://www.brookings.edu/ opinions/2009/12_japan_climate_hughes.aspx>.

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prediction of many commentators that Congress will not pass broader climate change legislation this year. The combined effect of the political and legal challenges likely means an extended delay in the actual effect of the EPA’s proposed rules, both for U.S. companies and for producers in Latin America and the Caribbean.

3. Sub-Federal Initiatives Wholly apart from the actions ongoing at the federal level, a number of U.S. states have moved ahead with their own plans to address climate change. California has perhaps been most aggressive, beginning implementation in 2006 of a comprehensive climate change program. The program includes a cap-and-trade program covering 85 percent of California’s emissions, a 30 percent reduction in vehicle GHG emissions by 2016, improved efficiency standards, and a goal of 33 percent renewable electricity by 2020.96 Whether California and other states can achieve their goals will necessarily depend on addressing current fiscal problems, as well as overcoming opposition on the state level that mirrors the controversy that has greeted both proposed climate change legislation and the EPA’s proposed rules at the federal level. Some states are taking the additional step of joining in regional initiatives with other states and, in some instances, with Canadian provinces, to promote regional cap-and-trade programs. Three such initiatives are currently under way. The Western Climate Initiative involves seven states and four Canadian provinces. The Midwest Greenhouse Reduction Accord covers six northern central states and Manitoba. The Regional Greenhouse Gas Initiative (RGGI) includes ten northeastern states.97 Among these regional initiatives, the RGGI is already operational. Participating states have capped emissions from the power sector, and are pledging reductions of 10 percent by 2018. Under their plan, states auction nearly all emission allowances and

96 UNFCC. Report of the centralized in-depth review of the fourth national communication of Japan. Rep. no. FCCC/IDR.4/JPN. United Nations, 15 Feb. 2007. Web. 13 Feb. 2010. <http://unfccc.int/resource/ docs/2007/idr/jpn04.pdf>. 97 Buckley, Chris. “China report warns of greenhouse gas leap | Reuters.” Business & Financial News, Breaking US & International News | Reuters.com. REUTERS, 22 Oct. 2008. Web. 8 Feb. 2010. <http://www.reuters.com/article/idUSTRE49L0Z920081022>; China State Council Information Office. “White paper: China’s policies and actions on climate change—china.org.cn.” China.org.cn – China news, weather, business, travel & language courses. Government of China, 29 Oct. 2008. Web. 10 Feb. 2010. <http://china.org.cn/government/news/2008–10/29/content_16681689.htm>.

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use the proceeds to support energy efficiency initiatives and other efforts to reduce GHG emissions.98 From the perspective of Latin American and Caribbean producers, the net effect of the regional and state measures is necessarily limited. The effort to construct a sub-federal cap-and-trade system for emissions is unlikely, even if it proves successful, to involve volumes sufficient to establish a global price for CO2 and other GHG emissions, although the state-level programs could contribute to that effort if integrated with broader systems like the EU ETS. More directly, access to the U.S. market, except in the circumstance of state-level government procurement, is established at the federal level by Congress and the international agreements to which the United States is a party. The supremacy of federal power over interstate and international commerce is said to “preempt” state attempts to set conditions governing the entry of goods and services into the individual states’ markets. As a consequence, Latin American and Caribbean producers are unlikely to face significant barriers to market access from the regional and state initiatives, except to the extent those initiatives fall into an exception to the “preemption doctrine,” as is the case with state public procurement.

4. Other Measures As was reflected in the discussion in Section II, U.S. action on energy and climate is, however, not solely dependent on passage of comprehensive climate and energy legislation or on promulgation of EPA regulations or by similar action at the state level. Several voluntary programs begun under past administrations have been continued or expanded, including the Energy Star program (discussed in detail above), the Climate Leaders Program (an industry-government initiative to help companies develop climate change strategies), and the Green Power Partnership (a partnership to promote organizations that wish to purchase green power).99 In addition, the Department of Energy has announced new energy efficiency standards for electrical appliances, and the EPA has announced more climate-friendly

Heggelund, Gørild. “CHINA’S CLIMATE CHANGE POLICY: DOMESTIC AND INTERNATIONAL DEVELOPMENTS*.” ASIAN PERSPECTIVE 31.2 (2007): 155–91. Asian Perspective. The Institute for Far Eastern Studies, 2007. Web. 2 Feb. 2010. <http://www.asianperspective.org/articles/v31n2-g.pdf>. 99 China State Council Information Office. “White paper: China’s policies and actions on climate change— china.org.cn.” China.org.cn – China news, weather, business, travel & language courses. Government of China, 29 Oct. 2008. Web. 10 Feb. 2010. <http://china.org.cn/government/news/2008–10/29/content_16681689.htm>. 98

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biofuels guidelines requiring new production to achieve a 20 percent reduction in GHG emissions versus conventional gasoline. The United States will need to increase biofuels production nearly 300 percent in coming years to meet a congressionally mandated target of 36 billion gallons by 2022.100 In a similar vein, President Obama has pledged to provide greater support for the nuclear power industry in the United States. That pledge will take the form of government guarantees on loans for the industry. There is one further U.S. initiative worth mentioning because it may, in the end, prove the most far-reaching. As highlighted in the discussion in Section II above, the SEC recently issued “interpretive guidance” to help companies decide what information related to climate change they should, as public issuers of securities on U.S. capital markets, share with investors and with their regulators. Information may include possible impacts of changes in government climate policy, potential exposure to climate-related lawsuits, and likely impacts from predicted sea level rise or increased storm intensity.101 The reason the SEC’s action may prove to be the most far-reaching of the U.S. initiatives outlined above is that it engages the power of capital markets to drive change among major market participants. To the extent that individual companies perceive an advantage in identifying their efforts to combat the risks associated with climate change and, as a result, find it easier to tap U.S. capital markets for financing, their competitors will be compelled to follow suit. That dynamic is particularly important in thinking about the potential reach of carbon accounting standards upstream through a major public company’s supply chain, given the obligations of accuracy that attend any filing with the SEC.

C. Canada Unlike the United States, Canada is a party to the Kyoto Protocol. Its emissions reduction target under that accord is 6 percent below 1990 levels by 2012. Canada is

Faiola, Anthony. “http://www.washingtonpost.com/wp-dyn/content/article/2009/12/19/AR20 09121900687.html.” The Washington Post. The Washington Post Company, 20 Dec. 2009. Web. 29 Jan. 2010. <http://www.washingtonpost.com/wp-dyn/content/article/2009/12/19/AR2009121900687.html>. 101 Watts, Jonathan. “China sets first targets to curb world’s largest carbon footprint | Environment | The Guardian.” Latest news, comment and reviews from the Guardian | guardian.co.uk. Guardian News and Media, 26 Nov. 2009. Web. 11 Feb. 2010. <http://www.guardian.co.uk/environment/2009/nov/26/ china-targets-cut-carbon-footprint>. 100

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not close to meeting this target. Emissions in 2004 were already 26.6 percent above 1990 levels. Much of the increase is attributable to increases in Canada’s population and significant growth in the Canadian economy. Ironically, much of that growth has occurred in the energy sector, particularly the production of fossil fuels. Canadian climate policy has shifted away from its previous reliance on voluntary approaches. The increasing reliance on a regulatory model began with the passage in October 2006 of Canada’s Clean Air Act. The Act takes a more comprehensive approach to improving air quality and reducing GHG emissions. That said, Canada’s Clean Air Act also defines the limit of what Canada has done or is likely to do in the near term. The formulation of climate policy in Canada is complicated because of the way in which governing responsibilities are divided between the federal, provincial, First Nations, and municipal governments under the Canadian constitution. Provincial governments have primary responsibility for the management of natural resources. The federal government has the lead role in the formulation of national environmental policy and the negotiation of international treaties. The powers of both the federal and provincial governments are constrained by the rights accorded Canada’s aboriginal peoples. Given the multi-sectoral, crosscutting nature of climate policy, effective policy development and implementation require a great deal of cooperation between the various levels of government.102 Unfortunately, such cooperation is currently in short supply. Policy formulation is further complicated by the unique relationship between the United States and Canada, and the close integration of the U.S. and Canadian economies. Canadian governments are loath to put Canadian industry at a perceived disadvantage relative to American industry regarding environmental policy, and often see efficiencies in harmonizing Canadian and U.S. environmental policy. Evidence of the complicating effect was on display shortly before the start of the Copenhagen climate negotiations. Canadian Environment Minister Jim Prentice signaled that Canada would scrap its earlier pledge to reduce GHG emissions in 2020 by 20 percent from 2006 levels. He announced that Canada would, instead, align its commitments with whatever target the U.S. government would later announce

Wei – Director General, Dept. of Climate Change NDRC, Su. “China’s Autonomous Domestic Mitigation Actions.” Letter to Yvo de Boer. 28 Jan. 2010. United Nations Framework Convention on Climate Change. United Nations, 28 Jan. 2010. Web. 5 Feb. 2010. <http://unfccc.int/files/meetings/application/pdf/chinacphaccord_app2.pdf>. 102

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(that target would turn out to be a slightly less ambitious 17 percent cut from 2005 levels).103 In addition, the Minister indicated that ongoing efforts to regulate GHG emissions in Canada would be contingent on American actions. Current plans to regulate tailpipe GHG emissions, for example, await further U.S. EPA action on the regulation of American automobile emissions. Similarly, Canadian plans to regulate industrial GHGs through a regulatory framework known as “Turning the Corner” are delayed indefinitely, awaiting U.S. action on a cap-and-trade system or other regulatory action.104 Critics of the government’s action have complained that waiting for American action might indefinitely delay any Canadian action on a comprehensive GHG regulatory regime. They also maintain that the United States and Canada are not exactly the same, and that an appropriate climate policy in the United States may not be appropriate for Canada. Quebec Premier Jean Charest was particularly critical of the government decision, even going so far as to travel to the Copenhagen meetings to tout Quebec’s own emissions reduction pledge (20 percent below 1990 levels by 2020) and a law regulating GHGs from automobiles.105 There is considerable diversity in the approaches to climate change at the provincial level, as Premier Charest’s statements reflect. Rather than creating a cap-andtrade system, for example, British Columbia has opted for a carbon tax. Ontario, on the other hand, which is home to the bulk of Canada’s manufacturing base, has begun the process of implementing a mandatory GHG reporting requirement akin to that launched by the U.S. Environmental Protection Agency. Despite the wait-and-see approach to GHG regulation, other Canadian climate activities are under way. Canada is, for instance, continuing its development of

103 Leggett, Jane. China’s Greenhouse Gas Emissions and Mitigation Policies. Rep. no. RL34659. Congressional Research Service, 10 Sept. 2008. Web. 12 Feb. 2010 <http://www.fas.org/sgp/crs/row/RL34659.pdf>; Seligsohn, Deborah. “Fact Sheet: Energy and Climate Policy Action in China (Update) | World Resources Institute.” World Resources Institute | Global Warming, Climate Change, Ecosystems, Sustainable Markets, Good Governance & the Environment. World Resources Institute, 5 Nov. 2009. Web. 15 Feb. 2010. <http://www.wri.org/stories/2009/11/fact-sheet-energy-and-climate-policy-action-china-update>. 104 Bradsher, Keith. “China Leading Global Race to Make Clean Energy.” The New York Times. The New York Times Company, 31 Jan. 2010. Web. 31 Jan. 2010. <http://www.nytimes.com/2010/01/31/business/ energy-environment/31renew.html>; China State Council Information Office. “White paper: China’s policies and actions on climate change—china.org.cn.” China.org.cn – China news, weather, business, travel & language courses. Government of China, 29 Oct. 2008. Web. 10 Feb. 2010. <http://china.org.cn/government/news/2008–10/29/content_16681689.htm>. 105 Bradsher, Keith. “China Leading Global Race to Make Clean Energy.” The New York Times. The New York Times Company, 31 Jan. 2010. Web. 31 Jan. 2010. <http://www.nytimes.com/2010/01/31/business/ energy-environment/31renew.html>.

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“Canada’s Offset Program,” which could become a component of any cap-and-trade program Canada eventually introduces. Canada is also continuing to make progress toward its goal of ensuring that 90 percent of Canada’s electricity supply comes from non-GHG-emitting sources by 2020. It is already at 73 percent, with the vast majority of that coming from hydropower. In terms of financial assistance, Canada currently provides significant funding for its ecoEnergy programs, which are designed to increase energy efficiency across the Canadian economy. Canada is also committing approximately $3 billion toward the research and development of carbon capture and storage technology.106 In a broad sense, the potential effects of any Canadian policies on climate change from the perspective of Latin American and Caribbean producers mirror the effects of such policies in the United States. Progress on a national level has been fitful, and there is a deep (and understandable) reluctance to move before the regulatory environment in the United States provides greater clarity. There are, on the other hand, provincial initiatives that either have or will take effect in the near term. Taken together, the slow progress at a national level and the relatively small impact that would flow from action by any individual province adds up to a picture that does not describe significant potential impacts on Latin American and Caribbean producers.

D. Japan Japan’s long history of consensus-based climate policy development—one that has contributed to slow progress on its international commitments—may change with the recent election which brought the Democratic Party of Japan (DJP) a majority in the lower house of Japan’s parliament. The DJP campaigned in part on a new approach

106 Attempting to achieve “strength-in-numbers,” some large corporations have for years joined with other corporations sharing similar interests in trade associations or lobbying groups to engage in the debate over climate change and influence policy development. One such group, the U.S. Climate Action Partnership, has been very engaged in the current discussions in the U.S. about climate change policy. Founded in January of 2007, the group includes a wide range of corporations, such as automobile manufacturers, power companies, chemical companies, as well as major environmental organizations. The group has a detailed wish-list of climate change policy recommendations, including a timetable for emissions reductions, credit for early action by corporations, and a version of a cap-and-trade program— all contingent, however, on “simultaneous action” by all major emitting countries. “Summary Overview: USCAP Blueprint for Legislative Action.” United States Climate Action Partnership. 15 Jan. 2009. Web. 10 Feb. 2010. <http://www.us-cap.org/newsroom/blueprint-for-legislative-action/overview/>. There have been a number of companies that have recently left the USCAP coalition, stating that it had served its purpose.

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to environmental and energy policy-making, including aggressive new targets for reductions in GHG emissions. During the decades-long rule of the former government of the Liberal Democratic Party (LDP), climate and energy policy (including targets and measures) was determined primarily through negotiation between government and industry. The government negotiated a voluntary emissions reduction target with industry that resulted in a roughly 13 percent reduction in industrial GHG emissions between 1990 and 2008. The government also provided substantial subsidies for the development and deployment of energy-efficient and renewable energy technologies. During the election, the LDP offered an emissions reduction proposal for 2020 of 15 percent below 1990 levels, but did not propose any mandatory constraints. That proposal became a focus of the election campaign, with the DJP calling for a considerably more ambitious reduction: 25 percent over the same time frame.107 The new Japanese government reaffirmed its commitment to a 25 percent reduction in advance of the Copenhagen COP 15 session in December 2009. That commitment was, however, made expressly contingent on negotiation of “a fair and effective international framework” in which all major economies have “ambitious targets.” In addition, the new Japanese government pledged to increase renewable energy to 10 percent of the country’s total energy supply. The government also proposes to require the purchase of renewable energy by power companies, institute a carbon tax as part of broader reform of energy taxes, and develop a cap-andtrade system with mandatory emission limits. The DJP has long held that greater

“Sixty Corporations Begin Measuring Emissions from Products and Supply Chains.” Greenhouse Gas Protocol Initiative. World Resources Institute & World Business Council for Sustainable Development, 20 Jan. 2010. Web. 6 Feb. 2010. <http://www.ghgprotocol.org/sixty-corporations-begin-measuring-emissions-from-products-and-supply-chains>. The companies include: 3M Company; Acer Inc.; Airbus S.A.S.; AkzoNobel; Alcan Packaging; Alcoa; Anvil Knitwear, Inc; Autodesk, Inc.; Baoshan Iron & Steel Co. Ltd.; BASF SE; Belkin International; Belron International; Bloomberg LP; BT Plc; CA, Inc.; Coca-Cola Erfrishungsgetränke AG; Colors Fruit SA (Pty) Ltd.; Deutsche Post DHL; DuPont; Eclipse Networks (Pty) Ltd.; Ecolab; The Estee Lauder Company; Ford Motor Company; General Electric; U.S. General Services Administration; Gold’n Plump Poultry LLC; Highways Agency (UK); Hydro Tasmania; IBM; IKEA; Italcementi Group; JohnsonDiversey, Inc.; Kraft Foods; Lenovo Corporation; Levi Strauss & Co.; Mitsubishi Chemical Corporation; National Grid; Natura Cosméticos; New Belgium Brewing Co.; Otarian; PepsiCo, Inc.; Pinchin Environmental Ltd.; PricewaterhouseCoopers (Hong Kong); Procter & Gamble Eurocor; Public Service Enterprise Group, Inc.; Rogers Communications, Inc.; SAP AG; SC Johnson; Shanghai Zidan Food Packaging & Printing Co., Ltd.; Shell International Petroleum Company Ltd; Suzano Pulp and Paper; Swire Beverages (Coca-Cola Bottling Partner); TAL Apparel Limited; Tech-Front (Shanghai) Computer Co., Ltd./Quanta Shanghai Manufacturing City; Tennant Company; Veolia Water; Verso Paper Corp.; VT Group Plc; Webcor Builders; Weyerhaeuser Company and WorldAutoSteel.

107

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transparency has been needed in decision-making, in part through a reduced role for industry. 108 Whether Japan will adopt and ultimately achieve these new proposals in what is already a very energy-conscious and energy-efficient society is yet to be determined. The new policies could well impose unequal burdens in the economy, and industry has already indicated that they will oppose proposals that will harm competitiveness. Though the DJP currently enjoys a substantial majority in the lower house of Japan’s Diet, a breakdown in the historic policy-making consensus with industry may pose significant challenges.109 In the meantime, Japan will continue its current policies in the energy, transport, and industrial process sectors. Japan has significant programs to improve energy efficiency in commercial and residential buildings, and is also improving energy efficiency in transport, including marine transport and aviation.110 Given the normal pace of Japanese legislative action, Latin American and Caribbean producers are unlikely to confront major new barriers to access to the Japanese market attributable solely to measures adopted to mitigate the effects of climate change. Equally, given the Japanese instinct to ensure that the position eventually adopted represents a broad consensus among the interests in the Japanese economy and

See, e.g., Reporting the Business Implications of Climate Change in Sustainability Reports – A Survey Conducted by the Global Reporting Initiative and KPMG’s Global Sustainability Services (2007); High-impact Sectors: the Challenge of Reporting on Climate Change, Global Reporting Initiative and the Association of Chartered Certified Accountants (2010). 109 See, e.g., Hughes, L., Climate Change and Japan’s Post-Copenhagen Challenge, The Brookings Institution Northeast Asia Commentary No. 34 (December 2009). 110 See, generally, Stewart, D. and Wilczewski, W., How Japan Became an Efficiency Superpower – Lessons for U.S. Energy Policy under Obama, Policy Innovations, Carnegie Council (February 3, 2009); Japanese Putting All Their Energy Into Saving Fuel, The Washington Post (February 16, 2006); Japan Sees a Chance to Promote Its Energy-Frugal Ways, The New York Times (July 4, 2008). In 1998, Japan introduced by parliamentary decision its “Top Runner” program—a regulatory scheme designed to stimulate the continuous improvement in the energy efficiency in a variety of products—that has achieved considerable success. Nordqvist, J. Evaluation of Japan’s Top Runner Programme – Within the Framework of the AID-EE Project (July 2006). Japan has also been a leading proponent of vessel efficiency in the International Maritime Organization. See Japan to propose detailed marine fuel levy plan, Reuters Environmental Online Report (January, 15, 2010). As part of its efforts in civil aviation, Japan’s Ministry of Infrastructure, Land and Transport has encouraged the replacement of current fleets with new aircraft capable of greater fuel efficiency and has improved efficiency by upgrading of air traffic control systems. See Efforts Against Environmental Issues, Ministry of Land, Infrastructure, Transport and Tourism, http://www.mlit.go.jp/ koku/15_hf_000029.html. In addition, Japanese airframe manufacturers and Japanese airlines have also contributed a variety of innovations. And Japan Airlines, for example, has recently launched its own carbon offset program designed to enable passengers using its flights to voluntarily offset the CO2 gases generated by their trips. See, e.g., Japan’s eco-technology to take flight, Daily Yomiuri Online (January 1, 2008); Japan Airlines Launches Carbon Offset Program, JAL Group News Release (January 5, 2009). 108

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society that would be affected by any such measure, Latin American and Caribbean producers that are currently a part of the global supply chains organized by global companies headquartered in Japan are not likely to find themselves suddenly shunted out of their current supplier relationships due to the implementation of measures that do not take the interests of those global companies into account.

E. China Given the size of its economy, China’s participation is vital to any international efforts to address climate change; it is now the world’s largest emitter of GHGs, even though its per-capita emissions are still quite low.111 China also represents a growing market for Latin American and Caribbean exports. Thus, any standards China eventually adopts could prove significant for Latin American and Caribbean producers seeking access to the Chinese market and for those regional companies producing goods for China’s exports to global markets. The powerful National Development and Reform Commission (NDRC), the same body responsible for the development of China’s Five-Year Plans for economic and social development and state energy policy, has been responsible for domestic climate policy since 1998. The NDRC does, nonetheless, have to work with a number of other important actors, including large state-owned industries, with a variety of different priorities.112 The Chinese government has officially acknowledged the existence of climate change for a number of years. Both China’s National Climate Change Program, announced in June 2007, and the government’s White Paper: China’s Policies and Actions on Climate Change (released in October, 2008) highlight the particular vulnerability of

China’s Greenhouse Gas Emissions and Mitigation Policies, U.S. Congressional Research Service Report No. RL34659 (September 10, 2008) (“CRS Report on China”). China’s per capita emissions in 2006 stood at 4.6 metric tons per person, with the expectation that per capita emissions would rise to 8.0 metric tons per person in 2030 (the highest percentage increase of all countries globally). Chapter 8 – Energy-Related Carbon Dioxide Emissions, International Energy Outlook 2009, U.S. Energy Information Administration (2009). That estimate would, however, still leave China far short of the United States in terms of emission per capita, even if U.S. per capita figures decline from their 2006 levels of 19.7 metric tons per person to an expected 17.1 metric tons by 2030. Ibid. 112 See, e.g., Price, L. and Wang, X., Reducing Energy Consumption in the 1000 Largest Industrial Enterprises in China, Ernest Orlando Lawrence Berkeley National Laboratory (May 2007) (highlighting the difficulty that China has had in implementing emissions reductions at its largest industrial enterprises, many of which are state-owned); CRS Report on China (pointing out that “[c]ontrolling local and regional pollutants like oxides of sulfur and nitrogen, particulates, and mercury is difficult because of the different priorities of local and central government officials and insufficient enforcement”). 111

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China’s environment and societal development to climate change.113 Despite China’s position as the foremost emitter of GHGs, the two documents reject any mandatory caps on GHG emissions, and emphasize that the developed countries of the world bear greater responsibility in addressing climate change, because of their cumulative GHG emissions and greater financial and technological resources.114 China’s international partners have nevertheless been encouraged by its participation in multilateral and bilateral climate and energy initiatives, including the Carbon Sequestration Leadership Forum, Methane-to-Market Partnership, and Asia-Pacific Partnership on Clean Development and Climate. The United States, too, was encouraged by China’s relative openness toward greater transparency regarding emissions accounting at the COP 15 negotiations. The United States had made international verification of emissions a prominent part of their negotiating position, something China had opposed as a violation of sovereignty.115 As much as its emissions, China’s growing economic influence ensured that it would be one of the primary interlocutors at the Copenhagen Conference. In November 2009, just before the start of the conference, China pledged to reduce the carbon intensity of its economy by 40–45 percent by 2020 compared to 2005 levels. It is important to stress that China’s pledge did not entail an actual reduction in emissions from current levels. Rather, it involved a commitment to becoming more efficient in its use of energy (i.e., reducing emissions relating to any given level of output). Chinese success in this pledge would reduce the rate of growth in emissions given current and projected levels of GDP growth, but would not cut emissions themselves. China reaffirmed this commitment following the Copenhagen Conference in a letter to the UNFCCC in late January 2010.116 The letter emphasized that China’s “autonomous domestic mitigation actions” would be “voluntary in nature.” It stated that China will endeavor to lower its carbon dioxide emissions per unit of GDP by 40–45 percent by 2020 compared to the 2005 level, increase the share of non-fossil fuels in primary energy consumption to around 15 percent by 2020 and increase forest coverage by 40 million hectares and forest stock volume by 1.3 billion cubic meters by 2020 from the 2005 levels.117 China’s National Climate Change Programme, Prepared under the Auspices of National Development and Reform Commission, People’s Republic of China (June 2007); White paper: China’s policies and actions on climate change, State Council Information Office (October 2008). 114 Ibid; see also CRS Report. 115 China and U.S. Hit Strident Impasse at Climate Talks, The New York Times (December 14, 2009). 116 55 countries send UN their carbon-curbing plans, BBC News (February 1, 2010). 117 Letter to The Honorable Ban-KI Moon, Secretary-General, United Nations, from Wen Jiabao, Premier of the State Council, People’s Republic of China (January 2010). 113

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In some cases these goals extend the time frames and targets adopted earlier as a part of China’s National Climate Change Program, Renewable Energy Law of 2005, Energy Conservation Law of 2008, and 11th Five-Year Program (2006–2010). China, nonetheless, does have a number of programs and policies designed to improve its energy and emissions efficiency. The National Climate Change Program itself lists 52 initiatives and policies to address climate, including: 1. Economy-wide energy efficiency target of 20 percent reduction in energy intensity between 2005 and 2010; 2. Closing of inefficient industrial facilities and improved power sector efficiency; 3. Fuel economy standards averaging 36 miles per gallon for passenger cars; and 4. Improved appliance efficiency standards aimed at reducing electricity use by 10 percent by 2010, and providing subsidies for purchase of energy-efficient appliances.118 There is little doubt that energy policy will remain a top priority in China, given the nexus between energy and economic growth, and between economic growth and political stability. The government recently created a “super ministry” known as the National Energy Commission, which will be led by the Prime Minister.119 It is also worth underscoring that, for the government, growth in the renewable energy sector is about more than just a need for environmentally-friendly alternatives to China’s continuing heavy reliance on coal-fired power generation to service electricity demand growing at up to 15 percent each year. It is also about becoming the world’s leader in the production and export of clean technology.120 Over the last two years, for example, China has become the world’s largest manufacturer of both solar panels and wind turbines.121 To promote development of cleaner technologies, China gives priority to renewable energy for electric grid access and transmission, and requires full-price purchase of renewable energy by utilities. It also charges a fee to all energy users (more for

118 China’s National Climate Change Programme, Prepared under the Auspices of National Development and Reform Commission, People’s Republic of China (June 2007). 119 China’s National Energy Commission is established, People’s Daily Online (English Version) (January 27, 2010). 120 CRS Report. 121 Ibid.

