E15 ag groupreport agricultural trade and the environment

The

E15

Initiative

Strengthening the multilateral trading system

Group Report Internalizing the costs of greenhouse gas emissions and other externalities

E15 Expert Group on Agriculture and Food Security

IATRC/IPC E-15 Expert Group Meeting on Food Security – Geneva, September 27-28, 2012 Report of the Group on Agricultural Trade Policy and the Environment – Internalizing the costs of greenhouse gas emissions and other externalities The Challenge Adaptation to global climate change (which is already underway) and climate change mitigation (reduction of GHG emissions, carbon sequestration) are critical issues for the global food system. Efficient and sustainable resource use at the global level will be needed to meet the expanding food demands of a growing population with higher incomes. This will involve what has been variously been described as reducing the environmental footprint, the greening of agriculture, or sustainability. The central issue is how can we make agriculture more environmentally friendly, in terms of its impact on soil resources, water quantity and quality, biodiversity and GHG emissions and how can we make agriculture more resilient in the face of climate change, while at the same time meeting other key objectives such as food security. There will inevitably be trade-offs involved in trying to meet multiple objectives – there is unlikely to be a win-win option.

In terms of climate change, an important consideration is that it is probably unrealistic to assume that we can reduce total GHG emissions from global agriculture. The challenge is to increase emissions efficiency, i.e., to reduce emissions per unit of product or even better per food calorie. These are not the same, since the latter will almost certainly involve significant dietary change, particularly among the more affluent members of society. Higher emissions efficiency is likely only to be achievable through changes in both production methods (how food is produced) and the location of production (where it is produced), as well as in food consumption (what is consumed). It will also be necessary to deal with other issues such as the reduction of food waste and increasing energy efficiency in food processing, storage, distribution and preparation for final consumption.

Some countries (e.g., tropical countries) may have a comparative advantage in the production of lower-emission food supplies (because of climatic advantages) and they need to be able to take advantage of this. A purely 1

domestic focus in emissions reduction (adoption of the aim of reducing emissions for each country individually, particularly in a situation where there are barriers to international trade) is unlikely to be an efficient approach.

Trade will need to play a key role in achieving global emissions efficiency. It is important to realize that the need for global intensification of production in order to meet the anticipated growth in food demand does not necessarily imply that intensification of production in all countries is the best option for reducing the environmental footprint of agriculture. Over time, the pattern of production will need to change. Food will need to be produced in the most efficient areas (those with the lowest inputs per unit of output) and international trade will play a key role in that process. There is obviously a potential conflict between the need for change in the location and intensity of production and food security, particularly if this is viewed to be based on increasing national self-sufficiency. Efforts to increase the self-sufficiency ratio in individual countries may reduce global efficiency in terms of lowering the environmental footprint of agriculture.

Domestic Policy Choice With this background, the key issue is what domestic policy choices exist for addressing environmental issues in agriculture and what are their international implications? In assessing this, we