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industrial customers) that goes to grid operators to cover the increased cost of purchasing renewable energy.122 China also offers significant financial incentives to encourage the shift toward cleaner energy. Those include low-cost loans for power companies to purchase energy service equipment, and generous subsidies for consumers to install their own solar panels.123

F. Private Sector Initiatives The discussion above illustrates that the action of individual countries or regions, whether among the industrialized countries of the OECD or elsewhere, presents less of a direct threat to Latin American and Caribbean producers’ market access than is often suggested. While much has been proposed, whether at the national or international level, little has actually taken effect. Arguably, the greatest obstacle the current environment creates, in so far as it relates to public policy, is the uncertainty that hangs over international transactions because the risks remain unknown. Individual market participants cannot determine how risks might be allocated among them as a result. Given the relatively high barrier that uncertainty and transaction costs represent in international trade, particularly as globalization has reduced other geographic and logistical barriers, the impact of that uncertainty on Latin American and Caribbean producers should not be underestimated. Nor is it being underestimated by global firms, many of which are pursuing their own approaches to climate change precisely in order to eliminate as much of that risk as possible, even in the face of the unsettled regulatory environment described above. Many private entities have become increasingly active in addressing climate change for the same reason. This engagement takes two principal forms. The first involves policy advocacy, in which both private firms and non-governmental organizations try to shape national or international policy with respect to climate change. To the extent those efforts have shaped or will shape public policy outcomes, they have been implicitly addressed in the discussion above. It is the second form of engagement that is actually far more relevant for Latin American and Caribbean producers at this stage. Significantly, even with more comprehensive regulation, private firms would likely prove to be the medium through which climate change policies adopted by any of the countries just mentioned would 122 123

Ibid. Ibid.

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eventually reach Latin American producers and consumers. More importantly, however, those same private firms are increasingly taking action on energy and GHG emissions on their own initiative.

1.â&#x20AC;&#x201A; Creating Effective Carbon Accounting Standards One of the main efforts under way in the private sector is the development of a number of practical means of assessing the environmental performance of firmsâ&#x20AC;&#x2122; operations, supply chains, and products. As highlighted above, firms recognize that, regardless of the ultimate choice of mitigation measure imposed by governments, each depends heavily on the means for assessing the CO2 content of goods, production processes, and logistical networks. In practical terms, that implies the need for sophisticated forms of GHG emissions accounting. The motivations for contributing to the effort to create practical GHG emissions accounting standards are as varied as the companies involved. Some may see new market opportunities in the transition to a lower-carbon global economy. Others may simply wish to reduce their vulnerability or exposure to the financial risks created by climate change and any response. Most may simply wish to get ahead of policy changes they see as inevitable, and are working to influence those outcomes as much as possible. Whatever their motivations, all of the companies involved understand the inherent value of adopting a single set of workable and effective standards, rather than trying to do business globally under a variety of disparate, potentially conflicting accounting norms. In the effort to create those standards, corporations are often being joined by environmental groups; these groups appreciate how important assessing the GHG emissions resulting from industrial operations, supply chains, and throughout product life-cycles is to the ultimate solution to climate change. The leading example of its kind is the partnership between the World Resources Institute (WRI) and the World Business Council for Sustainable Development (WBCSD) to develop their recently unveiled Greenhouse Gas Protocol Initiative. The Initiative actually involves two new GHG protocols that provide methods to account for emissions associated with individual products across their lifecycles, and of corporations across their value chains. Significantly, the 60 corporations participating in the initial testing of the WRI/ WBCSD protocol represent more than 20 industry sectors and 17 countries, including a variety of companies headquartered in developing countries, including China. The companies have made the judgment that the information they gain and the business Climate Change Mitigation Measures Adopted or Proposedâ&#x20AC;&#x192; 73

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processes they develop will aid them in making informed decisions about changes in operations and decision-making that will improve efficiency and environmental performance, thereby lowering the firm’s cost of moving to a low-carbon global economy. They will, as a part of the process, gain a much-improved appreciation of when and where GHG emissions occur in their operations and supply chains, which could pay significant dividends in responding to any future policy developments or regulatory changes. It is worth highlighting the extent to which initiatives like that of WRI and WBCSD blur the distinction between what is public and what is private action on climate change. The information developed under the WRI/WBCSD initiative will, for example, make for easier compliance with the EPA’s new GHG reporting rule in the United States, and in informing investors about GHG performance and potential vulnerabilities (or opportunities) in a warming world, as would be consistent with the SEC’s interpretive guidance discussed in Section II above. The impact of initiatives like the WRI/WBCSD GHG Protocol Initiative on Latin American and Caribbean producers may, in the end, prove far more important than the actual constraints on emissions imposed by governments. The reasons relate to the changes wrought by globalization in international trade. Globalization has, in effect, redrawn economic geography. By making global supply chains possible, globalization also made them a competitive necessity, leading to the current situation in which greater than 50 percent of world trade involves trade in intermediate goods, often with the same corporation (including its affiliates) or with the broader reach of its global supply chain. In that context, the companies that organize the supply chain become the de facto standard setters, often prescribing commercial standards that exceed those that governments would otherwise prescribe. From the perspective of Latin American and Caribbean producers, those global standard-setters also represent the gatekeepers to world markets, in many instances. As is reflected in the discussion above, the region’s producers will likely escape many of the direct effects of policies adopted by governments, even in their most important export markets; consequently the commercial standards set by global firms, whether in the form of product standards or in the form of processes, like carbon accounting methods, become the more significant obstacles to trade.

2. Private Voluntary Reporting Codes The movement toward developing a workable set of carbon accounting standards dovetails with another trend among private firms—a trend toward participating in 74 Trade and Climate Change Mitigation Measures

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private voluntary reporting of emissions of CO2 and other GHGs. Prominent examples include the Principles for Responsible Investment (PRI), the Climate Registry, the Carbon Disclosure Project (CDP) and the Global Reporting Initiative (GRI). The Climate Registry describes itself as a nonprofit “collaboration among North American states, provinces, territories and Native Sovereign Nations,” intended to set “consistent and transparent standards” to calculate, verify, and publicly report GHG emissions. Qualifying companies can make use of the Climate Registry logo. The real object, however, is to provide a single repository of verified and verifiable data that could be used by participating companies to satisfy their legal obligations under any mandatory reporting regime, like that under development by the U.S. EPA, as well as to allow the registered companies to participate effectively in either mandatory or voluntary emissions trading regimes. By participating in the Climate Registry, companies can minimize costs by filing their GHG emissions reports in a single place, which they make available to relevant government agencies, independent auditors and investors, or any other institution the registrant authorizes. The CDP offers a contrasting example. The organization, based in the United Kingdom, represents nearly 500 institutional investors representing $55 trillion in private capital. To meet the needs of those investors, the CDP works with both shareholder and corporate management to ensure accurate accounting, reporting, and disclosure of GHG emissions by major corporations. In 2008, for example, the CDP published emissions data for 1,550 of the world’s largest corporations, which accounted for an estimated 26 percent of global anthropogenic emissions. The GRI offers yet a third variety of reporting initiative. It does not focus on GHG emissions, or even on climate or the environment, alone. It is a broad-based organization that develops “sustainability reporting frameworks” that organizations can use to measure and report their “economic, environmental, and social performance”— commonly referred to as the “triple bottom line.” Its reporting methodologies cover everything from basic economic development to human rights. In the context of climate change, GRI performs two roles. The first involves research regarding the approaches currently employed by corporations in measuring and reporting on the effect of climate change on operations and financial performance. The GRI also provides a forum for creating a multi-stakeholder process designed to produce a set of mutually agreed standards for reporting. In that regard, the GRI process yields rules that help improve the process of reporting, rather than setting specific guidelines for measuring emissions or other pollutants. From the perspective of Latin American and Caribbean producers, the practical import of the private voluntary reporting initiatives is the number of multinational Climate Change Mitigation Measures Adopted or Proposed 75

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corporations that participate in one or more of the initiatives. In many respects, the private-sector firms make up the market for the region’s exports as much as any individual country. The rules that govern access to this “market” are every bit as important as those that apply in any specific country or geographic territory. To the extent the reporting initiatives reinforce the trend toward more sophisticated carbon accounting along the entire length of the firms’ global supply chains, they will likely flow upstream to many of the region’s firms, just as would mandatory reporting requirements imposed by the U.S. EPA.

3. Private Product Labeling Initiatives The private sector’s efforts on carbon accounting standards and private voluntary reporting codes also link directly to a third form of private initiative—private product labeling standards. The Carbon Trust—a not-for-profit company established by the British government that was discussed in connection with the United Kingdom’s labeling requirements above—offers a paradigm for how most of the private efforts on labeling function. The Carbon Trust has established its own Carbon Reduction Label. To display that label, companies must register with the Carbon Trust, which will either directly assist the registrant or recommend a consultant who can help with a product life cycle assessment (LCA) to determine the product’s carbon content. That assessment, which can take from 2 weeks to 3 months (depending largely on the availability of data), is then independently verified to ensure it meets the British Standards Institute’s Publicly Available Specification 2050 standard, which is itself based on the International Standards Organization’s LCA and greenhouse gas accounting standards and is consistent with the WRI/WBCSD GHG Protocol. Once its LCA has been verified, the company then purchases a license from the Carbon Trust to use the Carbon Reduction Label. As part of its license agreement, the company commits to reducing the carbon footprint of the product subject to the verified LCA over a 2-year period. (The carbon reduction targets are set on a product-by-product basis). The cost of the process remains relatively high, but it has become an attractive option for producers that perceive a commercial advantage in letting consumers know about the company’s efforts on climate change. There are a number of other models, all of which operate on roughly the same principles. They include CarbonFund.org, a U.S.-based non-profit corporation, and the Canadian non-profit corporation, CarbonCounted. CarbonFund.org licenses a 76 Trade and Climate Change Mitigation Measures

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CertifiedCarbonFree label and provides assistance to its licensees in terms of effectively marketing their certified products and monitors each certified product’s carbon emissions on a quarterly basis. By contrast, CarbonCounted, offers a publicly available, “web-based” tool called “CarbonConnect” that allows businesses to assess carbon content along a company’s supply chain. The CarbonConnect standard must be independently verified before the producer can use the CarbonCounted label. In addition to the non-profit entities mentioned above, individual firms have adopted their own standards. The French supermarket chain Casino, for example, established its own standard in conjunction with an environmental consultancy, and now applies the “indice Carbone” label to a variety of the products it stocks. Similarly, Migros, which occupies a position in the Swiss market akin to that of Casino in France, created its own Climatop carbon label. Migros relies on MyClimate, a carbon offset company, to carry out the LCA calculations and audits that lie behind the Climatop label. What the discussion above reflects is a trend among retailers in many of the most important markets for Latin American and Caribbean producers to embrace both product labeling and the carbon accounting methodology that supports the individual labels. At this juncture, qualifying for the labels remains entirely voluntary. As such, while the private labels may offer their licensees a competitive advantage, they do not yet operate as an affirmative barrier that the region’s producers must negotiate to gain access to the retailers’ shelves.

4. Voluntary Emissions Trading Regimes In addition to the private-sector measures identified above, this decade has also seen the emergence of a number of voluntary emissions trading regimes. They include, inter alia, the U.K. Emissions Trading Scheme (ETC), Japan’s Voluntary Emissions Trading Scheme (JVETS), and the Chicago Climate Exchange (CCX). The U.K. government launched its ETS for greenhouse gases in 2002 as part of a broader set of climate change policies. Under the ETS, a number of organizations, including many of Britain’s major corporations, voluntarily undertook to cut CO2 emissions below set targets. The inducement to join was provided by incentive payments made by the U.K. government totaling £215 million. Over the initial life of the U.K. ETC from 2002 to 2006, the scheme generated the equivalent of 12 million tons of emissions reductions. Japan’s Ministry of the Environment created its own Voluntary Emissions Trading Scheme in May 2005. Under JVETS, the Japanese government subsidizes Climate Change Mitigation Measures Adopted or Proposed 77

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the installation of emissions reduction equipment for selected participants making specific commitments to reduce CO2 emissions. As with the U.K. ETS, participants in JVETS can enter the market for CO2 emission allowances to meet their reduction targets. Japan introduced the scheme in order to gain experience with CO2 emissions trading. In that sense, JVETS might best be regarded as a pilot project designed to help Japan introduce an effective emissions trading mechanism if required by future international agreement. The Chicago Climate Exchange, in contrast to the U.K. ETS and JVETS, does not depend on either a government mandate or government-provided financial incentives. In that sense, CCX is arguably the only truly voluntary climate exchange in the world. CCX members make a voluntary but legally binding commitment to satisfy yearly GHG emission reduction targets. As in other emissions trading schemes, those participants that exceed their goals in terms of reducing emissions gain surplus allowances to sell or ban. Participants that fail to reach their emissions reductions targets must comply by purchasing CCX “Carbon Financial Instrument” (CFI) contracts. Each CFI contract, the commodity actually traded on the CCX, represents 100 metric tons of CO2 equivalent. CFI contracts are comprised of Exchange Allowances (issued to emitting members in accordance with their emission baseline and the CCX Emission Reduction Schedule) and Exchange Offsets (generated by investing in qualifying “offset projects”). As was discussed in connection with the EU ETS above, the likely impact of voluntary emissions trading on Latin American and Caribbean producers would take one of two forms. The first involves the contribution the voluntary exchanges make in establishing an effective global price for carbon. While none of the three examples of voluntary emissions trading discussed above carry sufficient volume alone to set a global price for carbon, they could potentially contribute to that end by reinforcing existing mandatory schemes like the EU ETS. The second effect is the further incentive that the voluntary exchanges create for carbon emissions accounting standards, and the prospect that those accounting standards would flow upstream to Latin American and Caribbean producers.

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CHAPTER

Impact on Producers in Latin America and the Caribbean

he discussion above highlighted the region’s exposure to the various climate change mitigation measures in general. In this section, the analysis goes a step further to develop a framework for assessing the potential impact of such measures on individual industries. As we turn to the potential impact of the measures identified above, it is helpful to clarify precisely what we will be analyzing. The World Bank recently released a significant study of the broader implications of climate change for the region. That study—Low Carbon, High Growth: Latin American Responses to Climate Change— offers a comprehensive assessment of the impact of climate change on the region.124 The study usefully distinguishes between the two broad classes of measures that governments can use to address the potential effects of climate change. One class involves efforts to mitigate climate change by reducing GHG and slowing the rate of global warming (de la Torre, Fajnzylber, and Nash 2009). The other involves actions aimed at encouraging adaptation (i.e., facilitating adjustment to “moderate harm or exploit beneficial opportunities” associated with climate change or related mitigation measures) (de la Torre, Fajnzylber, and Nash 2009). The World Bank analysis also highlights the two forms of costs that both policymakers and business executives will focus on in their efforts to address both climate change and the effects of any mitigation measures. The first involves financial costs, which represent the direct outlays that will affect public finances or a firm’s balance sheet (e.g., the cost of shifting to alternative sources of energy; the cost of new, less energy- or emissions-intensive capital equipment). The second form of cost

124

For a summary of the study’s conclusions, see de la Torre, Fajnzylber, and Nash (2009). 79

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involves opportunity costs—those costs that flow from diverting resources to alternative uses (e.g., forgoing income-generating opportunities of harvesting a forest, rather than preserving it, or of allowing land to lie fallow, rather than planting it) (de la Torre, Fajnzylber, and Nash 2009). A broader analysis of the economic effect of global warming would involve weighing those costs against the potential economic harm likely to flow from unabated global warming. Striking a balance between the two forms of costs animated the studies regarding climate change discussed above in Section I. The aim here is, in a sense, more limited. The discussion focuses not on the balance between potential harm from global warming (or its impact on an industry or a firm’s balance sheet), but on the financial costs that producers will face as a result of the mitigation measures imposed by governments in the producers’ principal export markets. Having said that, the following analysis goes farther in assessing how climate change mitigation measures will actually affect the financial costs facing the region’s producers. Very little work has been done either on how the costs of mitigation flow through to the individual producer, or on the extent to which those costs will actually have an impact on the producer’s balance sheet, rather than being passed on to the ultimate consumer. In order to illuminate those features of the economics of climate change mitigation, the following discussion is divided into two parts. The first examines climate change mitigation measures from a producer’s perspective—what form the costs take, how they flow through to the producer (e.g., in the form of direct costs or in the loss of revenue attributable to higher market access barriers) and what the structure of the industry suggests about who bears the ultimate cost of the mitigation measures. The goal is to outline a framework for assessing the impact of climate change mitigation measures on individual industries in the region. The second part applies the framework to four industries in Latin America and the Caribbean: cement in Mexico, plastics in Colombia, forestry and agriculture in Uruguay, and mining in Peru. The purpose is to examine the challenges that climate change mitigation measures pose to producers at a microeconomic level.

A. Climate Change from a Producer’s Perspective In discussing the policy actions Latin American and Caribbean countries might take to ensure that they do not face a demand for rapid adjustment later in the face of climate change, the World Bank analysis discussed above (de la Torre, Fajnzylber, and Nash 2009) recommends that regional policymakers adopt an initial strategy that they frame 80 Trade and Climate Change Mitigation Measures

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as “no regrets in the present.”125 That strategy would focus policymakers on those actions that would yield both higher economic growth and rising productivity (the keys to development) while at the same time making measured progress on mitigating the effects of global warming. As an adjunct, the Bank’s analysis suggests a counterpart strategy of “no regrets in the future” in a more carbon-constrained world economy, by implication moving ahead of the pressure both companies and countries will face “to internalize the social costs imposed by emissions.” What that requires is an effort to incorporate the “prospective future emergence of carbon pricing” into current investment decisions, including the “likelihood of future government policies and carbon market forces penalizing GHG emissions,” especially in “carbon-intensive” sectors (de la Torre, Fajnzylber, and Nash 2009). The reality for the region’s private sector is that the future is now. From a producer’s perspective, a number of trends (among those highlighted above) suggest that a firm should already be incorporating expectations about the potential impact of global warming and the potential effects of both government policies and commercial practices in their current corporate planning and capital investment decisions. At least for energy-intensive industries, those trends will likely create a “shift in the global business environment on the same order of magnitude as the one launched by the oil crisis of the 1970s (Enkvist, Naucler, and Rosander 2007).” The reason for that shift in thinking is that many of the mitigation measures that will have lasting effects on the way firms and industries in the region do business are already being put in place by private firms, even in the absence of government-imposed regulation or the adoption of market-based measures to meet the challenge of climate change. Firms have already begun to adapt to the “fundamental impact” that climate change and measures designed to mitigate its effects will have on “business strategy,” particularly with respect to production economics, cost competitiveness, investment decisions, and the value of different types of assets (Enkvist, Naucler, and Rosander 2007). Not surprisingly, from a producer’s perspective, the issues that dominate any discussion of business strategy in the face of climate change and the potential impact of any mitigation measures relate to the value of the company as a going concern. There are a number of ways to explore that question. One would involve examining the potential impact of climate change and the efforts to deal with it on a company’s 125 The Bank’s analysis lists a number of examples—investments in energy efficiency; reduced deforestation; improved public transportation; development of low-cost and sustainable biofuels; increased agricultural productivity, and improved waste management.

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market value or, more pointedly, the firm’s “value-at-risk” and how best to measure and manage that risk. Another approach would look to how the specific aspects of climate change will impose constraints on the company’s growth or, alternatively, create opportunities that might contribute to its value. A third approach would focus on risk, specifically balancing the risks of action versus the risks of inaction. In each instance, however, the outcome will depend heavily on four factors: 1. the company’s exposure to the risks of climate change and any mitigation measures, which boils down to the relative energy intensity of the industry or firm (i.e., its energy input relative to its output); 2. the industry’s structure, which affects the firm’s ability to shift the risks and consequent costs associated with climate change and any mitigation measures upstream to suppliers or downstream to customers; 3. the implications of climate change and its mitigation for the firm’s growth, which relate to the firm’s ability to contest new markets at home and abroad; and 4. the impact of climate change mitigation measures on the transaction costs that largely drive the demand and supply of globally-traded goods and services. The following discussion explores these key private sector drivers.

1. Thinking in Terms of Emissions and Energy Intensity Whether Latin American and Caribbean firms succeed in their efforts to remain competitive in the face of the challenge that climate change and its mitigation presents will depend on a variety of factors. Perhaps the most important, however, are the relative emissions intensity and energy intensity of the region’s industry.126 Much of the region’s industry is concentrated in the initial stage of transforming raw materials into finished goods and services, which has long been recognized as the most energy-intensive stage of production.127 The underlying logic of the following discussion is largely derived from the useful discussion of reducing global energy demand in McKinsey Global Institute (2007). 127 See, e.g. Park, Dissman, and Nam (1993). Significantly, this basic fact raises some questions regarding the conclusions reached in previous papers by World Bank economists regarding the relative distribution of the effects of climate change mitigation measures on different regions of the world (Mattoo et al. (2009). That study suggested that China and India would suffer most in terms of de-industrialization from climate change mitigation measures, but it is not clear to what extent the study took into account 126

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For the foreseeable future, and certainly within the timeframe in which the region’s industry will confront the effects of climate change mitigation measures, industry’s energy intensity will remain relatively fixed and industry’s ability to make the capital investments necessary to embrace emission-reducing or energy-saving technologies will be limited by the lower rates of return to be expected in a lower-carbon regional and global economy. It is therefore necessary to think in terms of the relative emissions and energy intensity of the region’s industry and its individual firms in assessing their potential exposure to climate change mitigation measures, particularly as it affects their capital investment decisions. From an economic perspective, the appropriate way to frame the challenge that global warming presents involves adopting policies that reduce the emissions intensity of both products and production processes, rather than energy intensity. Hence, the intense focus of international, regional, and national efforts to create a price for CO2 and other GHG emissions. Establishing a market price for emissions is an absolute predicate for encouraging the most efficient adjustment to a lower carbon-economy without sacrificing the prospects for economic growth and development. Measuring the emissions efficiency of an enterprise or particular production process involves a comparison of emissions inputs to output. That comparison ultimately requires an effective means of counting and measuring emissions (i.e., an effective methodology for carbon accounting, as discussed above). From a firm’s perspective, improving the emissions efficiency of its production will be viewed through a slightly different lens, but it boils down to the same requirement: an effective way of accounting for carbon emitted as a part of its operations. For a profit-maximizing enterprise, improving emissions efficiency will (or should) be treated as a capital investment decision and measured in terms of its internal rate of return (IRR). Such a decision will then be assessed as part of a capital budgeting process that will force the investment in emissions efficiency to compete for scarce capital against other potential capital investments. This suggests a slightly different approach to thinking about emissions: one that measures emissions productivity, which is the inverse of emissions efficiency. It involves a measure of the value added produced by a given set of emissions inputs.128 the relative shift in those countries toward fabrication from the initial stages of producing raw materials which has been going on for some time and would, all things being equal, tend to suggest a relatively lower exposure to the impact of climate change mitigation policies. See, e.g., Sinton and Levine (1994). 128 In that sense, the measure is directly related to other measures of productivity, like labor productivity or capital productivity. A measure of emissions productivity involves an assessment of the quantity and quality of goods or services produced with a given set of inputs, in this case CO2 and other GHG emissions. Impact on Producers in Latin America and the Caribbean 83

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From a firmâ&#x20AC;&#x2122;s perspective, it should focus on improving the productivity of its emissions because of the impact that has on the IRR generated by an investment in reducing emissions. As emphasized above, however, a firmâ&#x20AC;&#x2122;s ability to measure its emissions productivity depends entirely on knowing a market price for GHG emissions and implementing an effective means of accounting for the CO2 and other GHGs emitted in its production processes. While establishing a market price for GHG emissions lies outside the control of the firm, establishing an effective means of accounting for carbon is within its control. But establishing that system of accounting will face the same challenge noted above: it has to be justified in terms of the IRR it will generate, just like any other capital budgeting decision. What that suggests, of course, is that one means of assessing the impact of climate change and its mitigation on Latin American and Caribbean producers is through their effect on the IRR that an investment in emissions abatement would generate. Among Latin American and Caribbean producers, many of which produce goods and services relatively farther upstream from the ultimate point of sale of a finished good or service to a consumer, there is an added complexity. Assessing the IRR on a capital investment in abatement may require the firms to adopt the carbon accounting methodology employed by its customer or customers. There are two risks that flow from that added complexity. The first, of course, is that the cost of implementing the carbon accounting methodology is simply prohibitive in light of the capital constraints on the individual producer. The second is the possibility (indeed, the likelihood under the currently evolving set of practices) that the producer will be confronted with multiple and potentially conflicting carbon accounting standards. Latin American and Caribbean firms and governments have a stake, therefore, in the adoption of a uniform set of rules for carbon accounting. In addition, as will be discussed in greater detail in Section V, governments in the region also have a significant stake in including business processes, such as carbon accounting methods, among the technologies that need to be broadly shared as part of the effort to reduce the cost of the transition to a lower-carbon regional and global economy. Given the discussion above in Sections I and II, it should be clear that the global and national mitigation efforts to date have failed to produce an effective price for GHG emissions. At the same time, firms that are among the most important customers of Latin American and Caribbean producers are already moving ahead with their efforts to implement effective carbon accounting standards. The tension between those two trends has largely been reduced by turning to an imperfect surrogate for emissions intensity and emissions productivity: the price of fossil fuels acts as 84â&#x20AC;&#x192; Trade and Climate Change Mitigation Measures

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a substitute for the price of emissions and thereby creates a measure of both energy intensity and energy productivity.129 The price of energy, in effect, is substituted for the price of emissions in a firm’s calculation of the IRR on capital investments designed to improve the firm’s energy productivity. From the perspective of Latin American and Caribbean producers, thinking in terms of energy, rather than emissions, efficiency reduces the uncertainty and risk associated with estimating the price of carbon in the currently unsettled economic and regulatory environment. However, opting to use energy efficiency as a surrogate will not satisfy the carbon accounting methods that are being developed by individual firms or by broader groups such as the World Resources Institute/World Business Council for Sustainable Development discussed above. From a firm’s perspective and, equally important, from the perspective of policymakers in the region, thinking in terms of energy efficiency also creates its own set of complications. One point that is generally recognized yet often overlooked in specific analyses of climate change, is how efforts to mitigate the effects of climate change interact with the price of fossil fuels. The recent global economic downturn highlights that relationship. As economic activity fell sharply, the price of fossil fuels declined even more dramatically relative to prices of alternative, cleaner sources of energy. That decline has already led a number of market participants to postpone or decrease investments in alternative energy. Wholly apart from this sort of cyclical effect on energy prices and investment patterns, what is less often acknowledged is that a longer-term decline in the energy intensity of production due to efforts aimed at mitigating global warming’s impact may well cause a longer-term secular decline in the price of fossil fuels. In that sense, efforts to mitigate the effects of climate change are in constant competition with the price of fossil fuels. That has important ramifications for both policymakers and industry in Latin America and the Caribbean. The exposure of any particular economy in the region will depend heavily on the energy intensity of its production, and the ability of policymakers to facilitate a transition to a lower-carbon economic environment will also vary with the price of fossil fuels under almost every conceivable scenario.

129 Using energy as a surrogate for emissions is imperfect for a variety of reasons, not the least of which is the tendency to ignore the fact that other inputs (i.e., labor, capital, technology) are not entirely independent variables. See, e.g., Costanza (1980). Most calculations of energy efficiency tend to treat the variables as independent, which tends to understate the impact of energy prices on GDP or IRR calculations in the case of the individual firm. Correspondingly, the analysis may well understate the actual rate of return from efforts designed to improve energy efficiency (Costanza 1980).

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As the oil shocks of previous decades have shown, the rising cost of energy can have dramatic effects on the economic prospects of even the strongest of the region’s economies, unless they are self-sufficient in energy or a net exporter. Conversely, a decline in the cost of energy alleviates that constraint for economies that are net energy consumers and exacerbates the challenges faced by net energy exporters in terms of economic development. The same reasoning applies to a country’s efforts to adjust to climate change. Countries in Latin America and the Caribbean that depend heavily on energy-intensive industries for a significant share of their GDP will necessarily face higher adjustment costs in the transition to a lower-carbon global economy. A lower price of energy will have the opposite effect and may well undermine the political imperative to undertake the adjustment to a lower-carbon economy as well. That logic applies with equal force to industries and individual firms. The relative exposure of industry in the region both to climate change and to the impact of any mitigation measures will depend heavily on its energy intensity. A higher cost of energy will necessarily confront heavy users of fossil fuels with greater constraints on the capital needed to finance adjustment toward less energy-intensive means of production, whereas a lower energy price will, all things being equal, tend to offer industries and firms greater leeway in their capital spending and adjustment efforts. It may also reduce their incentive to adopt less energy-intensive production processes and reduce the energy intensity of their supply chain generally. The reason for highlighting the relationship between energy prices and the impact on Latin American industries and firms is that the actual cost that these industries and firms face will depend heavily on the success of the mitigation measures in raising the price of fossil fuels. To the extent that either a global agreement or the aggregate effect of individual countries’ choices on mitigation measures drives the cost of energy up, Latin American and Caribbean producers in energy-intensive industries will, all things being equal face a more significant challenge in competing in global markets. To date, it is safe to say that neither the effort to forge an international agreement on climate change nor the aggregate effect of individual countries’ mitigation measures has had a significant impact on the price of fossil fuels. To the extent they have had any effect at all, larger economic forces, such as the global economic downturn, have swamped that effect. Ironically, where mitigation measures have had an impact on energy prices in individual markets like the European Union, they have mostly driven calls for border measures to protect the local industry from imports. 86 Trade and Climate Change Mitigation Measures

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The discussion above suggests three lessons for any analysis of the challenges that individual industries and/or firms in the region will face as a result of climate change and its mitigation. First, it suggests that one important lens into assessing the region’s exposure to climate change and its mitigation will be the relative emissions intensity and energy intensity of its industries and firms. Evidence suggesting that the energy intensity of countries does not tend to converge (i.e., will remain a significant distinguishing feature among countries of the region and between countries of the region and countries that represent their principal export markets) tends to reinforce that conclusion.130 Second, the discussion suggests that the appropriate way to think of the exposure that the region’s industries and firms will face is through the impact of emissions and energy prices on the calculation of the internal rate of return associated with investments in emissions abatement. In other words, from a firm’s perspective, much of how it reacts will depend heavily on the influence of climate change and climate change mitigation measures on its capital budgeting decisions. Third, the inability of current mitigation measures to establish an effective price for GHG emissions or to affect the price of fossil fuels does not allow Latin American and Caribbean producers (or policymakers) to ignore the issues of emission intensity and energy intensity and the impact they have on firms’ capital budgeting decisions. Rather, it suggests that, regardless of the complications and uncertainty, an early focus on how best to ensure that firms can make the appropriate calculations, and to ensure accounting conventions are more clear and consistent, is critical to the ability of the region’s producers to remain a part of the global supply chains that dominate world trade today.

2. Analyzing Industry Structure Another way of assessing the potential impact of climate change and its mitigation on the region’s industries and firms involves analyzing a particular industry’s organization and the relative size and position of a firm within that industry. The reason for adopting that approach is to gain a rough measure of whether an individual firm must fully absorb the rising cost of emissions or the costs of compliance with any regulatory regime—or whether those costs can be imposed on suppliers upstream or passed on to customers or to the ultimate consumer of finished goods and services.

130

See, e.g., Stegman and McKibbin (2005). Impact on Producers in Latin America and the Caribbean 87

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The easiest way to understand the importance of industry organization for the analysis of the impact of climate change mitigation measures is through a comparison of the positions of producers in two industries discussed in greater detail below. One is the position of CEMEX in the Mexican and world markets for cement relative to the position of the individual farmer or forester in Uruguay. CEMEX plainly has faced considerable challenges as a result of the collapse of residential and industrial construction in a number of its key markets, and there is considerable competition at a global and regional level in the industry. Nevertheless, in its home market and in parts of one of its most significant export markets, the United States, CEMEX holds enough market power to ensure that upstream suppliers must fully internalize their costs, including those associated with climate change mitigation. It also has enough market power, when construction is booming and the relative elasticity of demand favors cement producers, to pass its own costs of compliance on to customers and to the ultimate consumer in the form of higher prices. The situation confronted by individual farmers and foresters in Uruguay is just the opposite. As large as some of the farms or forestry operations may be in a Uruguayan or even a Latin American context, none of them are of a sufficient size to force suppliers of major inputs (with the notable exception of labor) to bear the full cost of compliance with various climate change mitigation measures, rather than facing the situation where those costs, in some proportion, are passed on to Uruguayan farmers and foresters in the form of higher prices (e.g., for seeds, fertilizer, etc.). Equally, given the global nature of agricultural commodity markets, the individual farms or forestry operations are largely price takers in their export markets and, indeed, may well be price takers in their domestic markets as well, in light of the structure of the downstream industry, which is made up of food processors, grocery manufacturers, and retailers. Assessing industry organization involves the application of three tools. The first involves constructing a picture of the industry and its organization by drawing a supply-chain map of the industry in question. The map can be used to identify the carbon content of inputs and production processes involved. In the process, the map can highlight weaknesses in the existing supply chain from the perspective of carbon emissions or energy usage. The mapâ&#x20AC;&#x2122;s real value in this instance, lies in its ability to graphically depict the number and relative size of the participants in the industry, as well as the number and relative size of the participants in important upstream and downstream industries. In short, it provides a graphic illustration of the industry that can help in defining the relevant industry for applying the second of the three tools discussed here. 88â&#x20AC;&#x192; Trade and Climate Change Mitigation Measures

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The second tool applies the sort of analysis commonly associated with investigations of industry concentration and market share. These draw on the economics of industrial organization to understand the relative market power of firms within an industrial sector, and, particularly, relative to the concentration and market power employed by participants in upstream and downstream industries. There has been an ongoing debate in the economic literature for some time regarding what matters most: industry concentration per se or the market share of the individual firm.131 In part, that debate reflects the fact that much of the analysis in the area of industrial organization relates to the measures applied by enforcement agencies or courts in the application of competition policy or in the context of antitrust litigation.132 The generally accepted approach in that context was to focus on industry concentration because of the potential for collusion that industry concentration facilitates (Hall and Tideman 1967; Saving 1970).133 However, the more relevant issue here is market share, because of the market power that such share offers a firm—in effect, power to make others bear the costs of adjustment to a lower-carbon economic environment, whether they are upstream suppliers or downstream customers.134 The third tool is an assessment of the elasticities of demand that industries and individual firms face for their goods and services. More specifically, it is the price elasticity of demand that the firm faces for its goods or services that is relevant (i.e., how sensitive the demand for the firm’s goods or services are to changes in their price). With a relatively elastic demand, producers in the region can expect that they will be forced to absorb the cost of adjustment imposed by any climate change mitigation measures. A relatively inelastic demand has the opposite effect; it increases the prospect that the costs of adjustment can be passed through to customers and, potentially, to the ultimate consumer, without affecting the quantity of goods the producer in the region can sell in that particular market. Plainly, the price elasticity of demand that any firm faces will depend heavily not only on consumer demand (or, in the case of many of Latin American and Caribbean producers, the derived demand from downstream consumer markets), but also on the substitutability of other goods and services and the relative propensity of consumers to make that substitution based on price. In that instance, the ability of the producer in Latin America or the Caribbean to pass on the costs of adjustment may well depend See, e.g., Gale and Branch (1982). For valuable early discussions of the establishment and use of such measures, including their application in an international context, see Hall and Tideman (1967) and Saving (1970). 133 Ibid. 134 See, e.g., Azzam (1997). 131

132

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on the cross-price elasticity of demand between the good or service the firm produces and any potential substitutes. The cross-price elasticity of demand for substitutes is always positive. All other things being equal, the greater the positive correlation, the greater the likelihood that firms in the region will lose sales to substitutes for their goods or services; hence the need for both firms and policymakers to understand not only the elasticities that their industries face, but the cross-price elasticities of substitutes and the relative exposure of the substitutes to many of the same cost pressures that regional firms will face as a result of climate change mitigation.

3. Rethinking Market Access in Light of Globalization The third key private-sector driver highlighted above involved examining the implications of climate change mitigation for growth at the firm and industry level. Assuming for purposes of analysis that all firms within a particular country in the region will face similar costs attributable to domestically imposed climate change mitigation measures, the impact of such measures on firm and industry growth is likely to flow from measures imposed in other markets. In short, the limits that climate change mitigation may impose on growth relate, to a large extent, to the limits those measures may impose on market access.135 Given the current contours of the global economy, it is helpful to distinguish between two very different types of effects that climate change mitigation may have on regional producers’ access to world markets. The first is the extent to which the mitigation measures would directly constrain market access (e.g., carbon tariffs imposed on the region’s exports to the European Union). The second involves the impact that mitigation measures may have on producer costs, which will not directly limit their ability to access any individual market, but may result in their losing what grip they have on global markets by denying them access to global supply chains. The reason for drawing that distinction has a great deal to do with how market access is defined. As the discussion below reflects, if defined in conventional trade While the discussion here focuses on the impact of mitigation measures on Latin American and Caribbean firms’ access to foreign markets, it remains true that firms in the region may face stiffer competition in their home markets as a result of subsidies offered to producers in other markets. Such subsidies could, all things being equal, offer the foreign exporters a price advantage in competing in the Latin American and Caribbean producers’ home markets. That is most likely to be the case where the subsidy exceeds the cost of any adjustment those firms must make in the face of climate change and its mitigation and to the extent that similarly situated firms in Latin America and the Caribbean do not also benefit from such subsidies. 135

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terms, the analysis would focus on whether the mitigation measures imposed additional border measures such as carbon tariffs or would result in subsidies that are “actionable” in trade terms, either under the WTO rules or under separate bilateral or plurilateral trade agreements that might govern trade relations between the individual country in Latin America or the Caribbean and the government imposing the mitigation measures. If, on the other hand, we start from market access as it looks to Latin American and Caribbean producers trying to gain or expand a foothold in global markets, the issue is very much one of cost as well. It is also a question of meeting the commercial standards imposed by global firms that provide the conduit for much of the region’s trade to the export markets affected by the mitigation measures. The conventional definition of market access would start by assessing the current border measures that the region’s exporters face, and then determining whether the mitigation measures identified above would add to those barriers. Since all of the countries or entities discussed above are members of the WTO, as are all of the countries of Latin America and the Caribbean, the tariff bindings and other rules governing trade among WTO members provide the basic benchmark against which any new border measure should be assessed. The next step in that analysis would involve examining the various bilateral or plurilateral agreements between individual countries of the region and the countries introducing climate change mitigation measures.136 Those arrangements offer export market access on terms significantly better than that provided under the WTO. In certain instances, they also provide stronger dispute settlement provisions and other rules that would potentially constrain the imposition of trade measures inimical to Latin American and Caribbean trade interests. In addition, there are a wide range of free trade or preferential arrangements among Latin American and Caribbean countries. To the extent that those arrangements include members with free trade agreements with major North American, European, and Asian markets, they may also offer some insulation for those exporters that send their goods to another country in the region for further processing and

For example, Mexico, Chile, Peru, the Dominican Republic, Costa Rica, Nicaragua, El Salvador, Guatemala and Honduras are all parties to free trade agreements with the United States. Chile, Costa Rica, Colombia and Peru all have free trade agreements with Canada and Canada is currently negotiating similar arrangements with Panama, El Salvador, Guatemala, Honduras and Nicaragua. Mexico and Chile have free trade agreements with Japan. The Caribbean recently negotiated an extensive Economic Partnership Agreement with the EU and is currently in the process of negotiating a similar arrangement with Canada. Both Chile and Peru have free trade arrangements with China. 136

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substantial transformation before the product is exported to one of the markets identified above in Section II. Understanding the interplay among the various arrangements is challenging enough for well-trained trade lawyers in the WTO Secretariat, much less small landholders or small producers of goods and services. There is a real need for assistance in making sense of the plethora of trade arrangements: of what they mean in terms of market access, and whether or not they would ensure that an individual country within the region might be held harmless from any trade measures imposed by the countries noted above. With those benchmarks in hand, however, the analysis of what a carbon tariff or other trade sanction might do to trade between Latin America and the Caribbean and the country imposing the measure is relatively straightforward. A number of recent studies have examined the potential effect of measures like carbon tariffs on the exports of developing countries generally.137 The analysis outlined above is helpful, as far as it goes, in identifying the most visible effects of the existing or proposed mitigation measures. That said, the entire basis on which producers enter world markets has shifted with globalization. The forces driving the integration of world markets have essentially redrawn economic geography.138 The recent economic downturn helps illustrate why analyzing the implications of climate change mitigation measures in terms of their impact on access to global markets makes sense. A growing body of economic literature has examined the response of trade flows to the fallout in credit markets and its impact on economic growth and incomes. What has been dubbed the Great Trade Collapse was unprecedented, even compared to the decline in trade during the Great Depression; world exports in the first quarter of 2009 were, in value terms, 31 percent lower than a year before; world imports were 30 percent lower. In the event, international trade dropped five times more rapidly than global GDP over that time and turned out to be one of the main channels of transmission of See, e.g., Mattoo et al. (2009). The forces driving globalization are many and varied. See Aldonas (2009a). The end of the Cold War erased political divisions that cut the world in half throughout the last half of the 20th century. That created a broader plane across which the ongoing revolution in computing, communications and transportation has played out. The globalization of private capital markets has facilitated the technological revolution, helping to finance the expansion in world trade, international investment, and the technology transfer that accompanies both trade and investment flows. Trade liberalization, principally on industrial goods, contributed as well. Perhaps the most significant event, however, has been the decision of many developing countries to these unfolding political and economic dynamics—a large share of the developing world opted to join the global economy, adding roughly 2 billion new workers and consumers to global markets and significantly higher world economic growth. 137 138

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the economic crisis. The fact that trade declined that sharply even while freight rates on containers shipped from Asia to Europe dropped to zero at the beginning of 2009 for the first time ever highlights the extent of the impact of globalization and the networks of global supply and value chains on the prospects for trade generally, and on the fortunes of Latin American and Caribbean firms in particular. This example highlights the extent to which globalization has made it possible to organize production on a global basis, largely without reference to underlying resource endowments, and has largely redrawn the landscape of economic geography. The underlying changes in the global economy have fundamentally altered the basis of commercial competition; having made it possible to operate a global supply chain, globalization has now made it a competitive necessity. World trade is increasingly organized by global firms that mobilize capital, talent, and ideas on a global basis to produce for world markets rather than for national markets. The effect has been to change the paths by which Latin American producers connect to global markets. In this new world, “market access” is defined less by the ostensible barriers in a particular market and more by the ability of Latin American and Caribbean producers to satisfy the commercial standards imposed by global buyers, including their environmental standards. In addition, Latin American and Caribbean producers have to adapt to the global buyers’ business processes. In a global economy that depends increasingly on the ability to deliver “just in time,” the “thickness” of interaction among participants in the global supply chains created by global firms is much deeper than was previously the case. In fact, the linear concept of a supply chain no longer captures the information and goods and services flowing among different participants in what would better be seen as economic ecosystems that thrive on sharing information, technology, and production processes. These dynamics are now visible in the trade statistics. Today, less and less of international trade involves an arm’s-length sale between independent buyer and seller in separate countries. Since 1960, intra-industry trade has doubled as a share of world trade, from 27 percent to 54 percent (World Bank 2009). Roughly half of world trade now consists of intermediate goods (i.e., inputs or goods in the process of production), suggesting that the majority of world trade now takes place within global firms or in the broader reach of their worldwide supply chains.139

139 The most recent version of the World Trade Organization’s International Trade Statistics, which takes a conservative approach to measuring such trade, suggests that trade in intermediate manufactured products represented roughly 40 percent of the non-fuel world trade total in 2008 (WTO 2009). The WTO’s

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For Latin American and Caribbean producers, what this trend means in practical terms is that their access to global markets is increasingly defined by their ability to participate in the global supply chains that serve those markets. Their ability to participate in these evolving economic ecosystems is certainly defined by the ability to deliver inputs at the lowest possible cost, a consistent effort to raise quality, and, increasingly, the ability to participate in the effort to create new products and production processesâ&#x20AC;&#x201D;all of which assumes the ability to comply with the internal controls, including accounting standards, imposed by the downstream entities that mobilize the capital and organize the production processes designed to deliver goods and services to the ultimate consumers.140 Thus, for example, from the perspective of Latin American and Caribbean producers, the obligation to meet the carbon accounting standards of global buyers represents an additional hurdle in their efforts to gain access to global markets. Clearing that hurdle will require efforts to address the microeconomic costs that developing country producers face in satisfying those standards. Otherwise, they are likely to find themselves in a far less competitive position than their competition in developed countries that enjoy ready access to a deeper and more liquid pool of investment capital and the technology essential to satisfying the new standards. An understanding of this dynamic is essential to comprehend the true implications of any effort to mitigate climate change. To the extent that climate change mitigation measures conflict with this unfolding economic transformation, they will necessarily raise the cost of adjustment and, to the extent that they limit development, will undercut the effort to confront climate change more generally.

figure reflects the fact that trade in intermediate goods has grown faster than trade in final products. See, e.g., Hummels, Ishii,. and Yi (2001. Perhaps more significantly, trade in intermediate goods varies widely by country depending on their export specialization. In OECD member countries, for example, trade in intermediates, on average, represents 56.2 percent of trade in goods and 73.2 percent of trade in services (Miroudot, Lanz, and Ragoussis 2009).. The figures for Chinese Taipei are still higher, with trade in intermediate goods and services holding a 65 percent share of imports and a 71 percent share of exports, indicating that roughly two-thirds of its trade was in intermediate goods in 2008 (WTO 2009). 140â&#x20AC;&#x201A; The discussion above raises the question of whether, in the case of agriculture, minerals and other raw materials that make up a major share of Latin American exports, the firms that dominate global value chains involved in the production of those commodities will take care of the required environmental upgrading regardless of location. That would likely prove true only to the extent that the multinational firm in question was fully integrated on a vertical basis. In addition to redrawing geography, globalization has also driven a process of deverticalization. Fewer and fewer firms remain organized on a vertically integrated basis. Even in the case of the vertically-integrated multinational, moreover, its local operations depend on local producers of various inputs, which will be obliged to adopt the carbon accounting standards that the multinational imposes on its local operations. Perhaps most importantly, for a deverticalized firm with any degree of market power, there is a tremendous incentive to shift as much of the cost of compliance toward their suppliers as possible, including in those areas in which Latin American exports have been concentrated in the past. 94â&#x20AC;&#x192; Trade and Climate Change Mitigation Measures

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What it suggests, however, is a very different way of measuring both current market access and the impact of any climate change mitigation measures. Instead of looking at the impact of border measures like carbon tariffs, the challenge is to understand how the various policies adopted in the countries identified in Section II will filter through to the bottom line of producers in Latin America and the Caribbean, and whether or not the producers in the region must wrestle with those costs or pass them on to other producers or to the ultimate consumer. The implications of this dynamic for Latin America and the Caribbean are amplified by its dependence on the export of commodities. To the extent that any measure designed to reduce GHGs favors goods and services with a low weight-to-value ratio (i.e., low weight, high value) in terms of shipping costs and energy inputs, it raises the cost for producers of bulky commodities, including many agricultural products that have relatively higher weight-to-value ratios and are energy-intensive to produce.141 What is more, as a matter of political economy, trade protection in the form of carbon tariffs, or their equivalent in the form of antidumping or countervailing duties imposed for environmental reasons, is more likely to fall on bulk commodities than on higher-value-added goods and services, if history is any guide. To the extent that the region’s production is weighted toward commodities—particularly minerals and agriculture—it will see a bigger impact on costs of virtually any measure.

4. Examining the Effects on Transactional Costs The analysis above explored the implications of globalization for the definition of market access in the analysis of the implications of climate change mitigation measures. It highlighted the distinction between those conventional measures that might impose direct restraints on trade and those measures that may limit access to markets by virtue of their implications for costs. Here, the task turns to identifying what the impact on transaction costs might be. One way of viewing the impact of globalization is through its effect on transaction costs. Having lowered those costs, globalization also makes decisions regarding sourcing more sensitive to increases in those costs. In that sense, the impact follows from the discussion of the price elasticity of demand and the cross-price elasticity of In Moreira, Volpe, and Blyde (2008) the authors highlight the extent to which the region’s exports are more “transport intensive” than those of its competitors in other regions due to the region’s comparative advantage in natural resources that entail higher weight to value ratios than most other goods—“Natural resources are quintessential ‘heavy’ goods; a dollar’s worth of iron ore is many times heavier than a dollar’s worth of semiconductors.”

141

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competing goods mentioned above. Globalization has increased the number of sources globally for a variety of manufactures and services, which implies a change in the price elasticities facing producers in the region and globally, all other things being equal. In practical terms, what globalization means is that any impact that mitigation measures have on transaction costs facing producers in the region are likely to have disproportionate effects on their ability to export to global markets. This is particularly true if the effects on transactional costs are higher for producers in the region than for producers elsewhere, including, most importantly, for producers of competing goods or services in the target market itself. An example helps explain why. To the extent that a carbon tax, fully adjustable at the border, were imposed on all sales of copper tubing in the United States, and that the base in terms of emissions used to calculate the tax included all of the energy consumed in both production and transportation, the effect on the transactional costs facing Chilean and Peruvian copper relative to those borne by domestic production in the United States would sharply favor domestic production. That may also prove to be the case as between Chilean and Peruvian copper and mines in Australia, to the extent that the Australian producers would be more efficient at moving their copper through Australian ports onto waterborne transportation. Similarly, from the perspective of Uruguayan agricultural producers, the relative cost of installing an appropriate carbon accounting methodology and spreading its cost across its production will present a challenge in the face of the producersâ&#x20AC;&#x2122; competition with farms in the United States. US farms enjoy enormously greater economies of scale that allow them to defray the capital cost of implementing an effective carbon accounting methodology across a much broader production run. In broad terms, the potential effects of climate change mitigation measures on transaction costs fall in the following indicative list: Higher Information Barriers: Perhaps the most significant cost that producers in the region are likely to face generally involves the cost of information: information regarding potential export opportunities as well as the commercial standards buyers impose on their suppliers globally. Climate change mitigation measures will add to that burden in the absence of efforts designed to improve the flow of information to Latin American and Caribbean producers regarding carbon accounting standards and the means of satisfying those standards. Greater Uncertainty: As in the adoption of any system of regulation or accounting conventions, the introduction of global carbon standards will introduce 96â&#x20AC;&#x192; Trade and Climate Change Mitigation Measures

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significant uncertainty regarding their application and the means by which the rules might be satisfied. The implications of increasing uncertainty for Latin American and Caribbean producers are significant. The complexity of satisfying government regulators in multiple markets, even assuming climate change negotiations lead to a common set of global carbon accounting standards, increases the potential for conflicts. From the perspective of global buyers, the uncertainty created by those implementation efforts translates into risk, which buyers will avoid either by eliminating those suppliers least capable of contributing to reducing the global firm’s carbon footprint, or by reducing the prices offered potential suppliers to offset the risk associated with buying from suppliers with a marginal capacity to satisfy the buyer’s standards. Rising Compliance Costs: From the perspective of the region’s firms, satisfying sophisticated standards for carbon accounting requires a significant capital investment, both in terms of acquiring the hardware and software to manage compliance, but also the human capital within enterprises that are essential to guarantee consistent implementation of the internal controls that the accounting standards imply. Designing carbon accounting standards and implementation in ways that build on existing norms in international trade would help reduce the cost by allowing the region’s producers to draw on their installed capital to the maximum extent possible, but the new regulatory environment may also call for new technologies and institutions that could reduce these costs. Limited Economies of Scale: Particularly for the small and medium-sized producers in the region, climate change mitigation measures will exacerbate the cost disadvantage that flows from the region’s producers’ lack of current access to global markets and consequent inability to take advantage of economies of scale. Expanded access to global markets would help offset the costs of compliance that developing country producers face, because of the higher return exports command, and because expanding their scale of production lowers the per-unit cost of their compliance efforts. Efforts to expand market access and producers’ capacity to engage in trade should, as a consequence, form an important part of any effort to address the effects of climate change mitigation strategies on the Latin American and Caribbean producers. Access to Capital: By raising producer costs and increasing the uncertainty regarding their ability to tap global markets, climate change mitigation measures will also exacerbate the traditional lack of access to capital that affects many of the region’s Impact on Producers in Latin America and the Caribbean 97

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producers, particularly small and medium-sized firms. Increasing risk will drive up the rate of return that investors will require before investing in or expanding production in the region. Developing the institutional arrangements that would allow Latin American and Caribbean producers to participate actively in global emissions trading, for example, would help offset that effect, either by creating a new stream of income or by allowing them to acquire a financial asset that could be converted to working capital or an alternative form of trade finance. In either event, thinking concretely about the question of access to capital, as part of any overall strategy to secure the full participation of the region’s producers in the global economy and in efforts to address climate change, will prove essential to achieving better economic and environmental outcomes. Thinking of the individual firm’s prospects for gaining or maintaining its foothold in the global market place will prove essential to understanding the impact of climate change mitigation measures on the industries examined below.

B. Implications for Four Industries The industries examined below represent an interesting cross-section of the Latin American and Caribbean regional economy. They range from highly consolidated industries with large, vertically integrated companies that are among the largest in the world to widely dispersed and highly differentiated manufacturers working relatively small market niches, to two very different forms of natural resource production, and the varied economic arena that is agriculture. The four industries also differ markedly in their exposure to climate change and to measures designed to mitigate its effects. That diversity helps underscore a number of the basic themes highlighted in the discussion above. First, and most important, is that the effect of mitigation measures will vary by type of industry and by firm. The effect will vary with the relative energy intensity of the industry, the industry’s structure, and its level of existing engagement in the global economy, particularly in markets adopting climate change policies that create the demand for trade restraints to protect local industry. Second, whether the firms in a particular industry will actually bear the cost of any adjustment to climate change or measures adopted for its mitigation will depend to a great extent on the structure of the industry involved and the elasticities of demand it confronts in the markets for its products. The analysis below illustrates the extent to which understanding the organization of an industry is essential to understanding the challenge it faces in adjusting to a lower carbon regional and global economy. 98 Trade and Climate Change Mitigation Measures

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Third, while many industries remain at risk from the potential implementation of border measures designed to limit carbon leakage or offset the competitive effects of mitigation measures imposed domestically, Latin American and Caribbean industries and firms are currently at greater risk from the uncertainty surrounding the response to climate change, the higher risk that uncertainty creates, and the impact it has on transactional costs in international trade. The region’s industries are also exposed to new requirements and commercial standards imposed by their customers, who are themselves implementing a variety of new business processes and accounting measures in order to assess their own exposure to climate change and its mitigation. Fourth, this variegated picture of regional industry detailed below should ultimately suggest a fundamentally different approach to the challenge that countries in the region face in adjusting to climate change. Staking out broad policy positions in international environmental negotiations will not suffice to ensure that the needs of the region’s industries and firms are considered and addressed. The discussion below further illustrates the need for a coherent regional trade and climate change agenda informed by an understanding of the varied challenges that producers in different industries and different markets will confront. In that sense, the region’s preparation for future discussions of climate change should take the form of a regional approach to a trade negotiation (i.e., ensuring continued market access and pursuing the assistance needed to facilitate adjustment), rather than thinking of climate change discussions solely in terms of the restraints they impose on GHG emissions and the notion of technology transfer at a relatively abstract level, as is currently the case.

1. The Cement Industry in Mexico Cement is a key component in virtually all forms of construction from homes and office buildings to industrial facilities, power plants, ports, and roads. It is also one of the largest industrial consumers of energy and one of the chief industrial emitters of GHGs, accounting for roughly 5 percent of all GHGs emitted globally.142 Given the tension between the ubiquitous use of cement in construction and its significant contribution to GHG emissions, it is no surprise that the industry has come under intense scrutiny by governments and non-governmental organizations and is a likely target of most countries’ climate change mitigation measures. In addition,

142

See, e.g., Worrell et al. (2001). Impact on Producers in Latin America and the Caribbean 99

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cement represents one of the frequent targets of trade actions by importers due to the fierce price competition in various regional markets.143 All of which raises the potential that industries in various export markets might seek to take advantage of mitigation measures imposed by their governments to target imports, including those from Latin America and the Caribbean. The scrutiny focused on cement globally has led the industry preemptively to establish its own initiative on GHG emissions: the World Business Council on Sustainable Development’s Cement Sustainability Initiative (CSI). The CSI’s members include a number of the major players in the Mexican cement industry, including CEMEX, Holcim, and Lafarge (World Business Council on Sustainable Development 2009). In the ten years since its launch in 1999, the CSI has developed industry-specific tools for measuring and reporting CO2 emissions. The private-sector-led initiative has, more recently, sought to identify “effective policy measures that could be adopted at national level” to reduce CO2 emissions in the cement sector, such as revising cement product standards based on performance rather than composition; developing construction codes that emphasize “green” building products that would yield significant reductions in energy usage over the lifetime of a building; orienting public procurement toward greener products; and expanding the use of blending materials, which can lower the energy intensity of cement (World Business Council on Sustainable Development 2009). All of those factors make the cement industry in Mexico a useful test case for the broader challenges policymakers and businesses throughout Latin America and the Caribbean will confront with climate change and its mitigation in the future. The following discussion examines the implications of both the government-imposed and private voluntary mitigation measures on the industry’s prospects. a. Energy and Emissions Intensity As noted above, a company’s or industry’s exposure to the unintended consequences of climate change mitigation measures adopted in a variety of markets flows is the effect its relative energy intensity and its emissions. The manufacture of cement represents one of the leading industrial uses of energy globally, with energy representing 20 to 40 percent of total production costs (Taylor, Tam, and Gielen 2006). 143 Cement exports from Mexico to the United States, for example, have been subject to some form of restraint under the U.S. antidumping laws for over two decades.

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The remaining inputs consist of raw materials – the most common combination consisting of limestone (for calcium) coupled with smaller quantities of clay, shale, and sand, which is used as a source of silica, aluminum, and iron (Bye 1999). Cement makers may also use other alternatives such as mill scale, fly ash, and slag, which consist of waste products produced by other industries (Taylor, Tam, and Gielen 2006). Cement plants generally rely on nearby quarries for limestone to minimize transport costs. The rock is blasted from the quarry’s face and is transported to a primary crusher to break the rock down to sizes capable of being milled together with other inputs. The resulting mix is heated in a kiln, which represents the primary piece of capital equipment employed by the manufacturer (Peray and Waddell 1972). Fuel, consisting of coal, pet coke, natural gas, and/or alternative fuels such as plastic, solvents, waste oil, or meat and bone meal, is fired directly into the kiln where it feeds a flame that can reach as high as 2000°C (Bye 1999). The heat causes chemical and physical changes that transform the feedstock into a material called clinker (Bye 1999). Given the temperatures needed to generate those physical and chemical changes, it is no surprise that the production of cement clinker from limestone and chalk consumes enormous amounts of energy. Most of the energy consumed takes the form of fuel for the production of cement clinker; however, additional amounts of energy in the form of electricity are used in grinding the raw materials and the finished cement. The result is a production process that consumes, on average, between 4 to 5 gigajoules of energy per ton of cement produced (Taylor, Tam, and Gielen 2006). Wholly apart from its relative energy intensity, the production and distribution of cement involves high GHG emissions (so-called “process emissions”). Indeed, the emissions released in the chemical transformation of the raw material into a semi-finished or finished state exceed the emissions from the burning of fuel. The process of calcination refers to the decomposition of CaCO3 to CaO, which releases CO2, accounting for 60 percent of the total emissions from a cement kiln. What that means is that improving energy efficiency alone will not suffice to constrain emissions from the manufacture of cement (Taylor, Tam, and Gielen 2006). All of which suggests that the Mexican cement industry could be uniquely exposed to the adoption of climate change mitigation measures in one form or another (Taylor, Tam, and Gielen 2006). Any increase in the cost of energy or the establishment of a benchmark price for carbon would undoubtedly translate into higher costs to the industry. Whether the industry ultimately bears those costs is another matter. For the reasons discussed below, it seems likely that those costs would be passed on Impact on Producers in Latin America and the Caribbean 101

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to consumers without a significant impact either on the Mexican cement industry’s market access, profitability, or growth. b. Structure of the Mexican Cement Industry and Its Primary Markets The Mexican cement industry is highly concentrated. With an annual capacity of 57 million metric tons, it is dominated by six companies: CEMEX Mexico (Cementos Mexicanos), Holcim-Apasco, GCC Cemento (Grupo Cementos de Chihuahua), Cooperativa La Cruz Azul together with Cementos y Concretos Nacionales, S.A., Corporacion Moctezuma (Cementos Portland Moctezuma), and Lafarge Cementos (International Business Strategies 2009). The consolidation in the Mexican market reflects the consolidation of industry globally.144 The Mexican industry is, as a result, well integrated into the global economy and a leading exporter to or producer in most of the major regional markets around the world. CEMEX, for example, which is Mexico’s largest cement producer (controlling nearly half of the Mexican market), vies with France’s Lafarge for the title of the largest cement producer worldwide (International Business Strategies 2009). At the same time, foreign-owned firms like Holcim, headquartered in Switzerland and also one of the world’s top three cement producers, is a major player in the Mexican market as well (International Business Strategies 2009). While highly consolidated in terms of its ultimate ownership, the actual production of cement in Mexico and elsewhere is highly localized due to the cost of transporting the bulk commodity significant distances. The industry consists of 32 plants disbursed around the country, but they tend to be concentrated by manufacturer in particular locales, creating near-monopolies in sub-regional markets (International Business Strategies 2009).145 As noted above, those plants depend on local limestone quarries for the principal input into their production. In Mexico, many producers control their own quarries, reflecting a vertical integration that allows the major players to keep production costs

144 The past 25 years has witnessed a significant consolidation within the cement industry which is now dominated by six multinational firms—Switzerland’s Holcim, France’s Lafarge, Britain’s Blue Circle, Mexico’s Cemex, Germany’s Heidelberger Zement and France’s Ciments Français, a subsidiary of Italy’s Italcementi. See Economist (1999) (The Swiss firm Holderbank changed its name to Holcim in 2001). The six major firms made inroads in Asia (with the exception of the Chinese market) in the aftermath of the Asian financial crisis when a number of regional firms became takeover targets (Economist 1999). 145 Cemex, for example, has the only plants in Sonora and all of Baja California, giving it particular market power throughout the Mexican Northwest and into the market in the Southwestern United States (International Business Strategies 2009).

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low. Internal supply of raw materials is supplemented by a number of market participants, both large and small. In addition, the recent economic downturn has accelerated a new phenomenon: the sale by Mexican cement companies of their quarries to outside investors in the private equity industry, which has been driven by the need of the companies to gain access to capital in order to fuel continued consolidation on a global basis. Energy needs of the Mexican cement firms are largely met in Mexico by the national oil company, Petróleos Mexicanos (PEMEX) and by regional electrical utilities. From the perspective of who would bear the ultimate cost of any climate change mitigation measures, the structure of the Mexican industry strongly suggests that the cost would be passed on to consumers, rather than being borne by the producers. The demand for cement is a derived demand—one that depends on the demand for downstream products, like housing and other construction projects. While demand for cement may slow along with the demand for housing and other construction, the demand for cement in the applications for which it is used is relatively inelastic. There are no readily available alternatives at a reasonable cost.146 There is some considerable softness in demand currently. The Mexican cement industry has been working at roughly 80 percent capacity in recent months, largely because of the slowdown in U.S. housing and commercial real estate construction (International Business Strategies 2009).147 The decline in U.S. construction has, however, been offset by significant increases in infrastructure investment in both Mexico and the United States. President Calderon’s National Infrastructure Program (NIP), launched in July 2007, includes a number of priority infrastructure projects: dams, power plants, roads, railroads, airports, ports, low-income housing, and commercial real estate development.148 To the extent that demand grows along with increased infrastructure spending in Mexico and in other markets where the Mexican cement companies operate, companies will be able to absorb the marginal effect of any climate change mitigation

146 The long use of cement in construction has led to significant reductions in cost and large economies of scale. As such, it is unlikely to cede its position as the single most-used building material in many countries in the absence of significant increases in costs relative to other materials. While there has been a marked trend over several decades toward steel frame and glass in many office buildings, the base and much of the core of even those buildings is still made with concrete using cement. 147 See also Cement Industry Overview, Portland Cement Association (2009) (indicating that, from 2007 to 2008, U.S. consumption of Portland cement fell by 15.2 percent, reflecting, in large part, the sharp fall in residential housing construction, which was down 18.5 percent in 2007 and 29.9 percent again in 2008). 148 The transportation sector reflects the intensity of the NIP effort. It involves roughly 100 road projects, 13 new piers at national ports, 3 new airports and expansion of 31 existing airports (International Business Strategies 2009)

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measures on their operations and pass the rest on to consumers in the form of higher prices for cement. c. Implications of Climate Change Mitigation Measures for Market Access and Growth While, as discussed above, the Mexican cement industry’s energy and emissions intensity exposes it to significant risk from climate change mitigation measures globally, there are two significant factors that limit that risk. First, the structure of the industry, both in Mexico and globally, diminishes the risk of any competitive disadvantage flowing from such measures. The industry is, as noted, made up of a higher number of plants across all geographic markets to avoid the cost of shipping the bulk commodity significant distances. In practical terms this geographic dispersion means that, with the exception of the U.S. market, the Mexican cement industry participates in foreign markets largely through foreign direct investment in those markets (i.e., ownership of the geographically dispersed plants serving various consumer markets in different countries). Those investments and production facilities will doubtlessly be exposed to local regulation of GHG emissions, whatever form that takes, but are unlikely to be put at a competitive disadvantage unless the regulations are written in a way so as to affirmatively discriminate against foreign investment in the cement industry. The risk from the imposition of carbon tariffs or some other border measures is highest in the United States, the single largest export market for Mexican cement producers. As noted above in Section III, to the extent that the U.S. Congress passes legislation implementing a coherent set of climate change mitigation measures, that legislation is likely to contain border tariffs to offset the feared loss of competitiveness from the mitigation measures. Given the past history of trade actions against Mexican cement imports, a focus on cement in crafting such border measures would not be surprising.149 That said, the continuing consolidation of the industry globally has meant that much of the U.S. production is now held by multinational firms, including CEMEX, with a footprint in both

149 Mexican exports of cement to the United States faced antidumping duties for over two decades until a settlement of the case was reached in 2006. That settlement agreement provided for a three-year transition period under which 3 million tons of cement imports from Mexico would enter the U.S. market subject to tariffs that would decline from $26 per ton to $3 per ton over the life of the agreement. The transition period is now over and Mexican imports are entering the U.S. market relatively free of obstruction for the first time in more than 20 years.

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the U.S. and Mexican markets. There is little incentive for those firms to press for any restraints that would penalize their own Mexican operations. Second, any effort to discriminate against imports from Mexico would have to confront the fact that the Mexican cement industry is already one of the world leaders in improving its energy efficiency and reducing its GHG emissions. Within Mexico, the cement industry is the only industrial sector in which all production facilities have been certified by Mexican authorities as meeting “Clean Industry” standards. The leading Mexican companies have adopted a similar approach in the foreign markets in which they operate. In the United Kingdom, for example, CEMEX’s local operation was the first cement company in the world to be certified by the U.K. Carbon Trust to use the Trust’s carbon reduction label. As noted in the discussion of the Carbon Trust in Section II, the label assesses the CO2 generated by CEMEX cements produced in the United Kingdom from “cradle to grave”—from the extraction of the raw materials to manufacturing and distribution through its use by customers and its eventual disposal—under the British PAS2050, one of the first international standards for measuring the carbon footprint of goods and services. More recently, the U.S. EPA named CEMEX’s U.S. affiliate a 2010 Energy Star Partner of the Year for the second year running (Pit & Quarry 2010). CEMEX received the award for its energy management and GHG emissions reductions: CEMEX’s U.S. affiliate reduced its energy intensity by 2.2 percent in 2009 by implementing the company’s new Energy Management Program, which applies the EPA’s Energy Star guidelines (Pit & Quarry 2010). It is not yet clear that Mexican cement will satisfy all standards being adopted in the various downstream markets that Mexican producers serve, but that is largely a function of the relatively recent adoption of those standards, rather than the production methods used by Mexican producers. 150 Unless the standards are set in a blatantly discriminatory manner designed to penalize imports of cement no matter how they are produced, the investments that the Mexican industry has made and the leadership it has shown, both in its Mexican production facilities and those it owns abroad, are

150 Thus, for example, the United States Green Building Council (USGBC) has developed a rating system to evaluate the environmental performance of buildings known as the Leadership in Energy and Environmental Design (LEED) standards. See generally United States Green Business Council, http:// www.usgbc.org/DisplayPage.aspx?CMSPageID=1988. The LEED standard applies a point-based system that credits builders for applying cleaner building materials and methods. Ibid. Using cement can, in certain instances, help contribute to a builder achieving a LEED certification. Ibid. Although it is not yet clear that Mexican cement imports or cement made in Mexican-owned facilities in the United States will qualify, the odds are that they will based on the investments that companies like Cemex have made in adopting new technologies designed to lower energy usages and cut emissions.

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likely to limit the impact of any mitigation measures eventually implemented because the cement produced in those facilities is likely to satisfy any non-discriminatory standard. Cement produced in the Mexican plants should be able, therefore, to compete on an even basis with their competitors in selected export markets like the United States. d.â&#x20AC;&#x201A; Effects on Transaction Costs As was discussed above, the impact of climate change mitigation measures on a firm is not simply a function of their impact on market access as conventionally defined. They may also affect the transaction costs facing the firm as it tries to open new markets or maintain current sales to world markets. This holds true in the case of cement as well, although not to the same extent as in the case of the other industries discussed below. Again, it relates to the structure of the industry and the relatively forward-looking strategy that the Mexican industry has adopted toward its adjustment to climate change and a carbon-constrained global economy. Thus, for example, while there may be some increase in information barriers regarding particular markets or particular opportunities due to changing commercial standards or local building codes, the commodity nature of the product and the wellorganized mechanisms for distribution are unlikely to be significantly affected. As for the adoption of particular carbon accounting standards that might conflict with the Mexican industryâ&#x20AC;&#x2122;s own current business practices or carbon accounting standards, the industry has largely preempted that concern by aggressively developing standards that have largely defined the core elements of any such accounting mechanism adopted in particular markets. Where local standards or carbon accounting methods may differ in some marginal respect, the difference is not likely to put the Mexican industry at any particular competitive disadvantage, given its current ability to satisfy the international standards adopted to date, such as the PAS2050 standard applied by the Carbon Trust in certifying the use of its label. There is little doubt that the Mexican cement industry will confront greater uncertainty as to the potential for regulation of GHGs in every market in which it operates. It is, nonetheless, equally true that the Mexican industry is as well or better prepared for that eventuality than any of its competitors. The USGBC LEED standard mentioned above offers a case in point. It is not entirely clear at this stage exactly how the standard will apply, all of which raises at least some risk for cement producers generally. But the structure of the LEED standard offers more of an opportunity than a threat because of the way in which it allows builders credits for using cement. Moreover, it is clear that the makeup of the Mexican industry, where two of 106â&#x20AC;&#x192; Trade and Climate Change Mitigation Measures

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the world’s largest cement manufacturers control roughly 60–70 percent of the entire local market and a substantial share of any market in which they operate, leaves Mexican producers in at least as advantageous position as any of its competitors in absorbing or reducing the uncertainty surrounding the application of such standards. Any climate change mitigation measures will confront the Mexican cement industry with rising compliance costs. Those costs are unlikely to have a significant impact on the industry for two reasons. The first is that the industry has already absorbed much of the cost of compliance by investing in manufacturing technologies that reduce energy consumption and by participating in voluntary efforts such as the WBCSD’s Cement Sustainability Initiative. The actual out-of-pocket financial cost to set up the institutional structure to comply, as well as the cost of building the human capital needed to manage the enterprise under such new constraints, has already been absorbed to a great extent. The second reason rising compliance costs are likely to have little effect is that they are, for the reasons discussed above with respect to the structure of the industry, likely to be passed on to consumers. Indeed, many of those costs already have been passed on to consumers as a result of the investments that the Mexican industry has already made to ensure that their efforts to inform the eventual regulatory environment would limit the distance they have left to close. Potential limits on economies of scale do not present a significant challenge for the Mexican cement industry either. First, the size of Mexican firms’ current operations, both at home and abroad, are such that they have achieved significant economies of scale where they can be generated in a business that must be structured around local production facilities in most instances. Second, the structure of the industry imposes inherent limits on the economies of scale that can be generated by any particular facility due to the geographic constraint imposed by the weight-tovalue ratio of the commodity the industry produces and transports. The imposition of additional costs of compliance does not alter that equation from the perspective of Mexican producers or of their competitors in various markets. The only issue is who will bear the costs of compliance in light of the constraints imposed by those limits that exist for separate reasons. Finally, the imposition of any climate change mitigation measures in downstream markets is unlikely to have an effect on the Mexican cement industry’s access to capital. The industry has proven quite capable of tapping the global capital markets when needed to make the acquisitions that have made it one of the survivors in a global consolidation of the industry. Because any new mitigation measures are unlikely to raise compliance costs substantially, they are unlikely to affect the industry’s profitability Impact on Producers in Latin America and the Caribbean 107

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and are unlikely to affect its access to capital as a result. To the extent they did raise compliance costs, those costs would likely be passed on to consumers in any event.

2. Plastics in Colombia The plastics industry in Colombia offers a sharp contrast to the Mexican cement industry. Rather than a highly consolidated and vertically integrated industry that manufactures one major product, the plastics industry involves a wide array of product niches and significant numbers of small and medium-sized companies, as well as large players in the national market. The term “plastic” refers to a number of different synthetic or man-made polymers (i.e., organic compounds similar in many ways to natural resins found in trees and other plants, but produced by polymerization) that are “capable of being molded, extruded, cast into various shapes and films, or drawn into filaments and then used as textile fibers.”151 Plastics are generally made by combining small molecules called monomers, that represent the building blocks of carbon, to create polymers—substances with the special properties and characteristics, particularly the durability and malleability that consumers associate with plastic. The monomers are usually derived from petroleum or natural gas (American Chemistry Council 2010). Polymers are generally made at very high pressures and high temperatures. Each type of plastic has an associated manufacturing technique that is driven by the product’s specific chemistry. All, however, consume significant amounts of energy and release substantial amounts of GHGs due to the temperatures involved and the reliance on fossil fuels as feedstock’s. a. Energy and Emissions Intensity Given the nature of the products involved, virtually all of which involve forming polymers from the basic building blocks of carbon at high temperatures, the industry is a

American Chemistry Council (2010). Common examples of plastics include polyethylene (wide range of uses), polypropylene (used in food containers and appliances), polystyrene (used as packaging foam and in food containers, disposable cups, plates and cutlery) polyethylene terephthalate (used in beverage containers), nylon (used in fibers, toothbrush bristles, fishing line), polyester (used in fibers and textiles), polyvinyl chloride (used in plumbing pipes and flooring), polycarbonate (used in compact discs and eyeglasses), acrylonitrile butadiene styrene (used in electronic equipment cases, such as computer monitors, printers, keyboards, et.), polyvinylidene chloride (used in food packaging), teflon (used in heat resistant applications and low-friction coatings), polyurethane (used as insulation and upholstery foam), and bakelite (a ceramic material, but one using a phenol formaldehyde resin as binder; used for insulating parts in electrical fixtures).

151

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significant consumer of energy and emitter of GHGs. According to the Colombian industry’s trade association, Acoplástico, the industry accounts for 10.8 percent of all electricity used by Colombian manufacturers (Acoplásticos 2010). As in the process of manufacturing cement, the emissions from making plastics are due both to the fuel burned as part of the manufacturing process and to the chemical processes involved in bonding various monomers to create the polymers and resins that make up the substance of the finished products. Unlike cement, however, plastics benefit from the fact that their use in a variety of applications may help conserve energy and reduce emissions when measured on a total life cycle cost basis. Because plastics often present a lightweight, durable alternative to other materials that require more energy to convert and shape, the broader use of plastics to reduce energy and emissions can provide new market opportunities for Colombian producers as those market niches grow in response to the imposition of stricter constraints on GHG emissions. According to the Society of the Plastics Industry, a U.S. plastics industry trade association, for example, the lighter weight of plastic parts saves 650 gallons of gas over the lifetime of the average car (Society of the Plastics Industry [SPI] 2010;.152 Plastics used as insulation in major electric appliances reduce their energy consumption by 53 billion kilowatt hours of electricity annually, a 30 percent reduction (SPI 2010).153 The use of plastics in packaging cuts energy use in half (e.g., plastic bags require about one-third less energy to make than paper bags; foam polystyrene containers take 30 percent less total energy to make than paperboard containers, etc.). The lighter weight that plastics offer can also save considerably on the amount of energy used in transportation (e.g., reducing the weight of both trucks and payloads lowers the total energy consumed in delivering products to consumer markets) (SPI 2010). Textiles present a relevant example of how these savings come about. While significant, the CO2 emissions associated with producing textiles from nylon and polyester are not substantially greater than those associated with producing cotton textiles (International Council of Chemical Associations 2009). The primary source of the emissions abatement associated with synthetic textiles, however, stems from the longer lifetime of the synthetic material relative to its cotton counterpart, which creates a lower total life cycle cost for the product in terms of carbon emissions (International Council of Chemical Associations 2009). 152 153

See also Pilz, Schweighofer, and Kletzer (2005) See also Pilz, Schweighofer, and Kletzer (2005) Impact on Producers in Latin America and the Caribbean 109

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Plumbing offers another example, but with contrasting reasons for the energy savings generated by using plastics. Unlike textiles, the average life of plastic pipes is similar to that of competing product, but the emissions savings flow from lower raw material use combined with differences in production and disposal (International Council of Chemical Associations 2009). There is, moreover, a new movement toward creating plastics from renewable sources of energy and feedstock—a change that could favor Colombian producers of plastics and agricultural producers throughout the region. The processes include the development of plastics from sugarcane fermentation, microbial processes using sugar wastes, chemical modification of corn and other starches, and the trans-testerification of oil seeds (Coleman-Kammula 2008). The Colombian industry will certainly face challenges in adjusting to a carbonconstrained regional and global economy, given that carbon forms the basic building blocks of the industry’s products. At the same time, however, the industry may well find new opportunities, given the relative benefit of using carbon in this fashion when compared to products made with other materials in a wide variety of applications. b. Industry Structure Plastics represent a growing sector of Colombian manufacturing. Sales of equipment, materials, and resins grew by 14.2 percent in 2008, totaling US$2.2 billion (International Business Strategies 2009b). The industry is significant to Colombia in economic terms, accounting for roughly 1 percent of Colombian GDP. Some share of the industry’s growth reflects Colombia’s own economic performance (International Business Strategies 2009b; U.S. Central Intelligence Agency 2010). The industry in Colombia is divided into two basic sectors: one providing the resins and equipment for making plastics, and the other engaged in the business of forming plastics products for industrial and consumer use. Both sectors depend heavily on a derived demand for the downstream products into which plastics are incorporated. In terms of structure, plastics manufacturers tend to locate near production and processing plants that manufacture the downstream products. Equipment used in the manufacture of plastics is not made in Colombia. All of the equipment is imported, with the bulk of that capital equipment coming from the United States (International Business Strategies 2009b). In the case of resins, however, domestic production of resins accounts for 92 percent of consumption by the Colombian plastics industry. Local producers of resins produce inputs for a wide array of materials, including low-density polyethylene, linear low-, medium-, and high-density polyethylene, 110 Trade and Climate Change Mitigation Measures

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certain polymers used in the production of propylene, suspensions and emulsions for polyvinylchloride, high-impact polystyrenes, and polyethylene terephthalate resins for films and sheets (International Business Strategies 2009b). Colombia’s local production of various plastic resins is largely designed to serve local demand. The structure of the upstream industries varies, depending on the resins made. In the case of conventional polyethylene, for example, the local industry consists of one plant with a capacity of 56,000 tons per year that satisfies roughly 50 percent of local demand, the balance met by imports. Colombian production of resins such as polyvinyl chloride, polystyrenes, and polyethylene terephthalate resins satisfies most of the local market demand (International Business Strategies 2009b). Colombian producers export resins to a number of markets, mainly in South and Central America, with exports rising gradually from US$442.2 million in 2005 to a peak of US$530.1 million in 2007 (International Business Strategies 2009b).154 Polymer propylene and vinyl polychlorides make up the bulk of Colombia’s resin exports (US$272.5 million and US$212 million in 2007, respectively) (International Business Strategies 2009b). The upstream end of the industry is made up of a high number of small and medium-sized operations. Acoplástico suggests that the total number of facilities producing substances and chemicals related to the production of plastics totaled 642 in 2005 (Acoplásticos 2010). In terms of downstream consumers, the packaging industry makes up the bulk of demand in Colombia. It is the largest end user of both plastics machinery and resins. It is also made up of a large number of small and medium-sized producers, although larger retailers play a central role at the demand end of the industry locally as they do elsewhere in the world (Acoplásticos 2010). c. Implications of Climate Change Mitigation Measures for Market Access and Growth The likely impact of climate change mitigation measures on the Colombian plastics industry will largely flow through the impact of such measures on the price of energy and carbon. Any impact on price, however, will depend on emissions markets gaining sufficient depth and turnover to establish an effective global price for carbon that drives companies globally to account for their emissions as part of their normal calculation of financial performance. Between the EU ETS and voluntary markets

154

Ibid. See also, Acoplasticos at http://190.146.237.111/eng/acciones/tabla_5_resinas_plasticas.pdf. Impact on Producers in Latin America and the Caribbean 111

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elsewhere, such as the Chicago Climate Exchange, the size of carbon trading markets is growing, but they are not yet of sufficient size to drive the reaction of firms globally. In the short run, their impact on the price of fossil fuels is likely to be swamped by other factors affecting energy prices. From a market access perspective, the Colombian industry faces less risk simply because its principal export markets lie within the region, where the imposition of significant constraints on carbon is not in the offing. The one export market of significance to the industry that could be affected is that of the United States, where carbon tariffs may become an issue if any climate change legislation passes, but that seems unlikely in the near term. Imports of Colombian resins would, of course, be subject to the normal environmental regulations in every export market in which they compete and, there, the risk of U.S. action is more significant in the near term, given the recent proposals by the U.S. EPA to regulate GHG emissions directly under the Clean Air Act. But, the risk there would flow from the adoption of standards that affirmatively discriminated against Colombian or foreign exports—an approach that the EPA is unlikely to adopt on its own motion. Beyond those two obvious potential effects, there lies the potential for the flowthrough of carbon accounting standards and other requirements applied by the downstream manufacturers and retailers of products that rely on plastic packaging. It is not at all clear that the Colombian industry or the individual producers are adequately prepared for those eventualities. Like the situation with Mexican cement producers, the Colombian industry has introduced a set of industry standards and an industry-wide program, called “Responsible Care,” for environmental improvements. The program involves a series of management codes and self-assessment procedures developed and implemented in coordination with the Asociación Nacional de Empresarios de Colombia (ANDI) and the Consejo Colombiano de Seguridad (CCS) (Acoplásticos 2005).155 The Responsible Care program does address climate change and GHG emissions, although not with the specificity of the Cement Sustainability Initiative or the individual actions on GHG emissions by individual companies like CEMEX. Nonetheless, it does provide a platform on which the industry could continue to build to ensure that its products were capable of satisfying any standards eventually adopted in the U.S. market or otherwise. 155 ANDI is the leading business association in Colombia. CCS is a non-governmental entity dedicated to providing education and training to industry on health, safety, and environmental issues.

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What the Responsible Care program does not do is embrace the idea of accounting for GHG emissions in a way that would hold the Colombian industry harmless in the event that such standards become the norm and flow upstream to the industry from downstream buyers. Nor does the program yet offer anything in the way of carbon accounting that, conversely, the Colombian industry might use as a selling point to expand its market share where helpful. In short, while the program moves the industry in the right direction, it is not geared in ways that would improve the prospects for greater access to world markets for Colombia’s plastics industry. d. Effects on Transaction Costs The overall impact of higher transaction costs is likely to prove limited in the case of Colombian plastics largely because of the nature of the industry’s trade and the structure of the industry. Information costs offer a salient example. The resins that the Colombian manufacturers produce are sold in large lots to existing customers in the Andean region and the Central American isthmus. Those markets are unlikely to impose climate change mitigation measures in the near term and the Colombian producers’ costs in securing additional sales are not likely to rise for that reason. The one export market of any significance that could impose such measures, the United States, seems unlikely to do so soon. Creating a stronger export market in the United States does present challenges to the Colombian producers in terms of information costs, given the multiplicity of firms and subsectors in the U.S. plastics industry. But the adoption of climate change mitigation measures in the United States is unlikely to add significantly to those costs in the short run. The Colombian industry does face the same sort of uncertainty about the future of U.S. environmental regulation that the Mexican cement industry faces, although the impact on the industry’s fortunes is far smaller because the Colombian industry is far less dependent on the U.S. market for its future growth than are Mexican cement producers. Nonetheless, if the Colombian producers see the United States as a market for growth, the uncertainty of the regulatory situation will undoubtedly raise the risks associated with both their current sales and their growth strategy. The far more significant uncertainty for Colombian producers, however, stems from the standards that may be imposed by downstream end-users, distributors, and retailers for the plastic products made with Colombian inputs. Given that most of Colombia’s resins are destined for packaging, the question is whether its customers in its principal export markets in the region begin to demand stricter standards and an Impact on Producers in Latin America and the Caribbean 113

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accurate accounting of the carbon consumed and GHGs emitted by Colombian producers because that information is necessary for the customer to maintain its access to global markets. As noted above, the Responsible Care program implemented by the Colombian industry certainly helps to align the industry’s interest with those of a cleaner Colombian environment, but does not adequately equip the industry to meet the challenges that may flow through to it from its customers. The Colombian industry will not face increased compliance costs in the near term, with the possible exception of proposed EPA regulations in the United States. Neither Colombia nor the governments in the industry’s principal export markets have proposed climate change mitigation measures that would require any substantial added investment in compliance beyond that already required by law or the industry’s own Responsible Care program. At this stage, it remains too early to tell whether the EPA’s proposed rules will fundamentally alter the means by which exporters like the Colombian resin producers will have to comply with U.S. law and therefore raise the cost of compliance above that which Colombian exporters already bear. The weight-to-value ratio of most bulk commodities often limits the ability of producers to achieve significant economies of scale through international trade. The pattern of Colombian exports to surrounding markets in the Andean region and in Central America reflects that pattern of trade. That said, given Colombian producers’ access to reasonably efficient port facilities and the lower cost of water-borne transportation, the Colombian industry could increase their economies of scale through exports to a wider range of export markets, particularly in the United States. In the context of climate change mitigation measures, however, the real issue is whether the Colombian industry has the economies of scale to absorb any increase in transaction costs and defray them across a broader number of sales. In this instance, the industry is unlikely to face significant increases in costs in its principal markets for the reasons highlighted above, but the large number of producers and their relatively small scale would undoubtedly limit their ability to defray increased costs where they arise. The size and scale of many Colombian operations also work against obtaining access to capital to address such costs where they arise. From a financial perspective, any substantial increase in risk in the principal markets served by the Colombian industry would further diminish the industry’s ability to tap capital markets for investments in new equipment or business processes required for compliance with new regulations or commercial standards. That, however, does not appear to be a significant risk in the short term, given the markets the Colombian industry serves. 114 Trade and Climate Change Mitigation Measures

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3. Agriculture and Forestry in Uruguay Without a doubt, the Latin American and Caribbean industry most likely to face significant direct effects from global warming is agriculture.156 Forestry follows closely, in terms of the likely exposure to climate change and to measures intended to mitigate its effects (de la Torre, Fajnzylber, and Nash 2009). The two sectors’ exposure runs along two different vectors. One is attributable to geography and climate; the other to the nature of the industries. In general terms, the more vulnerable any agricultural sector is currently to shifts in climate and rainfall, the more vulnerable it will be under any conceivable future scenario as a result of global warming (Baethgen 1997). Equally, producers that are vulnerable to rapid shifts in the underlying economics of farming or forestry through “large changes in input/ output price ratios, changes in subsidy-related policies, modifications in rural credit policies,” and other similar economic trends will necessarily be more exposed to any climatic conditions that increase the variability of yields or demand more significant capital investment (Baethgen 1997). According to the International Food Policy Research Institute’s crop modeling, climate change will have a negative effect on crop yields in Latin America and the Caribbean generally. By 2050, the “region will face average yield declines of up to 6.4 percent for rice, 3 percent for maize, 3 percent for soybeans, and up to 6 percent for wheat”. Unsurprisingly, it is the marginal or subsistence operation that is more likely at risk as a result (International Food Policy Research Institute 1994). A more carbon-constrained global economy can, on the other hand, also create significant new opportunities for Uruguayan producers as the discussion below reflects. At a minimum, agricultural exporters like Uruguay are likely to find increased demand for cereals and proteins as a result of the first-order effects of climate on agricultural yields globally.157 Significantly, the sharpest increase in demand will likely occur in other developing countries, raising a question as to whether, in the absence of greater food-related financial assistance, that demand can be actuated (Rozenzsweig and Parry 1994).158

One particularly salient example in the case of Uruguay, given the broad flood plain created by the Rio Plata and its tributaries involves the potential damage from flooding due to increased rainfall. According to the World Bank, between 47 and 100 percent of the high flood-risk areas of Argentina, Peru, and Uruguay are expected to become even more exposed to intense rainfall as a result of changes in climate as temperatures rise (de la Torre, Fajnzylber, and Nash 2009). 157 See, e.g., Rosenzsweig and Parry (1994). 158 Ibid. 156

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Beyond the potential increases in exports due to the effects of climate change on agriculture globally lies the potential for investments in agriculture to contribute to mitigation and, potentially, yield a new source of revenue for both farmers and foresters in Uruguay. According to the World Bank, more than two-thirds of the worldwide opportunities for emissions abatement through investments in agriculture and forestry reside in developing countries (de la Torre, Fajnzylber, and Nash 2009). Indeed, countries like Uruguay may prove to yield the highest effective rates of return on such investments. Climate change and its mitigation can create similar opportunities in forestry. According to the IPCC (2007, Chapter 5), climate change may result in increased global timber production as a result of higher temperatures generating higher growth rates, and through changes in the location of forests, “especially when positive effects of elevated CO2 concentration are taken into consideration.” Improved forestry, which avoids deforestation and forest degradation, can reduce emissions, and can, moreover, increase the opportunity to create other streams of income from emissions trading, as well as lead to improved yields in core forestry operations. Sound forestry yields additional environmental benefits through improved hydrological flow (i.e., less flooding and less drought, which reduces the consequent economic and environmental damage), reduced erosion, and increased biodiversity. Uruguay, in particular, has important opportunities for reforestation and afforestation that could create substantial reductions in emissions through the expansion of existing carbon sinks or the creation of new ones (IPCC 2007, Chapter 5). Such efforts, in both agriculture and forestry, invariably create opportunity costs in the form of the income forgone from planting that marginal row of crops or harvesting the marginal fiber from the existing forest. As such they depend heavily on the establishment of a market price for carbon that would allow farmers and foresters to see a return from conservation that would otherwise satisfy the internal rates of return they would expect from other investments. In that sense, from the perspective of Uruguay’s farmers and foresters, the best-case scenario in terms of climate change mitigation is a global response that does yield an effective global price for emissions. The worst case, from the perspective of both farmers and foresters, is the implementation of a variety of potentially conflicting national measures that lead to pressure for border measures or subsidies for the benefit of developed country producers without establishing a global price for emissions that would offer Uruguayan producers an offsetting means of covering their costs of adaptation and contributing to the overall effort to respond to climate change. 116 Trade and Climate Change Mitigation Measures

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Plainly, much depends on the domestic policies adopted by Uruguay, but Uruguayan producers and their government can also improve the prospects for the sector through participation in global, regional, and bilateral processes focused on both climate and trade to effect the best-case scenario that serves their economic interests, while also contributing to the environmental goals outlined above. a. Energy and Emissions Intensity The following discussion examines the energy and emissions intensity of both agriculture and forestry in Uruguay. It also highlights the extent to which both industries can contribute to reducing their emissions and cutting emissions globally. Farming creates GHG emissions both as a result of farming activity and from converting land to agricultural use. Farming activity creates emissions through the use of machines such as tractors and combines for sowing and harvesting, as well as by the application of products derived from fossil fuels, such as fertilizers (International Council of Chemical Associations 2009). Estimates by the Intergovernmental Panel on Climate Change (IPCC) suggest that, globally, farming accounts for roughly 20 percent of all carbon dioxide emissions, as well as 50 percent of total methane emissions and 70 percent of all emissions of nitrous oxide (IPCC 1996, Vol. 2). The challenge that agriculture presents in Uruguay is particularly acute due to the importance of the sector, but also to its profile. The Uruguayan industry’s heavy dependence on livestock production, one of the main emitters of GHGs within farming, means that it is certain to be a potential target for mitigation measures adopted elsewhere (Hareau 2002). Agriculture, like the plastics industry discussed above, represents a case where more efficient use of products derived from fossil fuels can, on the other hand, actually drive emissions savings. In this instance, the savings come from the increased use of agrochemicals, including fertilizer, to protect crops and improve yields, thereby increasing the farmer’s return in terms of both investment and emissions (IPCC 1996, Vol. 2).159 Increasing yields also pays dividends by reducing land-use changes that contribute to global warming. Forestry is unlike much of agriculture in that it is driven by the derived demand for products that can be manufactured from wood fiber. What that means for

159 While the production and uses of agrochemicals are themselves a source of GHG emissions, in this instance the use of such chemicals significantly raises productivity, thereby reducing the emissions per unit of output.

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understanding the energy and emissions intensity of the forest sector is that it requires an analysis at two levels. The first of those levels really involves a question of land use—the balance between harvesting trees (e.g., for processing or to clear the land for farming or other uses) versus leaving the trees standing, which retains the forest as a carbon sink. The second level involves thinking about the eventual uses of the fiber and what that implies for the profile of the forest and/or any effort at reforestation. The fiber found in forests is generally put to one of three uses. One is timber for use in construction and other industrial uses, which by some estimates accounts for roughly 70 percent of all wood fiber harvested in a given year (Winjum, Brown, and Schlamadinger 1998). A second use of the fiber is for pulping and paper production, with paper mills consuming just under 30 percent of all harvested wood fiber. The third is energy, where most of the wood used is not harvested, but gathered as roundwood from the forest floor, either in its natural state or as waste left over from timber operations, for use in creating charcoal or biomass (Winjum, Brown, and Schlamadinger 1998). The three sectors vary considerably in terms of their energy use and emissions. The following chart, which illustrates the exposure of a number of U.S. industries to climate costs based on their energy intensity and import competition, helps illustrate the point. The production of paper consumes significantly higher levels of energy and emits far greater CO2 emissions than does the wood products industry.

Imports as a share of composition, 2006 (percent)

FIGURE IV-1 U.S. Industry Exposure to Climate Costs Based on Energy Intensity and Imports as a Share of Consumption 80

Apparel

70 60

Electronics

Machinery Transportation

40 30

Furniture Fabricated metals

20 10

Printing

0 0

Nonferrous metals

Plastics Food and beverage 2

Ferrous metals

Textiles Wood products Chemicals

Paper

Refining

Nonmetallic mineral metals 4

US energy costs as a share of shipment value, 2002 (percent) Source: US Department of Commerce, Bureau of Economic Analysis, Industry Economic Accounts, 2007; US Department of Energy, Energy Information Administration, Manufacturing Energy Consumption Survey 2002. Note: The Size of the bubbles indicates the total CO2 emissions from the industry in 2002. 118 Trade and Climate Change Mitigation Measures

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Canadian figures for emission by industry help illustrate the same point. The figures for Canadian pulp mills show annual emissions roughly on par with those of the cement industry, whereas emissions for the “wood products industries,” which include forest operations and sawmilling, accounted for less than a third of that amount in GHG emissions (Natural Resources Canada 2008). The Uruguayan forest sector’s potential exposure to climate change mitigation measures imposed in various export markets depends, therefore, not only on land use choices, but on the principal uses of the furnish harvested from Uruguayan forests. It will also depend on the extent to which those forests can, either from the collection of roundwood or slash left over from forest operations, find a market for biomass as an alternative source of energy. b. Industry Structure The farm sector is important to Uruguay. It accounts for 11 percent of the country’s GDP and more than 40 percent of its exports. The following chart reflects the predominance of livestock in terms of land use in Uruguay. Other crops make up only 4 percent of the land employed in farming. Forestry (natural forests and forest plantations, taken together) accounts for 5 percent of the land use in the agriculture. Most of the forestry operations take place on the plantations, which suggests that the relevant share of farmland used for the regular production of forest products is closer to the 2 percent figure identified below. Uruguay’s agriculture sector includes roughly 55,000 farmers largely engaged in livestock production for meat, wool, and dairy. As the chart reflects, livestock operations occupy nearly 80 FIGURE IV-2 Land Use Distribution in Uruguay 2002 percent of the total agricultural land, which is devoted to natural grassland Livestock 78% grazing. Crop production on the reOther uses 13% maining land yields rice, winter wheat, barley, sunflower, corn, and minor Plantation 2% amounts of crops such as potatoes. Like farmers everywhere, Natural forest 3% Uruguay’s producers also confront a Agriculture highly consolidated set of upstream 4% industries that provide inputs such as Source: World Forest Institute. seeds and fertilizer to farmers. They

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also face a significant degree of consolidation among processors and the middlemen that provide the link between farm and table throughout the food supply chain. What this suggests is that Uruguay’s farmers are unlikely to be able to shift the costs of adjustment or adaptation to any climate change mitigation measures either to suppliers or downstream to customers. Uruguayan forestry began as an adjunct to farming operations rather than the sort of freestanding industry that exists in major forest products producing countries like Canada. Forestry has grown in importance largely as areas previously devoted to livestock production have been reclaimed as forestland or have been newly forested. In that sense, forestry development in Uruguay is still relatively new. Plantings at the initial stages of the industry’s development (dating from 1994) mostly involved eucalyptus, the bulk of which has been managed for pulpwood production (McKinnie 2010). More recently, effective forest management techniques have focused on improving wood quality and tree size in order to expand the production of solid wood products (McKinnie 2010). Investment in these new plantations is largely foreign owned, with companies like Shell Oil developing sizeable projects.160 The bulk of Uruguay’s forestry harvest is, as noted, dedicated to low-value hardwoods that are destined for local pulp mills, rather than to lumber or other solid wood products for the Uruguayan and international market (World Forest FIGURE IV-3 Uruguay Annual Wood Institute 2010). As the chart below Production 2000–2010 reflects, softwood pines, which are grown for use in structural lumber and 10 many building applications, represent 8 a growing share of the total harvest, 6 but eucalyptus still predominates and 4 will do so for the foreseeable future. 2 In other words, the Uruguayan forest 0 sector is almost exclusively dedicated 2000 2004 2008 2010 to providing furnish for the pulp and Pine Eucalyptus Total paper industry. Million cubic m

Source: World Forest Institute.

In addition to Shell, a number of other international corporations have invested in land for forestry development in Uruguay, including Weyerhaeuser Corporation (USA); Emce (Spain); Kymmene (Finland); Fletcher Challenger (Chile & USA); and West Fraser (Canada) (World Forest Institute 2002).; see also Montero Lafourcade (2010). 160

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The following chart helps illus- FIGURE IV-4 Uruguay Forest Products Consumption 1999 trate where Uruguay’s forest sector once stood relative to its current proPulp and paper file. As recently as 1999, most of the 7% Posts and wood was harvested from natural forColumns Lumber 2% 18% ests for fuel. Export 14% Today, by contrast, Uruguay exports significant quantities of pulp and paper, generally consisting of highFuel quality products in small lots des59% tined for regional markets such as Argentina (World Forest Institute Source: World Forest Institute. 2010). Lumber is increasingly exported to markets in the United States, Japan, and England, although the total volume is low. Some quantities of eucalyptus logs and lumber are exported, primarily to Italy, for use in the manufacture of pallets (World Forest Institute). c. Implications of Climate Change Mitigation Measures for Market Access and Growth The economic implications of climate change mitigation for agriculture and forestry are unlike those of any of the other industries surveyed here, in that agriculture and forestry offer a far greater upside potential to producers in a carbon-constrained global economy. That positive balance, however, depends almost entirely on the establishment of an effective price for carbon and the existence of efficient markets for emissions trading that would allow the two industries to take advantage of the natural advantages they offer in the way of creating value in that setting. The extensive literature on the impact of climate change mitigation on agriculture suggests that the sector can operate without as great a dislocation as has often been feared (McCarl, Adams, and Hurd 2001). Still, these studies underscore the extent to which the ability of the sector to adjust depends on the “inclusiveness” of the global response, particularly with respect to the “international scope of emissions trading (McCarl, Adams, and Hurd 2001).” The reason for that result is that the ability of farmers to employ a variety of methods that would facilitate their own adaptation to climate change depends heavily Impact on Producers in Latin America and the Caribbean 121

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on the ability of the global regime to establish an effective price for carbon. Thus, for example, while a number of studies find that “agricultural emission reductions and offsets can be cost-effective strategies for GHG emissions offsets at relatively lower carbon prices,” that conclusion depends entirely on an effective market price for carbon, which requires a market for emissions trading of sufficient depth to establish that price (McCarl, Adams, and Hurd 2001).161 For emission reductions and sequestration options to pay off for farmers, moreover, they must be competitive with food production (McCarl, Adams, and Hurd 2001). Existing markets and distribution channels for the production of Uruguayan farms are well established (i.e., Uruguayan producers can trust the benchmarks those markets create for purposes of their capital investment, land use, and cropping decisions). That is not currently the case with markets for emissions trading, based on the European Union’s experience under the ETS; substantial questions remain following the December 2009 Copenhagen Conference of Parties on whether the market for emissions trading will ever achieve the scope that would be required for farmers (or producers in other industries) to make investment decisions based on the prices those markets set. That said, the evidence does suggest that farmers can achieve improved results from carbon sequestration at relatively low costs and low prices for carbon emissions. That has led a variety of studies to conclude that there is real potential from agricultural soil carbon sequestration at low cost to the farmer and a competitive return relative to farm output (McCarl, Adams, and Hurd 2001). The same holds true for forestry, where the nature of forest soils and standing timber afford timberland owners a natural advantage in carbon markets (McCarl, Adams, and Hurd 2001). Thus, for example, in light of the economic rents involved, forest owners can use the considerable leeway that offers to determine the optimal time for logging. They could do so when the interplay between demand in downstream markets and the price of carbon provide a maximum return to the landowner. While the landowner would normally harvest when the forest had reached its maximum potential in terms of usable fiber, given the price for various products in downstream markets, that point would be delayed in a carbon-constrained global market in which emissions trading set an effective price for carbon that would lead the

The same price effect could arguably be achieved through carbon taxes, which could alter the balance in terms of production of alternative fuels. What carbon taxes would not do in the absence of emissions trading is create a means by which farmers and foresters could create a separate stream of value through land use, cropping, and harvesting decisions.

161

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owner to place a higher value on standing timber. From the landowner’s perspective, the marginal cost of leaving the tree standing is low compared to the value that leaving the tree on the stump might garner in carbon markets. Effective carbon prices also create new opportunities in both farming and forestry for production of biomass as an alternative source of fuel. In the case of alternative fuels, however, emissions trading markets would not only have to set effective prices, those prices would have to remain relatively high in order to make biomass and other alternative fuels competitive with existing fossil fuels (McCarl, Adams, and Hurd 2001).162 Significantly, that same equation shapes the outlook for the production of ethanol. While most of Uruguay’s farmland is dedicated to livestock and the existing crops do not include significant quantities that could be used in the production of ethanol, a change in the relative price of ethanol and cleaner fuels relative to fossil fuels could alter that equation. At that point, Uruguayan farmers would, of course, have to take into account the stiff protection provided by the United States and other developed countries to ethanol production domestically. The other conclusion that is relevant to Uruguay is the relatively low potential the existing literature suggests for methane sequestration or the use of methane as an alternative fuel (McCarl, Adams, and Hurd 2001). Given the predominance of livestock in Uruguay, the ability to capture and use or sequester methane would make a material difference in the ability of the Uruguayan farm sector to adjust to a carbonconstrained global economy. That, however, does not seem likely in the absence of some significant technological breakthrough and, as always, a relatively high price for carbon established by effective emissions trading markets. Apart from the question of whether existing or proposed mitigation measures would yield an effective price for carbon, Uruguay’s farm and forest sectors have to confront the array of other challenges that mitigation measures might create in terms of market access. Of the industries examined here, it is agriculture in Uruguay that presents an example of what was described above as one of the potential unintended consequences of measures adopted for other purposes. Of those measures, the single most important relates to agricultural subsidies that benefit producers in developed countries, either directly, in terms of competing crops, or by lowering the cost of inputs, as is the case with livestock production. In this

162 Some studies suggest that the price of carbon would have to remain above US$60 per ton in order to make biomass competitive as an alternative to a coal-fired electrical power plant (McCarl, Adams, and Hurd 2001).

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context, it is less important that these subsidies distort trade than that they offer subsidized farmers a way to avoid fully internalizing the environmental cost of their production choices and reflecting them in the prices they charge to consumers—which suggests that conventional production subsidies offer a still greater competitive advantage in a carbon-constrained global economy. Another type of unintended consequence flows from the adoption of regulatory measures unrelated to climate change. Evidence suggests that Uruguay would benefit from greater application of GMOs in the production of crops like rice and potatoes. One of the benefits would be the reduction in both costs and emissions that would flow from applying GMO technology to grains like rice. That said, the use of GMO technology would also limit the markets open to Uruguayan exports by virtue of the European Union’s near-ban on the importation of GMO crops or goods derived from those sources. The challenge for Uruguayan foresters is more direct. The predominance of hardwoods dedicated to pulpwood implies that the carbon intensity of the forestry sector in Uruguay is relatively high, and that the sector can expect, all other things being equal, to face increased exposure to any climate change mitigation measures that apply to the finished paper that might be exported from Uruguayan mills. That said, the bulk of Uruguayan paper exports go to regional markets where they are unlikely to face any climate change mitigation measures in the near future. The greater risk, as a consequence, may be to the growing exports of softwood lumber to markets like the United States, where any climate change legislation is likely to carry some form of border measure, such as carbon tariffs, and where the U.S. industry has consistently exercised its rights under U.S. antidumping and countervailing duty laws to protect their market share. Significantly, a number of the actions that Uruguayan farmers might take to adapt to climate change would also serve to reduce their exposure to the risk created by mitigation measures imposed in their principal export markets (de la Torre, Fajnzylber, and Nash 2009). Uruguay, together with the rest of Latin America and the Caribbean, can derive significant gains from mitigation through “the deployment of improved agronomic and livestock management practices, as well as with measures to enhance carbon storage in soils or vegetative cover.” Uruguayan farmers can reduce emissions by improving crop varieties, extending crop rotation, and reducing their use of nitrogen fertilizers (de la Torre, Fajnzylber, and Nash 2009). They can reduce emissions from livestock through changes in feeding practices, use of dietary additives, breeding species, and “managing livestock with the objective of increasing productivity and minimizing emissions per unit of animal 124 Trade and Climate Change Mitigation Measures

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products.” By improving their own GHG emissions profile, Uruguayan farmers will likely find that their products face fewer barriers as a result of any mitigation measures imposed in developed-country export markets (de la Torre, Fajnzylber, and Nash 2009). Finally, it is worth underscoring that the impact of any climate change mitigation measures imposed in developed-country markets may ultimately prove less important to Uruguayan exports if the growth in demand for their products is growing fastest in the developing world. This may well prove to be the case for four reasons: population growth, urbanization, increases in disposable income, and the effects of climate change on production. Each of those trends is stronger in developing countries than in the developed world, meaning that the growth in demand is likely to be strongest where Uruguayan exports are likely to face the least restraints in the way of climate change mitigation measures. The obstacles Uruguayan farmers face in those markets will, at once, be quite different and far more familiar. They will flow from existing market access barriers imposed by the developing countries to protect their own farmers, developed country subsidies which may expand the market share that developed-country farmers might gain in these markets, and the ultimate question—whether the growth in income in many developing countries is sufficient to allow consumers to actuate their demand for food. d. Effects on Transaction Costs Assessing the impact of climate change mitigation measures on the transaction costs faced by Uruguayan farmers and foresters is aided by the nature of the industry and global commodity markets. The highly developed distribution channels, combined with the relative effectiveness of global commodity markets in establishing prices in both spot and futures markets, suggests that climate change mitigation measures are unlikely to have much impact on the information costs that Uruguayan farmers face in finding an outlet for their goods or determining the basis on which to make their investment decisions. The same holds true to a large extent with respect to forestry. Although the bulk of Uruguay’s plantation forestry is for pulp and paper production, the lumber that is sold on global markets flows through channels and commodity markets as well established as those for agricultural commodities (they are often the same). The fact that much of Uruguay’s commercial forestry is based on investment by international firms also reduces the concern that information costs might otherwise generate. Impact on Producers in Latin America and the Caribbean 125

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The central concern that Uruguayan farmers and foresters confront is the uncertainty surrounding the global response to climate change and the nature that response will take. Obviously, to the extent that global environmental talks yield significant constraints on GHG emissions and those constraints lead to an effective market for emissions trading, the economic environment, and the burden of adjustment and adaptation, will look very different (and more positive) to Uruguayan producers than will be the case if the global response takes the form of potentially conflicting national or regional efforts. Unfortunately, the latter result is far more likely, which raises the uncertainty regarding market access for Uruguayan farm produce in each of the markets adopting mitigation measures until the exact nature and market impact of those measures is clarified. Given the profile of Uruguayâ&#x20AC;&#x2122;s farm and forest sector, their compliance costs will become an issue only to the extent that they become a factor for downstream retailers and end users and the standards they face flow back upstream along the supply chain that extends back to the producer. Uruguayan livestock producers have faced considerable challenges in verifying that their products were free of diseases like hoofand-mouth; they widely recognize the importance of having those processes in place which would allow them to comply with regulatory standards in their principal export markets. The challenge here, however, is quite different. It lies in ensuring that they can account for emissions reliably in order to inform their customers, rather than government regulators. That will require access to business processes and capital investment that are not currently a part of the operations of most producers. The situation in forestry is slightly different because of the heavy investment by international firms in plantation forestry. Those firms, many of which are public issuers on global capital markets, will face growing pressure to account for their use of carbon in order to inform investors of its impact on their financial performance. The accounting measures they institute to effect those measurements will apply to their global operations, including their operations in Uruguay. While the Uruguayan operations will face the need to adopt new business processes, they will benefit from the fact that a large share of the cost of adopting those measures will be defrayed by the parent company. Lastly, in terms of access to capital, it is axiomatic that most farm operations lack the capital to invest in new machinery or technological innovations that would allow them to adjust to a more carbon-constrained global economy, while maintaining or expanding their access to global markets. The lean profit margins in most livestock operations and among Uruguayan farmers planting cash crops reinforce that point. 126â&#x20AC;&#x192; Trade and Climate Change Mitigation Measures

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The costs that farmers and foresters will face will exacerbate the broader economic impact of global warming on their operations. Most studies suggest that land values tend to fall with higher temperatures and higher precipitation, as is potentially the case in Uruguay, with obvious implications for farmers’ ability to acquire the capital they need to adjust and adapt (de la Torre, Fajnzylber, and Nash 2009).163 That implies challenges for farmers, both large and small, who will need access to capital to adopt new growing techniques, purchase weather-resistant varieties of seeds, implement the business processes that would allow them to account for the carbon they use and emit, and acquire the capital equipment needed to ensure they can operate profitably in a lower carbon, more volatile global commodity market in the future (de la Torre, Fajnzylber, and Nash 2009).

4. Mining in Peru Mining represents a significant share of Peru’s economy (an estimated 13 percent of GDP) (U.S. Commercial Service 2005). The industry produces significant quantities of gold, silver, tin, copper, lead, and zinc. Recent years have seen a significant expansion of gold production and an expansion into a variety of hydrometallurgical projects that involve substantial capital investments (Mbendi 2010). The following chart illustrates the distribution of mining in Peru by type as well as the growth in each sector from 2007–2008, just prior to the global economic downturn. The mining industry has contributed significantly to Peru’s economic growth over the past decade. Apart from gold, the industry’s growth has been driven by growth throughout the developing world and the demand that has consequently been created for various minerals involved in construction. That demand has sustained mining activity in Peru through the recent economic downturn. Continuing demand in the developing world has led to a significant expansion of both mines and processing facilities in recent years (Business News Americas 2008). Exploration is on the rise as well, with major global firms such as Chinalco, Vale do Rio Doce, Anglo American, and Southern Copper leading a broad array of smaller firms

163 The studies rely heavily on a “Ricardian” analysis, which examines how climate influences farmers’ decisions and the economic returns from farming. Because data exists on a large cross-section of farmers, their farms can be matched with climates and offer a picture of how farmers might react to climate change in terms of their choices regarding land use, cropping, herd size and composition, irrigation, the use of fertilizer and other relevant factors. The Ricardian analysis helps define the impact of climate change on profitability and, ultimately, on land values as a result.

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FIGURE IV-5 Peru: Mining Output 2007–2008 January–July Product

Unit

2007

2008

Var. % 2007/2008

Copper

Tonnes (fine copper)

654,002

716,364

9.54%

Gold

Grams

94,275,342

101,237,904

7.39%

Zinc

Tonnes

866,499

916,622

5.78%

Silver

Kilograms

1,957,533

2,047,359

4.59%

Lead

Tonnes (fine copper)

188,682

195,319

3.52%

Iron

Long Tonnes

3,018,628

3,032,795

0.47%

Stain

Tonnes (fine copper)

22,518

22,842

1.44%

Molybdenum

Tonnes (fine copper)

8,107

9,878

21.84%

Source: Business News Americas.

in that effort, making Peru sixth in the world as a destination for exploration (Business News Americas 2008). Given the source of rising global demand, it is no surprise that the industry is a major exporter, even in the face of the global economic downturn.164 Exports of minerals from Peru were well above US$17 billion in 2007 International Business Strategies 2008). When combined with oil, extraction industries account for roughly two-thirds of Peru’s exports by value (International Business Strategies 2008).165 a. Industry Structure Peru’s industry, once dominated by the parastatal Empresa Minera del Centro del Perú S.A. (“Centromin”), is now made up of more than 30 privately owned firms. The government has been in the process of privatizing Centromin for over a decade and has otherwise encouraged foreign investment in order to develop Peru’s resources more fully.166

According to recent reports, for example, world copper consumption will grow by 5.4 percent in 2010, with China accounting for roughly 40 percent of that increase in global demand (Agence France Presse 2010). That represents a significant rebound from the sharp decline the industry experienced in 2009 as the developed world slipped into recession and the world economy slowed. (Agence France Presse 2010). 165 See also MBendi (2010). 166 Centromin was formed to operate the seven mines Peru nationalized in 1974. The government began its privatization in 1996 with the sale of the concessions in Antamina (Arroyo Aguilar 2001). By early 2001, Centromin had significantly reduced its holdings in actual mining operations, although it continued to engage in exploration and serve as a manager of Peruvian mining concessions, rather than as a significant operating company (Arroyo Aguilar 2001). Centromin’s activities have since largely been subsumed 164

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Major global mining companies now make up a significant share of Peru’s production, including the operations of Barick (Canada), Doe Run (U.S.), Pan American Silver (Canada), Campbell Brothers (Australia), and the Shougang Group (China) (Mbendi 2010).167 The effort to encourage private investment in the mining sector has led to the opening of a number of new deposits, such as the Yanacocha and Pierina gold mines and the Antamina copper and zinc mine, which is one of the largest of its kind in the world. In addition to energy and electricity, upstream suppliers consist mainly of suppliers of the capital equipment involved in mining (International Business Strategies 2008). The great majority of those companies are major multinationals, such as Caterpillar, John Deere, New Holland, Komatsu, Atlas Copco, and Sandvik.168 The growth in mining operations has attracted a variety of new entrants as well, largely from Asia, including Ito, Xcmg, Liu Gong, Chan Tui, Sem, and Shantui. The influx of new entrants has increased competition based on both price and after-sales service (International Business Strategies 2008). Downstream customers consist of distributors, processors and major manufacturers in sectors as diverse as steel and semiconductors. Much of Peru’s output is sold through global commodity markets or supply contracts that reference prices, both spot and future, on those global markets. The heavy consolidation in many downstream industries in the developed world has largely been offset by the growth in demand and customer base in developing countries, leaving the mining companies with significant pricing power relative to their customers. b. Energy and Emissions Intensity Given the nature and location of most minerals, mining is both energy and emissions intensive. Mining, processing, and transportation consume significant quantities of fossil fuels. The following graphic illustrates that point by offering a comparison of energy intensity and energy consumption in a variety of industries. The energy and emissions intensity, as well as the options for abatement, in mining depend heavily on the type of ore, the method of mining, and whether the ore

in a new parastatal entity, Activos Mineros S.A.C, which was created in 2006 to provide oversight of the mining industry, supervise investments and mineral concesssions and assist in environmental remediation of those mining operations once owned by Centromin. See Activos Mineros (2008). 167 MBendi Information Services at http://www.mbendi.com/a_sndmsg/org_srch.asp?gloc=L205 &INDY=IMING. 168 Ibid. Impact on Producers in Latin America and the Caribbean 129

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Energy intensity (Thousand Btu/$ GDP

FIGURE IV-6 Industrial Energy Intensity vs. Energy Consumption 1000 Energy-Intensive Industries Petroleum

Mining

100

Primary Metals Textiles/Apparel

Tobacco/Beverages Leather

1 10

Plastics/ Rubber Printing Miscellaneous Electrical Furniture

100

Paper

Chemicals Wood Nonmetallic Minerals Food Processing Fabricated Metals Transportation Machinery and Computers 1,000

10,000

Energy Consumption (Trillion Btu) Source: Office of Energy Efficiency and Renewable Energy, US Department of Energy.

must be smelted before it can be transported and sold. The principal distinction lies between deposits that can be reached by surface mining, which involve a higher volume of fuel oil, diesel, and gasoline, or must be mined through underground operations, which depend more heavily on electricity. Direct mining activities in surface mining for copper, for example, emit significant levels of GHGs in drilling, blasting, loading, hauling, and ancillary processes, with 54 percent of the total coming from hauling by truck (U.S. Department of Energy [DOE] 2002). Underground operations use more energy because of the additional challenges of hauling, ventilation, water pumping, and hoisting of the minerals to the surface. Thus, for example, the amount of energy used to recover one ton of metallic gold from an underground mine is roughly twice that of recovering the same amount from an open pit operation (U.S. DOE 2002). Processing ore consumes large amounts of energy as well. In the case of copper, grinding alone accounts for roughly 45 percent of the energy used in the processing phase (U.S. DOE 2002). Smelting also consumes significant amounts of energy, particularly in the form of fuel needed to create temperatures sufficient to turn the ore into a molten state.169

Smelting requires the application of heat to fuse and allow the separation of ore so that it can be recovered from other minerals and impurities. Ibid. The result, in the case of copper, is two separate molten streams—one of copper-iron-sulfide matte and the other of slag. Ibid. Smelting produces significant amounts of sulfur dioxide gas in the process. (U.S. DOE 2002). 169

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The factors that increase the mining industry’s exposure to climate change mitigation measures, in general, apply with particular force in the context of Peru. The fact that most of Peru’s mining lies at high altitudes in the Andes make both extraction and transportation a challenge, physically and in terms of the energy consumed. Virtually all of the ore mined in Peru requires significant amounts of processing. All of this suggests that the industry would be almost uniquely exposed to climate change mitigation and a target of governments and non-governmental organizations. c. Implications of Climate Change Mitigation Measures for Market Access and Growth Much like the case with the cement industry in Mexico discussed above, the most serious impact of climate change mitigation measures on the mining industry in Peru is likely to flow from the impact of such measures on the price of energy. To the extent that emissions trading or other market mechanisms establish a global price for carbon, that price will be incorporated in the price of energy consumed by the Peruvian industry. Whether the rise in energy costs results in competitive effects depends on the relative scarcity of the mineral in question, the demand for that mineral, and the energy efficiency of Peru’s mining operations compared with operations elsewhere. In that context, Peru benefits from the gradual privatization of its mining sector and the influx of foreign direct investment by major international mining companies. Those companies have brought with them the technology that they apply in their operations globally to drive energy efficiency and reduce costs generally. Peru’s industry is, as a consequence, unlikely to be the industry laggard in terms of its competitiveness following an increase in energy prices. Beyond the direct impact of a rise in energy costs, the Peruvian mining industry is, for a variety of reasons, likely to avoid any major adjustment or dislocation due to mitigation measures imposed in downstream markets despite the fact that mining is a particularly energy and emissions intense activity. First, like many of the other industries and firms surveyed above, Peruvian production depends on a derived demand—one that flows from the downstream demand for goods made or services delivered that depend to a greater or lesser extent on metals made from ores mined in Peru and elsewhere. The strong growth in the developing world in the past decade has fundamentally altered the balance of market power in ways that benefit the mining industry, allowing the firms to raise prices and shift Impact on Producers in Latin America and the Caribbean 131

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costs forward to customers.170 Growth in the developing world is expected to continue, even while the economies of the developed world climb out of recession, with the expected effect on the demand for minerals.171 Second, the consolidation the industry has seen among customers in many developed country markets (e.g., steel, automobile manufacturing, etc.) and the technological changes that have caused a shift toward other materials (e.g., the development and use of glass instead of copper wire throughout the telecommunications industry) has been more than offset by the broad growth in demand emanating from the developing world. That tends to reinforce the market power of mining companies, which themselves have become consolidated on a global basis relative to the principal consuming industries.172 Third, countries are less likely to impose trade restraints on Peruvian ores for the same reasons that existing barriers to trade in those minerals are already low. Tariffs and other barriers are normally low for raw materials, tending to rise with the relative sophistication of the manufacturing involved.173 Few countries see an advantage in taxing the inputs that would make their own manufacturing less competitive in global markets under current economic conditions.174 The nature of the market and the downstream industries that Peru’s miners serve (i.e., manufacturers downstream in the value chain) tend to undercut the prospect of a country imposing restraints on trade in the commodities that would single out Peru as a result. The risks, instead, flow from customers that face either regulatory or marketdriven demands to improve their own energy and emissions efficiency and look for suppliers that can contribute to their adjustment and adaptation, as well as the impact

Recent events signal a continuation of the trend. See, e.g., Shanghai Daily (2010) (indicating that major Chinese steel makers would incur significant cost increases as a result of a decision by Rio Tinto and other iron ore suppliers who began scrapping annual contracts in favor of short-term sales based on surging spot market prices). 171 See, e.g., Wall Street Journal Asia (2010) (estimating that growth in China and other developing countries would account for a 7.8 percent increase in iron ore demand and output in 2010). Rio Tinto expected demand for copper to rise over the course of the year as well, despite a significant 1st quarter 2010 downturn in its own copper operations (Wall Street Journal Asia 2010). 172 See, e.g., Ernst & Young (2008) (highlighting the consolidation of the mining industry globally and indicating that the “pace of consolidation in the mining industry shows no sign of slowing” despite the economic downturn). 173 The reduction of this “tariff escalation” has been one of the developing world’s principal demands in the current round of multilateral trade negotiations within the WTO (Wainio. and Vanzetti (2008). 174 The trend, in fact, appears to moving in the direction of cutting tariffs on inputs to help lower the cost of doing business and boost productivity. See, e.g., Ottawa Moves to Eliminate Tariffs, Financial Post (March 4, 2010) (reporting that Canada would eliminate tariffs on roughly 1,500 tariff categories covering inputs to manufacturing, with tariffs on the remaining 380 categories of inputs being phased out by 2015). 170

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on transaction costs discussed below. The question is whether downstream demand is sufficient to blunt that instinct on the part of consuming industries and encourage them to look elsewhere for reductions in energy usage and emissions efficiency.175 d. Effects on Transaction Costs The nature of the mining industry and its downstream markets tends to diminish the importance of information costs that affect other industries. Both the mining industry and most of its downstream users are already heavily consolidated on a global basis, and the channels of distribution are well-established, which limits the impact that climate change mitigation measures might otherwise have on the information costs facing the industry. Uncertainty is a major consideration for the mining industry because much of the actual impact on their operations from climate change mitigation depends on the ability of market-based measures to establish an effective price for carbon. At this stage, that result does not seem likely in the near term, but it is nonetheless a risk that the Peruvian industry will have to find its own ways to mitigate. The most significant step the industry could take in diminishing that risk, of course, is to engage in a broadbased effort to improve its energy and emissions efficiency in advance of the point at which the market for emissions trading becomes sufficiently deep so as to have a discernible impact on the industry’s energy costs. Rising compliance costs will also be a significant consideration for the industry for two reasons. The first is that the industry will face continuing pressure to reduce its own environmental impact in Peru, both from local environmental groups and community organizations and from their international counterparts, which have proved enormously effective in bringing pressure on the industry for reform by influencing the political process in the international firms’ home markets. The second reason that the industry will face higher compliance costs relates to the demands that mining firms will face from their customers to account for the carbon content of the ore they deliver. While the implementation of carbon accounting in the mining industry is not likely to be a major cost driver relative to the other capital

175 In that context, it is important to draw a distinction between minerals like iron ore or copper that are generally used in significant quantities in construction and minerals like gold that are used sparingly in relatively high technology applications. In the latter, the actual amount of ore involved in the finished product will also diminish the instinct on the part of producers to look to the mineral sector for the energy and emissions reductions the downstream producers seek.

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investments the industry’s firms make on a regular basis, the cost will be higher than would otherwise be the case in most industries because of the complexity of the way in which energy effects every aspect of the industry’s operations. Economies of scale could become a problem if the costs that the industry faces under an emissions mitigation regime rose significantly while the demand for ore declined, making it harder to pass on the additional costs the industry confronts. This is one instance in which the industry’s scale operates against it. From the point of view of the individual mining operations in Peru, they already must operate on a sufficient scale to warrant the heavy upfront capital investment entailed in acquiring the concessions needed to mine, as well as the capital equipment and infrastructure needed to work those concessions. In the downstream markets, the industry already operates on a global scale because of the nature of the markets it serves. Consequently there is less that can be achieved through scale to reduce any additional costs the industry may face. The greater likelihood is that higher costs would simply reinforce the trend toward further consolidation. Access to capital, like economies of scale, is not likely to be a problem for the industry’s adjustment and adaptation, given current industry conditions; however, the recent economic downturn highlights the extent to which demand for ore can fall sharply with the economy and alter the picture for the mining industry’s profitability and access to capital. Most firms that are producing in Peru now seemed poised to make a sharp recovery as downstream firms have reached the end of their ability to cut their inventories and have begun to ramp up their own production as a result. That demand flows back upstream to the mining industry, improving both pricing power and profitability.

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CHAPTER

Implications for Policymakers

he analysis outlined above offers four important insights. The first is that the pursuit of a response to climate change will necessarily affect the trading interests of Latin America and the Caribbean, regardless of the form that response takes. Indeed, Latin American and Caribbean producers will feel the effects of climate change mitigation measures even in the absence of action by governments, as private companies that serve as the export market for many of the region’s goods and services begin to take the initiative to measure their exposure to the risks associated with global warming and its mitigation. What this suggests for policymakers is the need for an integrated approach to climate change and trade—a strategy that is designed to vindicate the region’s interests on both fronts. The region’s interests would be best served by a strategy designed to encourage a multilateral agreement on climate change mitigation that would blunt the incipient movement in a number countries toward carbon tariffs or other measures designed to insulate domestic industries from the perceived competitive effects of domestic climate change policies. The second insight is that a successful strategy that articulates the region’s goals with respect to both climate change and trade must be built from the bottom up. It must be informed by the actual challenges that Latin American and Caribbean producers will confront, rather than simply reiterate positions taken in previous rounds of negotiations within the UNFCCC process. Building an integrated climate change and trade strategy from the bottom up will allow policymakers to avoid the problems that inevitably arise from the attempt to create a “one-size-fits-all” solution for a region as economically and geoclimatically diverse as that of Latin America and the Caribbean. The challenges from climate change confronting the islands of the Caribbean plainly differ from those confronting Brazil, just as do the challenges of development in both regions. Similarly, the challenges confronting Uruguay’s livestock producers differ materially 135

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from those of CEMEX, which is both Mexico’s and the world’s largest cement producer. A bottom-up strategy, however, requires a different analytical and procedural approach. Analytically, building a workable strategy that addresses the diversity of the region’s needs requires a look beyond the macroeconomic effects of climate change and its mitigation. It requires an understanding of how global warming and mitigation measures will affect the microeconomics confronting the region’s producers in a variety of industries. Procedurally, a bottom up approach requires a great deal more participation by the region’s private sector as part of the policymaking process. That requires a considerably greater investment in consultation between policymakers and local business owners and other civic groups, in order to identify specific challenges and craft workable solutions that can be integrated into the region’s approach to climate change and trade. The third insight that the analysis above suggests is that policymakers must understand the implications of an industry’s organization and its relative integration into the global economy in order to understand the particular challenges that the producers in that industry will face in their efforts to adapt to climate change and adjust to any mitigation measures adopted, whether by governments or by private firms on their own motion. In particular, policymakers should take into account what the industry’s organization implies for its ability to pass the risks and costs associated with adaptation and adjustment on to consumers. The nature of the challenge that faces Peru’s heavily globalized mining industry in that regard, given the reignited growth in demand for its products, is, for instance, markedly different than the challenge facing plastics producers in Colombia. The final insight that the analysis suggests is that time is of the essence. The failure of the recent Copenhagen Conference of Parties to reach any binding global response to climate change does not mean that events are not moving apace, at least in terms of the potential effects on the region’s producers. As noted above, global participation is not essential to the establishment of an effective market price for carbon that would redraw the economic landscape for many of the region’s producers. Equally, there are a variety of private sector initiatives that are, in fact, global in scope and may well end up having broader effects on individual firms trying to enter global markets than would ultimately flow from a government-to-government agreement on global warming. The same holds true for the lack of action on comprehensive climate change legislation in the United States, a market of critical importance to many producers throughout the region. While a comprehensive climate change bill looks less likely, the 136 Trade and Climate Change Mitigation Measures

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U.S. Congress may well pass energy legislation with significant implications for the region’s producers (e.g., the potential to export alternative fuels to the U.S. market). Just as important, the EPA has begun the process of addressing climate change through regulations based on existing statutory authority, which means that Latin American and regional producers may confront a new regulatory environment in the United States, even in the absence of congressional action. Perhaps just as important, private firms in the United States, prompted in part by the SEC’s issuance of guidance on the financial risks associated with global warming, have begun to develop methodologies for carbon accounting that may well become commercial barriers to market access in the absence of an effort to ensure that Latin American and Caribbean producers can comply. In other words, Latin American and Caribbean policymakers should not view the breakdown in the UNFCCC process as an end to the potential risks involved to the region’s trade from measures intended to mitigate the effects of climate change. Rather, policymakers should take advantage of the opportunity that the UNFCCC’s failure presents to create a coherent strategy on climate change and trade that addresses the challenges the region’s producers will face in the shift toward a lower carbon global economy that is already under way. The following discussion outlines an approach that is designed to inform the efforts of policymakers throughout the region in developing an integrated climate change and trade strategy. It identifies the issues that would need to be addressed by such a strategy and discusses how the different tools and organizations that policymakers have at their disposal might be used to affect the strategy once complete.

A. Key Elements of a Climate Change and Trade Agenda There are a number of different ways in which the elements of an integrated climate change and trade strategy might be set out. The approach adopted below outlines the strategy by reference to the nature of the process involved and the capacity of policymakers in the region to affect their goals. It starts at the multilateral level, examining the approach that the region’s policymakers might adopt in international fora seized with the issues of climate and trade. The discussion then turns to the topic of what might be accomplished on a regional basis through cooperation and the adoption of unified negotiating positions. The discussion concludes by looking at the steps that policymakers can take within their own countries to reduce the potential effects of climate change mitigation measures on their industries and economies. Implications for Policymakers 137

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1. Global Participation and the Region’s Role in Multilateral Institutions Perhaps the single most important lesson that can be drawn from the above analysis is the stake that Latin American and Caribbean producers have in a globally agreed regime that addresses their concerns on both climate change and trade (de la Torre, Fajnzylber, and Nash 2009). Plainly, a global solution is preferable in terms of its impact on climate change and its ability to reduce the potential dislocation that might flow from global warming and its effects on the region. As described above, Latin America and the Caribbean have already begun to feel the negative effects of climate change. Particularly for the islands of the Caribbean and the many producers in Latin America that remain dependent on agriculture for their income, the IPCC’s estimates suggest more severe impacts in the future. The region “has a vested interest in the success of global mitigation efforts (de la Torre, Fajnzylber, and Nash 2009).” But a global solution is also preferable from the perspective of reducing the risk of economic harm from climate change mitigation measures as well. First and most importantly, reaching a global agreement on climate change, particularly one that addresses the trade implications of mitigation as well as global warming itself, would significantly reduce the uncertainty that Latin American producers will face in the absence of such an arrangement. The current trend is moving toward unilateral approaches that create uncertainty, not only as the process unfolds, but also because of the potentially conflicting requirements those approaches may impose on Latin American and Caribbean producers. Both information costs and compliance costs rise in the absence of a globally coordinated response. Latin American and Caribbean producers will confront the cost of determining how multiple sets of rules affect procurement of goods and services headed for a variety of different markets. Multiple sets of rules also raise the prospect of different obligations requiring both individuated responses and separate carbon accounting regimes. As both costs and risks rise, so too will the cost of capital facing Latin American and Caribbean producers. Finally, as highlighted in the discussion above, unilateral approaches create a demand for protection by local industries concerned for their competitiveness. While action of that sort has been forestalled thus far, that is largely a result of the fact that the climate change mitigation policies have not yet gone into effect or had any real bite thus far. If and when the policies adopted in many downstream markets do begin to force serious adjustments and costs onto local producers, the demand for protection will undoubtedly rise further. 138 Trade and Climate Change Mitigation Measures

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In short, Latin American and Caribbean policymakers have a continuing stake in the success of global negotiations on climate. They have the same stake in ensuring that those talks begin to address the trade implications of global warming and climate change mitigation measures as well. The most obvious venue for pursuing a multilateral response to climate change is the process developed under the UNFCCC. That process is in abeyance since the failure of the Conference of Parties to achieve measurable progress in Copenhagen.176 Although the next Conference of Parties has been scheduled for Mexico City, there is no clear picture of what the parties will actually discuss in that context. One option would be to continue to press ahead with negotiations on an agreement to replace the Kyoto Protocol while retaining its basic architecture, although the results from Copenhagen do not augur favorably for that approach (Hufbauer and Kim 2010). Another alternative would be to use the non-binding Copenhagen Accord as the platform on which to build a new architecture for addressing the risks associated with global warming, although that approach also suffers from some basic weaknesses (i.e., the lack of any material progress toward ensuring that producers and consumers are obliged to internalize the full environmental cost of their economic choices). A less obvious but vitally important forum for much of what Latin America and the Caribbean need addressed as part of a global solution on climate change falls within the ambit of another multilateral organization, the WTO. As the discussion above reflects, any agreement on climate change and, in fact, any unilateral measures adopted by nations to mitigate its effects in the absence of a global accord both raise significant and challenging issues that fall within the jurisdiction of the WTO.177 More broadly, the WTO might also provide a forum for the negotiation of wider market access that could be used to provide an incentive for developing countries to participate in any future global agreement on climate change. Indeed, integrating climate change and trade negotiating objectives may offer a way of creating a positivesum result that is both pro-environment and pro-development.178 One area of intense interest to Latin American and Caribbean policymakers offers a useful illustration of how that might work. Producers in the region are, without a doubt, among the most productive and lowest-cost producers of biofuels. If the See Hufbauer. and Kim (2010). See, e.g., Hufbauer, G. C., Charnovitz, S., and Kim, J., Global Warming and the World Trading System (2009) for a useful discussion of the multiple issues that climate change and its mitigation raise under the WTO rules. 178 See Aldonas (2009). 176 177

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countries of the region were to design a trading system in which the incentives were aligned to contribute to the effort to confront climate change as well as boost the economic prospects of Latin America and the Caribbean, eliminating the distortions that affect the production and sale of biofuels globally would rank high among the objectives. The countries that have pressed for broader developing country participation in any climate change agreement are also those that have in place the most significant subsidies and protections for their own industry.179 What that suggests is the potential for a quid pro quo that guarantees broader participation by the countries of the region in any climate change arrangement in return for the elimination or reduction of the limits those distortions impose on the market access that Latin American producers might otherwise enjoy in a growing market for biofuels. Such a deal need not necessarily prejudice the interests of producers in countries like the United States that benefit from the subsidies offered to ethanol production and the protection they enjoy from imports if combined with a joint effort to develop the market for biofuels globally on a joint basis. Wholly apart from multilateral standard-setting processes like the negotiations under the UNFCCC or talks within the WTO, the discussion above raises important issues regarding the role of the multilateral development banks and their contribution to the process of adjustment and adaptation. What many analysts have concluded (Burton, Diringer, and Smith 2006)is that working “through existing channels of multilateral and bilateral assistance to integrate adaptation considerations across the full range of development support” may prove to be “the most direct and effective means of discouraging investments that heighten climate vulnerability and promoting those that strengthen climate resilience.” That has led to various suggestions, including the application of climate risk assessments to development projects funded by the multilateral development banks (Burton, Diringer, and Smith 2006).180 That approach, however, seems less calculated to facilitate adjustment and adaptation than it is to avoid unintended climate consequences from any proposal under review. What is needed, in addition, is a thoughtful analysis of what sorts of assistance would materially aid the countries of the region and their producers as they adapt and adjust to a lower-carbon world economy.

See, e.g., Koplow (2006) (providing a comprehensive list from a distinctly environmental perspective of the policies adopted by the United States to encourage both the production and consumption of ethanol and other biofuels). 180 Significantly, the World Bank has begun developing a screening tool for purposes of analyzing whether proposed investments confront significant climate risk and how best to reduce a particular project’s vulnerability. See World Bank (2006). According to the Bank, the goal is to create a standard tool for assessing the risks from climate change for any particular project far earlier in the project cycle. 179

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Both the World Bank and the IDB have adopted forward-leaning programs to identify the challenges the countries of the region face, design solutions that will help facilitate adjustment and adaptation, and support individual countries in their efforts to cope with climate change and its trade implications. Those programs have not, to date, examined to any considerable extent the potential impact of climate change mitigation measures on trade. Nevertheless, there is one area in which both institutions have invested a great deal of effort that could make a significant contribution to addressing the potential fallout from climate change mitigation in trade terms. Much of what has been outlined above, both in terms of the impact of mitigation measures and in terms of the response, falls within the broad mandate of the World Bank and the IDB to develop aid-for-trade programs that assist developing country producers in gaining a foothold in global markets. Those programs could prove effective in assisting the region’s policymakers and producers in responding to new challenges as they arise. Aid for trade in this context could come in two forms. One is the initial assessment and benchmarking of current market access outlined below, as well as the potential impact of climate change mitigation measures on future exports. One significant parallel benefit of that effort would be improving the preparation that countries of the region have for all future trade negotiations and efforts directed at regional integration. The other form in which aid for trade could help lies in building the public and private institutions needed to ensure that producers in the region can effectively participate in a lower-carbon regional and global economy. This could take a number of directions—from mechanisms designed to reduce information costs related to determining the applicable standards, to carbon cooperatives designed to help producers reduce the cost of compliance and aggregate their savings in order to participate effectively in carbon trading, to regional public-private partnerships intended to tap the sophistication and technology of global firms that serve these markets as well as providing a conduit for their exports. A similar logic applies to the region’s use of the Clean Development Mechanism. There is, for obvious reasons, a sharp focus on technologies that reduce carbon in both goods and services and the means by which they are produced. 181 What has

See, e.g., Cigaran and Iturregui (2004) (evaluating the prospects for Peru’s use of the CDM). Participation in the CDM involves considerable up front costs to the participating government due to the complexity of the rules established under the Kyoto Protocol for the CDM. Ibid. For many countries in Latin America, the principal attraction of the CDM is the potential for technology transfer. Ibid. The general conception of what that entails focuses, not unreasonably, on large-scale projects with both climate and development benefits. Thus, for example, in the case of Peru, proposals for CDM projects

181

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largely been overlooked is the fact that most reductions in carbon, just like costs elsewhere in a production process, do not flow from a step change in technology. Rather, they flow from the incremental improvements in the field or on the shop floor. What that means in this context, since much of the impact of both climate change and climate mitigation measures falls on the cost side of a businessâ&#x20AC;&#x2122; ledger, is to think of business processes and improvements in production methods as critical forms of technology that producers in Latin America and the Caribbean need access to in order to remain competitive in global markets. It would be worth considering how sharing those production methods or business processes would work. The optimal arrangement, of course, is the sort of exchange that goes on between global buyers and their suppliers. The global buyers have an economic interest in expanding their network of suppliers in order to ensure both diversity of supply and competitive prices. Increasingly, such firms have found it essential to improve the business processes their suppliers employ in order to link them to the buyerâ&#x20AC;&#x2122;s supply chain and, at the same time, ensure that those new suppliers can meet both the regulatory and commercial standards with which the buyer must ultimately comply. The suppliers in the region have an equal stake in ensuring that they can comply, but often face liquidity constraints in acquiring the information and skills needed to achieve the results the buyer requires. This is an instance in which a special fund, set up under the CDM or separately, would contribute significantly as a vehicle for regional cooperation to easing those sorts of liquidity constraints at the lowest possible cost and with the greatest practical impact. There is one final aspect of the multilateral process that deserves attention. It has to do with financial markets and macroeconomic support. While much of the current discussion on financial matters focuses on the regulation of financial markets and international capital flows and assistance to governments confronting macroeconomic crises as a result of the recent economic downturn, organizations like the International Monetary Fund (IMF) and the G-8 and G-20 have a role to play on the climate front as well. Their role, however, has less to do with their ability to provide a forum for discussions on climate change, which is how they have been used to date (e.g., the IMF/ World Bank meetings and summits of the G-8 and G-20). Rather, it has to do with

have focused on large-scale hydro power projects that would undoubtedly create economic and developmental benefits that would accrue in some attenuated form to individual Peruvian producers. Ibid. That said, such projects do not address the practical challenges faced by individual Peruvian producers in their efforts to adapt and adjust to the standards imposed by their global customers. 142â&#x20AC;&#x192; Trade and Climate Change Mitigation Measures

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the macroeconomic management of the global economy and the support those institutions or groups should provide to countries within the region and elsewhere as they are forced to adjust to the effects of climate change and the changes wrought by any mitigation measures. In terms of macroeconomic management, the obvious point is to provide a platform for strong global economic growth and ensure a degree of price stability. The economic growth is essential to provide the wherewithal that countries within the region and globally will need to adapt and adjust. Price stability is essential to reducing risk and the cost of capital, as well as providing an environment that encourages private investment. In terms of support, there is little doubt that responding to climate change and grappling with any dislocations that arise from its mitigation will put stress on the public finances of the region’s governments. There would, as a consequence, be considerable merit in pressing the IMF, the G-8 and the G-20 to rething the IMF’s resources and programs in light of the challenges that those governments will face. The history of the international community’s response to financial crises is almost always ad hoc and after the fact, due to the lack of warning prior to the onset of the crisis. In this instance, the challenge is foreseeable and there is time to consider how the international monetary system could most usefully respond.

2. Regional Cooperation As the discussion above reflects, regional cooperation is essential to achieving the sort of agreement that would best serve the region’s interests. The World Bank has made the case that “leadership on the part of [Latin America and the Caribbean] would have a clear positive effect” on the international community’s ability to develop a global response to climate change (de la Torre, Fajnzylber, and Nash 2009). That said, there is ample reason for Latin American and Caribbean policymakers to pursue a regional approach as well. First, the likelihood of success for global talks within the UNFCCC framework has dimmed considerably after the failure in Copenhagen. Cooperation among the countries of the region may be needed to get those talks back on track (de la Torre, Fajnzylber, and Nash 2009). Failing that outcome, the need for regional cooperation will rise nonetheless. Latin America and the Caribbean will be better off under almost any climate change scenario if there is a collective effort to address the potential impact of climate change, facilitate the region’s adjustment to competing in a lower-carbon global economy, and bargain for outcomes that prevent a rise in barriers to the region’s trade. Implications for Policymakers 143

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The first step in that process has, in fact, already begun. In January, the IDB and the U.N. Economic Commission for Latin America and the Caribbean (ECLAC) signed an agreement to produce a series of studies on the economics of climate change in eight South American countries (ECLAC 2010). Those studies will build on work that the IDB already has under way and ECLAC’s current studies of the implications of climate change for Central America and the island states of the Caribbean (ECLAC 2010).182 The studies will examine the impact of climate change and its implications for the environment, economy, and society throughout the region (ECLAC 2010).183 As such, they will provide the essential foundation that the region’s policymakers will need in building a regional response on climate change and the issues raised by its mitigation. The studies would, of course, benefit from an explicit consideration of the trade implications by country as a way of informing the region’s efforts to develop a consistent position on the trade-related aspects of climate change and its mitigation. Both ECLAC and the IDB, as well as other economic organizations with a regional focus, have also funded a number of outreach efforts designed to explore specific issues. Those include areas in which gaining a better understanding of the effects of climate change is essential to any effort to establish a regional approach to mitigation and adaptation, such as the impact of climate change on one of the region’s critical natural resources, its forests.184 The second step will involve examining those areas in which regional cooperation would pay the highest dividends, which, in turn, will require the region’s policymakers to confront a set of strategic choices in terms of the focus of their joint efforts. There are a number of potential directions a regional effort might take, such as: »» a regional system of voluntary emissions constraints and carbon trading that would allow the region’s industry and policymakers to experiment with the market mechanisms and gain experience in trading that would serve the region’s producers as markets establish a price for carbon over time;

See also ECLAC (2009). According to ECLAC, the jointly funded studies “will also assess the range and value of national mitigation and adaptation activities, independent of international agreements, and will identify opportunities for regional participation in international policy instruments in support of mitigation and adaptation.” 184 See, e.g., XIV Seminario Regional Latinoamericano Bosques y Cambio Climático, Lima, Perú, April 27–9, 2010. 182 183

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»» a regional program designed to facilitate the adaptation and adjustment of the region’s main industries and exporters to competing in a lower-carbon global economy in ways that reinforce, rather than detract from, the individual country’s development strategies; or »» a regional focus on the development of alternative sources of energy as a way of creating opportunities for the region’s producers to become leaders in the production of alternative energy and for the region’s governments and utilities to become leaders in changing their economic models to allow for a greater diversity of supply so that more producers can benefit from such production incidental to their main economic endeavors. What the analysis above suggests, however, is that one area in which regional cooperation could pay immediate dividends as well as position the region for engagement in any multilateral process would be a regional trade arrangement that liberalized trade in those goods, services, and technology that would assist the region’s producers and consumers in their own adjustments to a lower-carbon global economy. Such an arrangement would, at a minimum, involve the liberalization of trade in a variety of environmental goods and services. It could, however, reach further and create a regional agreement on trade that provided an incentive for local producers to reduce their energy usage and emissions. In the process, the region could also begin to articulate the sorts of standards that its policymakers and producers would prefer to see in any multilateral arrangement on climate change and trade. There is a real value to using the region as a laboratory to experiment with different approaches that have been under-utilized in the past. It is not as if innovations in the trade area have not taken place, but those innovations have largely been the result of bilateral free trade arrangements or sub-regional customs unions of relatively limited scope in terms of actual liberalization and binding disciplines. What the region lacks is a conscious effort to create a trade environment that would enhance the advantages that the region enjoys in climate terms by virtue of its natural resources (e.g., unique forest cover; abundant sources of hydropower) and discourage the adoption of trade barriers that would yield a far worse outcome economically and environmentally. Thinking in terms of a regional trade arrangement in support of its adjustment and adaptation to climate change would help in one other respect. What it would offer producers regionally is the opportunity to achieve significant economies of scale that would, in turn, allow them to compete more effectively in a carbon-constrained global economy. They would, in the process of trading within the region, acquire both the Implications for Policymakers 145

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scale and skills that would allow them to satisfy the commercial standards imposed by the gatekeepers of global supply chains, whether as a result of government regulation or on their own motion. As will be discussed in greater detail below, the countries of the region should use their discussions of intra-regional trade to develop an integrated trade and climate change negotiating strategy that builds a regional position for multilateral talks as well. Plainly, negotiations within the region could bolster rules ensuring that the use of carbon tariffs or abatements do not become a process of disguised protection. This would help inform any negotiating position the various countries of the region adopted in multilateral discussions of the same theme, whether within the framework of future talks under the auspices of the UNFCCC or within the WTO. The same would hold true of a regional agreement on abatements that countries offer their producers to offset the effects of climate change on their competitiveness. A regional arrangement to ensure that such measures were designed in the least trade-restrictive and least trade-distorting way could serve as a basis for multilateral rules expanding the disciplines under the WTOâ&#x20AC;&#x2122;s Agreement on Subsidies and Countervailing Measures. While there is no region-wide trade arrangement of the sort outlined above, there are, as noted, a number of sub-regional agreements that might serve as stepping-stones to a regional accord on climate change and trade. Indeed, sub-regional arrangements such as MERCOSUR or CARICOM might usefully serve as laboratories for negotiating a regional arrangement, much like a regional accord would serve as a laboratory for the positions that the region may wish to take in multilateral negotiations on the same topic. There are, moreover, a number of other models of regional cooperation on closely related activities that already exist. The Caribbean Catastrophe Risk Insurance Facility, for example, spreads risk among 16 Caribbean countries and uses the reinsurance market to provide the liquidity needed in the face of hurricanes and earthquakes (World Bank 2008). The facility has already been put to use in the response to the recent earthquake in Haiti, and offers a means of addressing some of the more serious consequences of climate change to the extent that it drives increasingly extreme weather events. Those models provide a helpful starting point for thinking about how countries of Latin America and the Caribbean might work together to minimize the risk that will flow from measures taken to address climate change, particularly in downstream markets that are central to the regionâ&#x20AC;&#x2122;s trade. 146â&#x20AC;&#x192; Trade and Climate Change Mitigation Measures

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a. National Strategies Perhaps the most important recommendation with respect to developing a coherent trade and climate change agenda at the national level is to integrate that agenda into a broader national strategy designed to address the impact of climate change. Perhaps the most significant way in which policymakers can reduce the risk of their producers’ exposure to climate change mitigation measures is to facilitate their industries’ improvement in energy efficiency and emissions reductions. In agriculture and forestry, for example, there is an intense focus on land use as a tool to mitigate the effects of climate change. The introduction of farming and forestry methods that reduce carbon usage represent an important step in that direction. Ensuring that small landholders have access to that technology and the necessary inputs is critical to the success of that effort by virtue of their numbers. By the same token, ensuring that small landholders also have the ability to measure the gains they make in reducing the carbon consumed in growing their crops will become increasingly important to their efforts to find global markets and a higher rate of return. In other words, thinking in terms of how the owners of small farms can use the mitigation methods they adopt to their best advantage in gaining access to global markets should be an essential part of the process of developing and introducing the low-carbon farming methods from the outset. Steps like those are consistent with and can reinforce the region’s economic development. Such steps (de la Torre, Fajnzylber, and Nash 2009) are often “a byproduct of actions that the region would be interested in pursuing anyway in order to promote sustainable growth and reduce poverty, regardless of climate change.” Those steps make up what the World Bank has referred to as a “no regrets in the present” approach to climate change (de la Torre, Fajnzylber, and Nash 2009). There are five basic steps that governments in the region can take to facilitate the adjustment of their own industries to climate change and competing in a low carbon global economy. The first is the most practical: policymakers should focus first on the largest, most effective, and lowest-cost abatement opportunities that affect the broadest set of local industries possible. The goal must be to take those steps that impose the least cost on local industry while improving energy and emissions efficiency in order to minimize the impact of both global warming and mitigation measures on the prospects for economic development. The second step follows from the first. It involves an intense focus on improving the energy efficiency of the main industries that drive the local economy, particularly its exports. The key is to align the economic incentives within the domestic economy Implications for Policymakers 147

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in ways that provide incentives for energy savings, given that improving energy efficiency is the most cost-efficient method of GHG emissions abatement and the one step likely to contribute to development as a result of its contribution to rising productivity generally. The third step involves support for the early adoption of new technologies that reduce energy consumption and GHG emissions. Encouraging the adoption of such technologies will require incentives to ensure that they can compete effectively with other capital investments based on the internal rate of return on money spent on the new technologies. The fourth step involves encouraging the most efficient and sustainable use of energy used as feedstocks in various industrial processes, which is particularly important in the case of industries like cement, plastics, mining and agriculture. This step often involves removing existing subsidies for the use of fossil fuels, as well as providing incentives for the adoption of technologies that can make use of alternative sources of energy. The fifth step involves the adoption of policies designed to support the most efficient disposal, recovery, and recycling of waste products as part of a broader program to improve energy efficiency. Aligning the economic incentives domestically to encourage the recovery and recycling of waste and the recapture of energy currently lost in manufacturing operations can prove to be among the easiest steps to implement and among the most cost-effective. In each of the five steps outlined above, the goal is not to supplant market forces or cushion local producers from the need to internalize the full environmental cost of their production. Rather, it is to allow markets to incentivize and reward action by those companies that move fastest to achieve that goal. The reason for this approach is to encourage companies, in effect, to compete on the basis of their ability to reduce energy consumption and emissions. Those firms capable of internalizing the environmental costs of their production will, ultimately, prove to be the least exposed to the changes global warming will bring and the effect that climate change mitigation measures might otherwise have on their operations. The following chart helps clarify where policymakers can find some of the most cost effective means of reducing energy usage and emissions. What the chart illustrates is that not all of the gains in terms of energy and emissions efficiency will come from industry. Many of the most significant will involve changes in consumer behavior as well. Still, if the goal is to encourage industry to adapt as well as to reduce its own exposure to climate change mitigation measures, the chart indicates that there are significant savings available that would not require 148â&#x20AC;&#x192; Trade and Climate Change Mitigation Measures

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FIGURE V-1 Global GHG Abatement Cost Curve Gas CCS retrofit Coal CCS retrofit Iron and steel CCS new build

Residential electronics

Coal CCS new build

Residential appliances

Power plant biomass co-firing

Retrofit residential HVAC

Tillage and residue mgmt Reduced intensive agriculture conversion Insulation retrofit (residential) High penetration wind Low penetration wind Cars full hybrid Cars plug-in hybrid Degraded forest reforestation Solar PV Nuclear Pastureland afforestation Solar CSP Degraded land restoration 2nd generation biofuels Building efficiency new build

60 50 40 30 Abatement Cost ( € per tCO2e)

20 10

Waste recycling

Original soil restoration Geothermal Grassland management Reduced pastureland conversion Reduced slash and burn agriculture conversion Small hydro 1st generation biofuels Rice management Efficiency improvements other industry Electricity from landfill gas Clinker substitution by fly ash Cropland nutrient management Motor systems efficiency Insulation retrofit (commercial) Lighting – switch incandescent to LED (residential)

–10 –20 –30 –40 –50 –60 –70 –80 –90 –100 0

Abatement Potential (GtCO2e per year) Source: Global GHG Abatement Cost Curve v2.0, McKinsey & Company. Note: This is an estimate of the maximum potential of all technical GHG abatement measures below EUR 60/tCO2e. if each lever was pursued aggressively, not a forecast of what role different abatement measures and technologies will play.

significant new investments and should prove competitive with other items on a firm’s capital budget in terms of the internal rate of return they generate.

B. Integrating Trade and Climate Change Goals Regardless of whether the region’s policymakers embrace a vision of regional cooperation that would yield a legally enforceable international agreement, achieving progress on climate change and trade will depend heavily on the ability to articulate a set Implications for Policymakers 149

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of regional goals in the context of any multilateral arrangement. This will prove true whether the multilateral arrangement involves a new agreement on climate change within or outside of the UNFCCC or whether it simply involves the position the region should adopt in any discussions within existing international organizations, such as the WTO, on the climate and trade topics discussed above. Toward that end, it makes sense to think not only in terms of the substantive positions the region should adopt with respect to the relationship between climate change and trade, but also of the means by which those positions are reached. It also makes sense to think broadly in terms of the tools that the region’s policymakers might use to effect the goals they identify. The following discussion highlights a number of those elements. The first involves the means by which the region’s policymakers might build a participatory process to ensure that the views of the region’s producers are well understood and incorporated in the negotiating positions that policymakers eventually adopt. The second involves outreach to the private sector, both local industry and multinational companies, to play a constructive role in the broader process of adjustment and adaptation beyond simply making their views known for purposes of developing a regional climate change and trade strategy. A final element involves building the institutional infrastructure needed to implement an effective regional strategy on climate change and trade.

1. Building a participatory process Ensuring broad public support for any direction that the region or individual countries may take on climate change and trade is essential to any sustainable result. A consultative process is needed, involving a broad range of stakeholders dedicated to developing specific recommendations for the design and implementation of a trade-related climate change policy. To shape a climate change and trade initiative capable of contributing to the ability of the region’s producers to succeed in a lower-carbon global economy, policymakers will necessarily be forced to look at the varied effects of both climate change and its mitigation on individual industries in order to understand the economic challenges those industries face and to respond to their needs. This suggests the need for a consultation process mirroring that which is normally applied in the context of trade negotiations to solicit the input of various producers and non-governmental groups. Previous efforts at consultation on climate change and its mitigation in the region offer some helpful lessons for the design of a similar process designed to inform the development of a regional climate change and trade strategy. In 2008, with funding 150 Trade and Climate Change Mitigation Measures

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by the International Development Research Center and the U.K. Department for International Development, Fundación Futuro Latinoamericano (FFLA) undertook an extensive consultation process that included government officials, private-sector representatives, civic groups, and a wide number of individuals. This process provides a helpful paradigm (FFLA 2008). One of the main lessons to emerge from that effort was the importance of broad participation by both beneficiaries and decision-makers in the process. Their inclusion is essential to ensure that the results of the process actually meet their needs (FFLA 2008). It is also essential that policymakers identify the full range of challenges that producers may face, in order to ensure those concerns are addressed as part of an integrated climate change and trade agenda. The other main lesson to be drawn from the FFLA process involves the information that policymakers will need to make the judgments that are invariably involved in any strategic effort. The FFLA’s findings included a chart prepared by a number of the participants in the consultations; it identified both the information they thought was essential for policymakers and their impression about the availability of such information. Current availability of information for decision-makers on various sectors and thematic areas. The following chart illustrates the challenge that the region’s policymakers will face simply in acquiring the information needed to build an effective climate change and trade strategy. Although the chart does not cover all of the information that would be needed, it reflects the investment that will need to be made in developing the necessary input and information essential to their task. In that sense, the chart makes a compelling case for as broad an outreach as possible, simply as a way of building the database needed to inform their efforts to construct an integrated strategy. It also illustrates the need for an effective knowledge management tool that would provide a means for managing that information. This suggests a valuable role for a number of the regional economic institutions that already exist, both as a forum for consultations and for managing the information and process that would yield a regional climate change and trade strategy.

2. Engaging the Private Sector Given the nature of the challenge involved in developing a regional climate change and trade strategy and in implementing it, outreach to the private sector cannot be limited to soliciting its input at the initial stages of strategy in the broad participatory Implications for Policymakers 151

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FIGURE V-2 Sectors and Thematic Areas Sectors Thematic Areas

Coastal Zones

Health

Food Security

Energy

Medium

High

Low

Medium

High

Medium (transmission)

Key stakeholders to engage

Medium

Low

Low/Zero

History of impact and adaptation

Low/Zero

Low

Medium

Climate change impact scenarios

Low/Medium

Low

Env: Medium Social: zero Econ: medium Gov: zero

Low (env-0, soc-0, econ-medium, gov-0, ef.f.-medium)

Adaptation scenarios

Low/Zero

Low

Cost – benefit analysis

Low

Low/Zero

Medium

Low/Zero

Low

Baseline Vulnerability factors/ indicators

Monitoring and evaluation of adaptation decisions

Source: Fundación Futuro Latinoamericano.

process outlined above. There will be a continuing need for the private sector’s engagement. That effort to engage the private sector on an ongoing basis must operate at two levels. The first involves outreach to the region’s own producers. In part, the outreach to the region’s producers must be designed to inform them on a continuing basis of the challenges that will flow from any conceivable climate change scenario, as well as soliciting the private sector’s input on the potential economic implications for their operations and the private sector’s advice on what might be an appropriate response. The effort should be designed to provide an open channel regarding challenges or barriers they face so that the information-gathering effort is not static and so policymakers can respond to the challenges as they arise and as downstream mitigation measures evolve. As is often the case, the private sector will likely confront a new barrier commercially long before it comes to the attention of anyone in government. That will undoubtedly be the case in the context of climate change mitigation since that process itself will continue to evolve in an iterative process between policymakers and industry in a variety of downstream markets. Outreach to the region’s producers should also consistently reinforce the message that the private sector can reduce its own risk of exposure to the effects of climate change and any mitigation measures adopted in downstream markets by improving its 152 Trade and Climate Change Mitigation Measures

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own emissions profile. One of the dangers involved in any situation as fluid as the current circumstances involved in climate change is that the uncertainty tends to freeze the private sector’s own response, largely because the certainty needed to assess the risk and return of various actions is lacking. But it is quintessentially the role of government policymakers to provide a longer view of the challenges that both industry and society face, which in this case augurs in favor of constant pressure on industry to make progress on its own in areas within its control, such as reducing energy consumption and emissions reduction. There are a number of high-profile examples of the success of such efforts across the region that should help regional policymakers in their effort to encourage such action by the region’s producers. Plainly, the initiative undertaken by CEMEX individually and by the global cement industry as a whole in light of the obvious target their energy consumption creates in any mitigation scenario has served not only to shape CEMEX’s operating environment, but also has enhanced the industry’s voice in ways that allow it to protect its economic interests in any future discussions. The combination of affecting the current business environment in the short run, as well as contributing to the process by which significant issues will be decided in the future is, in fact, the private sector’s best insulation from any negative impact from climate change mitigation. That is the point that Latin American and Caribbean policymakers must drive home as part of their outreach to the private sector in the region. The second level at which private-sector outreach is needed is in connection with the opportunities for public-private partnerships that would enlist both the region’s business community and downstream customers in an effort to ensure that Latin American and Caribbean producers can meet any new commercial standards or accounting requirements imposed as a result of mitigation measures adopted by global buyers or by governments in downstream markets of importance to the region’s exporters. As noted above in Sections I and II, global buyers may well be the means by which the region’s producers actually confront the implications of climate change mitigation measures adopted by governments in downstream markets. While the ultimate target of such measures may, in fact, be producers in the region (i.e., in an effort to ensure that they are obliged in one form or another to bear the same costs that producers in the downstream market will bear as a result of climate change mitigation measures implemented in the downstream market), the instrument by which those measures reach the producers may flow through the global buyers in the form of product and process standards or carbon accounting requirements. Implications for Policymakers 153

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The process, by which those standards or accounting requirements are implemented, however, is not immutable. Global buyers have an important stake in the region’s producers, as markets and as a source of supply. Global buyers will therefore also have a stake in ensuring that their suppliers can, in fact, meet whatever standards are imposed in downstream markets, much the way that global buyers already work with suppliers in the region on satisfying existing product standards, customs rules of origin and other regulations affecting trade in downstream markets. That stake offers the opportunity to build a win-win outcome from the point of view of the region’s producers and their principal customers, since facilitating compliance by the region’s producers is in the interest of both parties. The constraint on creating such a win-win outcome is almost invariably the cost. Recall from the discussion above that the private sector’s willingness to take these sorts of steps depends heavily on the internal rate of return that they generate and a competition between investments of this sort (i.e., a public-private partnership) and other potential uses of capital. Seen in that light, the region’s policymakers not only have a deep stake in encouraging public-private partnerships, but also a similar stake in helping them overcome the obstacle that the cost of capital represents. There are a number of ways that policymakers can contribute to that positive outcome, all of which are designed to tilt the capital budget competition within local firms and global buyers in the direction of cooperation. First, while it is easy to overlook, the single most important thing any of the region’s policymakers can do to encourage the sort of business-to-business cooperation described above is by lowering the cost of capital and the risk inherent in investments in the region. The most important thing governments have to contribute in that regard is a macroeconomic policy that ensures price stability and provides a platform for economic growth. Creating an environment that is favorable to private investment runs a close second to macroeconomic stability. Second, and more specifically, it is important that fiscal systems within the region are designed in ways that, at a minimum, do not discourage joint action by the local private sector and global buyers to create a solution that allows the local producers continuing access to the buyers’ supply chains. They could, however, go further by offering tax incentives for the sort of cooperation that policymakers would like to encourage (e.g., tax credits, rather than deductions, for business expenses incurred in adopting energy-saving and emissions-reducing technologies or business processes that ensure that the local producer can comply with the accounting standards imposed by downstream buyers). 154 Trade and Climate Change Mitigation Measures

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Third, the region’s policymakers could also contribute by convening a discussion among local producers and their principal buyers to discuss the challenges that both sides already confront and will continue to confront in adjusting and adapting to climate change and its mitigation. The goal of that discussion should be to identify the specific hurdles that both local producers and their buyers agree stand in the way of expanding trade. Those hurdles may be specifically related to climate change mitigation measures, but are just as likely to involve issues with physical or institutional infrastructure that delays production and marketing and adds to the cost of both buyers and sellers. What is important for policymakers to recognize is that the source of the challenge (i.e., whether it emanates from climate change mitigation measures or not) is irrelevant to the calculation of what would most affect the internal rate of return on any investment in production or purchasing from local industry. In other words, if the region’s policymakers can clear other obstacles to trade that reduce the costs of producers and their buyers, that reduction in cost can be just as effective in reducing the exposure of local industry to the consequences of climate change mitigation measures as anything that the region’s policymakers might do explicitly on climate change. Fourth, the region’s policymakers should ask how they can contribute to the ability of their local producers to compete effectively in a lower-carbon global economy and how assistance from their governments could contribute to their success in that effort. Thinking in terms of where those efforts would pay the greatest dividends should lead to a focus on small and medium-sized businesses (i.e., those with the least wherewithal to cope with the capital investments needed to adapt and adjust) in the sectors that are most exposed either to the direct effects of global warming or the indirect effects of climate change mitigation measures on their downstream markets, such as agriculture.185 It is clear, for instance, that many, if not most, small producers of a variety of agricultural products in the region are not in the position to adopt sophisticated carbon accounting methodologies that may eventually be required of their downstream customers, due both to constraints on the farmers’ capital and their own business methods. Equally, the scale of the individual producer’s operations is likely to prove too small for him or her to create carbon savings sufficient to participate in emissions trading markets and create a new stream of income (another way of affecting the

185

See, e.g., Baethgen (1997). Implications for Policymakers 155

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internal rate of return associated with investing in the production methods and business processes needed to save energy and reduce emissions). There are a number of policy interventions that could assist local producers to overcome those obstacles and they need not be costly. To the extent that local law inhibits the creation of cooperatives, the rules should be modified to allow local producers to pool their investment capital where needed to acquire new technologies, capital equipment, and accounting methods that would be of use to all of them, as well as to aggregate the savings their efforts to reduce energy usage and emissions create so that they can be traded on carbon markets where such opportunities exist. Just as in the case of fiscal policy, discussed above, policymakers could go further and adjust rules in ways that affirmatively encourage such arrangements (e.g., allowing a deeper pooling of costs associated with exporting, akin to the “export trading companies” allowed under U.S. law.186 Lastly, policymakers in the region would benefit from a direct approach to many of the global firms that serve their markets as well as representing the immediate customer for many of the goods produced in the region. Large retailers like Wal-Mart already have active and innovative programs designed to improve the ability of their suppliers to satisfy regulatory standards in downstream markets and the often-higher commercial standards that the retailers apply. This provides a platform on which both the regions’ policymakers and the retailers could build to continue to draw the region’s producers into the stream of global commerce. There are a number of ways in which policymakers could incentivize global buyers without necessarily creating significant costs from the perspective of their implications for public finance. Thus, for example, facilitating the creation of carbon cooperatives could not only serve as a means of allowing local producers to participate in carbon markets on their own; they also could provide the basis for innovative trade finance arrangements. A global retailer like Wal-Mart could take the carbon savings along with the products they buy and serve both as customer and, in another sense, a broker for the local producers in terms of their participation in carbon markets. To the extent that the producers’ carbon savings generated a stream of revenue, that revenue stream could be used by the producers and their buyers as a means of financing both working capital for export and the credit terms that are often needed in the sale of goods internationally.

186

Export Trading Company Act of 1982, Public Law No. 97–290; 96 Stat. 1233.

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3. Building Institutional Capacity Plainly, developing and implementing an integrated climate change and trade strategy will require investments by Latin American and Caribbean governments in the institutional capacity needed to manage the public sector’s role in the process. That will require overcoming some unique challenges in virtually every government within the region precisely because the concept requires the involvement of both environmental ministries and trade or commerce ministries. Peru’s experience in preparing for its participation in the CDM offers some insight into what will be involved. To put Peru’s experience in context, it helps to understand that Peru adopted its Code for the Environment and Natural Resources only in 1990 (Cigarran and Iturregui 2004). Of particular relevance to Peru’s implementation of CDM projects, the legislature enacted its first ambient air quality standards in 2001 (the first emission limits imposed were on mining); at the same time it passed the Environmental Impact Assessment Act requiring an environmental impact assessment (EIA) on all major public and private projects (Cigarran and Iturregui 2004). Peru’s national environmental authority, the National Environmental Council (CONAM), came into existence in 1996 (Cigarran and Iturregui 2004). It has a relatively small staff that is supported by the environmental units in other relevant ministries.187 The complex rules governing CDM projects required Peru to appoint a “designated national authority” (DNA) responsible for their implementation. Peru identified CONAM as its DNA (Cigarran and Iturregui 2004). To serve as Peru’s DNA, CONAM became certified under various international standards (principally those International Standards Organization norms applicable to environmental management: ISO 9001 and ISO 14001) (Cigarran and Iturregui 2004). In its role as DNA, CONAM is responsible for developing and managing the “national project cycle” that provides for the review of all proposed CDM projects. That cycle involves a series of inter-agency communications, site visits, consultations with the local community where the project will be located, as well as with the promoters of the project, and the preparation of a final report on the project with input from all relevant ministries (Cigarran and Iturregui 2004). Much of CONAM’s role involves the coordination of a number of ministries that may be involved in a particular project or in the preparation of an EIA related to the proposed investment. While CONAM is ultimately responsible for approving or

187

Ibid. Implications for Policymakers 157

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denying a project proposal, it must seek the formal opinion of the ministries involved, as well as that of outside experts (Cigarran and Iturregui 2004). Each project has its own ad hoc committee made up of representatives of the relevant ministry or ministries, an expert on the type of project and EIA, and representatives of NGOs and the private sector (Cigarran and Iturregui 2004). Given the complexity of the process involved, it is no surprise that a review of the process and Peru’s well-thought-through strategy identified a “lack of institutional resources for developing, promoting and approving CDM projects” as one of the principal problems CONAM and the other government offices involved have had to confront. Peru has, moreover, had to turn to the World Bank and a variety of donors to finance the effort (Cigarran and Iturregui 2004). Peru’s experience under the CDM is instructive at three levels. The first is the extent to which Peru could build on the platform that it already had under construction for its own environmental policies. Policymakers in the region will benefit from considering the existing foundation within their own countries and how it might be used in the same way, but for the development of a broader, integrated strategy on climate change and trade. The second level at which Peru’s experience is instructive relates to its reliance on CONAM as the DNA and coordinator of the project cycle. What is significant about CONAM’s role in the process is the fact that it is essentially an arm of the President’s office, which ensures that it has the political standing and support needed to serve as a useful manager of the inter-agency process and the public outreach. The third level at which Peru’s experience under the CDM is instructive is its financing. Even though Peru built on an existing platform and designated an office as DNA that could effectively call on the added resources of the environmental units in other agencies, Peru still needed the support of the World Bank and a variety of bilateral donors to be able to afford the effort involved. That will undoubtedly prove true of efforts at a national and a regional level to develop and implement an effective strategy that meets Peru’s climate change and development objectives. Policymakers should, as a consequence, be thinking of how best to seek such material support in parallel with their efforts to develop the substance and process of such an initiative. What should be obvious from the discussion above is that investing in the institutional capacity to develop and implement an effective climate change and trade policy will require a significant commitment of both resources and human capital on the part of the region’s private sector as well as its governments. The ability and wherewithal of the region’s private sector to build the institutional capacity to compete in a 158 Trade and Climate Change Mitigation Measures

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lower-carbon global economy presents a potential market access barrier of its own, regardless of the form that downstream climate change mitigation measures take. Overcoming that barrier represents a substantial challenge in its own right. Producers across the region face their own capital constraints, as do governments. Policymakers must consider how best to help the private sector, particularly the smaller and more marginal producers, to maintain their access to global markets, which will, in the end, distill down to a question of how to help many of them afford the investments in equipment, business process, and training required to operate in the more complex business environment that is likely to follow in the wake of climate change and the various efforts at mitigation. One way to help, in that regard, is for policymakers to consciously design (or redesign) their regulatory systems to minimize the cost of compliance. The same basic thought applies to policymakers’ interface with the international private sector: pressing them for commercial standards and carbon accounting requirements that impose the least possible cost on the upstream supplier while still satisfying the international companies’ obligations under other countries’ mitigation policies. Lastly, the same challenge for the private sector should also inform policymakers’ approach to any international negotiation, whether on climate or on trade. Bargaining for the least cost as well as the least restrictive alternative should become an essential element of the region’s negotiating strategy.

C. Clarifying Objectives for Future Negotiations Distilling the discussion above to its essence helps clarify one important fact: the negotiations on climate change are, in fact, negotiations about trade, despite the fact that they are viewed almost exclusively through the prism of environmental policy alone. Acknowledging that fact is critical to ensure that the region’s trading interests are adequately protected in any future accord. At the same time, thinking of the negotiation in trade terms may also open up new alternative approaches that might make the challenges on the environmental front more tractable. Latin American and Caribbean governments should focus on the risks associated with various approaches to climate change mitigation, as much as on whether they will bear any of the outright costs of adjustment due to specific commitments to lower emissions. In other words, negotiations on climate following the Copenhagen Conference of Parties should, at a minimum, be broadened to address the potential fallout from the adoption of climate change mitigation measures. A broader vision, however, would think of how the climate change talks could also become a vehicle for Implications for Policymakers 159

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enhancing market access as a means of creating an arrangement that was both proenvironment and pro-economic development. The following discussion explores how policymakers in the region might create that sort of positive-sum result.

1. Negotiations on Climate The above analysis outlines two potential paths toward addressing the challenge climate change presents. The first involves concerted global action; the second involves unilateral (or, at best, regional) approaches that offer a distinctly second-best solution. In the absence of any breakthrough within the framework of the UNFCCC or an alternative multilateral arrangement, the global community will find itself on the second path by default. That was also the conclusion drawn by a recent World Bank analysis of the future of climate change negotiations (Barrett and Toman 2010). The study explained the reasons for the failure to date of the UNFCCC process in terms of the logic of collective action.188 As reflected in the discussion above in Section I, scientists almost universally agree that mitigation requires limiting GHG emissions. No country acting on its own can adequately limit GHG emissions in quantities sufficient to reduce the concentration of GHGs in the atmosphere in any material way. That means that achieving the desired reductions will depend heavily on the incentives each of the countries in the global system have to participate (Barrett and Toman 2010). In the case of climate change, even if the benefits of concerted action would be high, as is the case for much of Latin America and the Caribbean, the incentive to contribute towards the global reduction in emissions is low because each country will only receive a fraction of the benefit of its contribution to reducing emissions.189 That is particularly the case if the coverage of the constraints on emissions is limited and any number of large emitters are allowed to “free ride” on the contributions made by those

The logic of collective action was originally posited by Mancur Olson (1971) as a way of explaining the political economy of various instances in which groups, societies and political systems opted for solutions that were both less economically efficient and offered less for the general welfare than would be expected in light of any clear understanding of the economic challenge they faced. Olson asserted that— If the members of a large group rationally seek to maximize their personal welfare, they will not act to advance their common or group objectives unless there is coercion to force them to do so, or unless some separate incentive, distinct from the achievement of the common or group interest, is offered to members of the group individually on the condition that they help bear the costs or burdens in the achievement of the group objectives. 189 Ibid. 188

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countries that choose to participate.190 The fact that the benefits of participation will only accrue in the future, while the costs of adjustment to a lower-carbon economy must be faced currently, reduces the incentive to participate still further (Barrett and Toman 2010). Such clearly is the case with the ongoing negotiations under the UNFCCC’s auspices (Barrett and Toman 2010). It helps clarify why “it may not be possible to sustain a ‘first best’ climate policy.” Given the structure of the Kyoto Protocol on which the UNFCCC talks were based, this may not be a wholly negative outcome. From the perspective of a region like Latin America and the Caribbean, significantly exposed to the first-order effects of climate change (i.e., the actual impact of climatic change on sea levels, drought, and other effects that might flow from global warming), the UNFCCC process was unlikely to offer much in the way of actual relief. Given its significant exposure to the impact of global warming, the region clearly has a stake in an effective global response. The challenge for its policymakers in future negotiations on climate change is how to increase the incentives for global participation in any final agreement, while reducing the costs of abatement. In that regard, work done by the World Bank examines countries’ stake in climate change negotiations in terms of two vulnerabilities (Buys et al. 2007). The first involves a country’s exposure to the effects of climate change itself—what the study terms “impact vulnerability.” Impact vulnerability measures a nation’s susceptibility to harm from changes in weather and sea level. Not surprisingly, the study suggests that a country’s vulnerability depends heavily on the extent to which its economy and employment are weighted toward activities uniquely susceptible to weather-related damage (e.g., agriculture) (Buys et al. 2007). The other source of vulnerability is what the study defines as “source vulnerability,” which measures a country’s exposure to climate change and its mitigation due to its existing pattern of energy consumption. The study assesses a country’s source vulnerability based on its emissions intensity, its ability to tap cleaner sources of energy, its potential for sequestration of carbon, and its employment structure (i.e., the

As the authors of the World Bank study highlight, the collective action problem confronting the climate change negotiations is complicated further by the fact that the “risk of severe or catastrophic climate change remains quite uncertain and, therefore, “less likely to galvanize an easily maintained collective response.” Ibid. Equally, the UNFCCC process offers no guarantee that commitments by any individual countries would be matched by equivalent contributions by others. Indeed, the structure of the commitments explicitly leaves the largest emitter of GHGs—China—free from any obligation to reduce emissions (Barrett and Tolman 2010). 190

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extent to which “emissions-intensive economic sectors are also primary sources of employment”) (Buys et al. 2007).191 An obvious underlying tension exists between the two sources of vulnerability. The higher a country’s impact vulnerability, the greater stake it has in a comprehensive global agreement that constrains GHG emissions. For countries with a high source vulnerability (i.e., countries that are heavily dependent on the production of fossil fuels), the reverse is true: they have an interest in avoiding such limits. Countries within the region vary considerably in their source vulnerability and their impact vulnerability. Plainly, countries like Argentina and Uruguay that depend heavily on agriculture will face a far greater impact vulnerability than they would a source vulnerability. Conversely, countries like Venezuela and Ecuador that depend heavily on oil production for domestic consumption and export face a considerably higher source vulnerability than they do an impact vulnerability. Crafting a regional position (or at least coordinating views on climate) will require the region’s policymakers to equilibrate the interests of those two positions. Fortunately, more diversified economies, like Mexico, Brazil, and Colombia, lie somewhere along the continuum between those two poles. In those more diversified economies, the stakes for producers in other sectors may help offset the pressure that would otherwise flow from the energy industry to avoid binding international constraints on GHG emissions. There is, however, another way to look at impact and source vulnerability that is more compelling in terms of the choices regional policymakers face and may ultimately prove helpful in diminishing the potential conflict between countries with different impact and source vulnerabilities. That is the vulnerability poorest individuals confront across the region and their relative ability to cope with the adjustment and adaptation that will be required under almost any scenario. Thus, for example, while it is fair to say that the many companies and employees involved in the energy sector across the region will face a greater source vulnerability than impact vulnerability, the reverse is true for the small agricultural producers. What is more, the small farmer has considerably less in the way of resources to grapple with As discussed generally above in section I, capping emissions globally forces producers to confront the implicit cost of carbon they are currently avoiding. The limit on emissions creates a “shadow price” for carbon either in the form of an explicit tax or an opportunity cost created by the constraint on production and profits the emissions limit implies. That makes a country’s relative emissions intensity a useful indicator of its vulnerability because the higher emissions intensity per unit of output implies a higher tax or opportunity cost per unit of output. That economic logic applies with equal force to individual firms, which is why it has proved difficult to achieve a unified position on climate even within countries, much less at the regional or multilateral level.

191

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the costs of adjustment and adaptation than do the producers in the energy sector.192 That is one reason that the per capita benefits of a global response to climate change accrue to poorer states to a greater extent than to the industrialized or rapidly industrializing, particularly when contrasted with the costs of emissions abatement such countries face (Barrett and Toman 2010). There is thus a powerful reason for policymakers in all countries within the region to weight their negotiating positions heavily in favor of the poor living on the margins of the regional economy, which almost invariably means small farmers engaged in subsistence or near-subsistence agriculture. The number of people engaged in agriculture, particularly among the poor, remains high throughout the region. Those producers are the most exposed to the effects of both climate change and its mitigation, and the negotiating position adopted by policymakers in multilateral talks on climate ought to reflect their interests. Given the region’s relatively high degree of impact exposure, governments in the region could pursue what might be described as a “pro-poor” agreement on climate change—one that offers the greatest potential to retard the changes in climate already under way due to their likely effects on those living on the margins of the global as well as the regional economy. That will require an arrangement that, as discussed above, aligns the incentives throughout the global economy in ways that encourage all producers to internalize the full environmental cost of their production. Policymakers throughout the region should recognize that adopting a pro-poor perspective on climate change negotiations raises serious doubts about the value of any agreement that imposes constraints on GHG emissions solely on developed economies.193 An arrangement of that limited scope will do little ultimately to slow the trajectory of rising GHG emissions and will not materially diminish the costs of

In fairness, the World Bank’s study does capture some of this perspective implicitly by incorporating employment as one factor in its measure of source vulnerability. But, the study examines employment only as a feature of source vulnerability, rather than thinking of employment (i.e., the relative number of people engaged in a particular industry) as a factor in impact vulnerability as well. 193 Opting to support a global arrangement that encouraged all countries to constrain their emissions is, without a doubt, inconsistent with the position that many policymakers in the region and throughout the developing world have supported in the past. Both the Kyoto Protocol and the Bali Action Plan developed under UNFCCC auspices at the last Conference of Parties before Copenhagen expressly exempt developing countries from those strictures. The most recent discussions in Copenhagen (Hufbauer and Kim 2010) also confronted that orthodoxy: the outline of a proposal floated by the Danish government was roundly rejected by the G-77, representing the developing world, because it was viewed as a departure from the principles set out in the Kyoto Protocol and the Bali Action Plan, as well as a “means of sidelining the United Nations and forcing developing countries to agree to specific emission targets.” See also Vidal (2009). 192

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adaptation and adjustment the region would otherwise bear. It cannot be described as a pro-poor approach to climate change in light of the exposure that the region’s most marginal producers face from global warming. Creating a pro-poor global arrangement on climate will require an agreement that acknowledges the different capacities that developed and developing countries have to adjust and adapt, and addresses those differences through means other than differentiated responsibilities for managing emissions—which leads naturally to the topic discussed below: how a global agreement on climate might also address the trade concerns raised by climate change and attempts to mitigate its effects.

2. Negotiations on Trade There have been a number of proposals to replace the architecture of the Kyoto Protocol with alternative forms of a global agreement.194 Virtually all of the proposed alternatives suggest the inclusion of the developing world within a system of binding GHG emissions restraints on some basis (Aldy, Barrett, and Stavins 2003). The reason for that change in approach is the sense that Kyoto created a dynamic that produced “too little, too fast” (i.e., not enough action on emissions to limit the potential risks climate change creates, while at the same time proposing ambitious and, therefore, costly short-term economic dislocations). With that perspective in mind, the proposals suggest more moderate commitments at the outset of any new arrangement, which then become more stringent over time (Aldy, Barrett, and Stavins 2003). The proposals all call for developing countries to assume a greater degree of responsibility as the commitments are phased in (Aldy, Barrett, and Stavins 2003).195 A number of the proposals offer positive incentives to encourage developing country participation (e.g., giving developing countries relatively large emission ceilings in order to allow them to become net exporters of emission allowances).

For a helpful review of a number of the proposals for a post-Kyoto global agreement, see Aldy, Barrett, and Stavins, (2003). The authors analyze Kyoto and the various alternatives applying six criteria: environmental outcome, dynamic efficiency, dynamic cost-effectiveness, distributional equity, flexibility in the presence of new information, and participation and compliance. The Kyoto Protocol fares poorly under their analysis, particularly in terms of the environmental outcome. The other proposals offer some improvement in one dimension or another, but none did well under all six criteria. 195 A number of the proposals would require developing countries to take on emission commitments at the outset of a new arrangement; others recommend participation by developing countries above certain income levels. Still others involve developing country participation in ways other than emission commitments (e.g., participating in research and development activities to a degree). 194

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What the various proposals do not do is think expressly in terms of inducements for participation that would result from increased market access and tighter disciplines on trade measures; these would be of benefit to the developing world, particularly to producers in Latin America and the Caribbean. On the contrary, the only context in which the proposals mention trade is the use of trade sanctions to enforce the environmental aspects of any new accord (Aldy, Barrett, and Stavins 2003). Given that the poor throughout the region would benefit most from a stronger accord and that a stronger accord implies participation by the countries of the region and the rest of the developing world as well, policymakers have an incentive to determine how they can pursue that outcome at the lowest possible cost. One alternative that would contribute to that effort would involve expressly using market access for the countries of the region to increase the incentive to participate in any replacement for the Kyoto Protocol and to reduce the cost of assuming any obligations under such an arrangement. For purposes of argument, such a proposal might include two basic elements. The first would involve strengthening the existing disciplines under the WTO on various trade measures that might be used by governments to protect their own industries from the competitive effects of adjustment and adaptation to a lower carbon global economy. Given the nature of the trade measures that have been discussed to date, a proposal to reinforce the WTO’s current disciplines in order to ensure that the region’s exports did not face any fallout from mitigation measures designed to protect domestic industries would have to include the following minimum list: »» reinforcing rules guaranteeing non-discrimination (i.e., hardening the most-favored-nation clause and existing tariff bindings of Articles I and II of GATT 1994 and enhancing the rules regarding national treatment under Article III); »» clarifying and tightening the availability of Article XX exceptions related to environmental measures in order to prevent their misuse as a means of disguising protection; and »» strengthening disciplines on the use of subsidies, particularly with respect to the development and implementation of alternative forms of energy.196

One option on the subsidies front would be to add a provision to the existing Agreement on Subsidies and Countervailing Measures that would build on the provisions of Article XX. Article XX has been interpreted by the WTO’s Appellate Body to require WTO members to adopt the least trade restrictive means of implementing any regulatory measure for environmental or other purposes. In a subsidies 196

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The second element would involve a proposal for increased market access in a number of areas of interest to the region, from agriculture to manufacturing to services and the movement of people engaged in trade or business. This element would embrace, in essence, the market access negotiating agenda that the countries of the region sought to secure through the Doha Development Agenda (DDA) within the WTO. Again, the idea of not just a â&#x20AC;&#x153;development round,â&#x20AC;? but a truly pro-poor realignment of the incentives in the global trading system may prove instrumental in galvanizing action among WTO members. The DDA has plainly foundered; it is unlikely to yield any near-term results in the absence of some stimulus from outside the confines of the trade negotiations. Crafted carefully, the call for and negotiation of a pro-poor liberalization of world trade that is designed to complement the negotiations on climate could provide the political push that has been missing to date. Adopting that approach would offer one significant added benefit. It would create an opportunity to connect the efforts on many fronts that, taken together, make up the aid-for-trade agenda discussed above. In this instance, integrating climate change and trade negotiating objectives with the express goal of creating a pro-poor outcome would also provide aid-for-trade with an organizing principle that it has, in many respects, lacked since its inception. Financial commitments with respect to aid for trade could be explicitly linked to, and support the achievement of, both climate change and trade objectives. What the combined package would do is significantly expand the benefits of participating in the global response, which would help overcome the logic of collective action that has undermined progress to date.

context, policymakers may wish to consider a similar approach (i.e., one that ensured that any subsidy was, in fact, adopted in the least distortive form possible). Thus, for example, the added discipline might extend protection against any WTO action only to those subsidies that could be justified in terms of their 166â&#x20AC;&#x192; Trade and Climate Change Mitigation Measures

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Trade and Climate Change Mitigation Measures:

Implications for Latin American Producers Preliminary Version

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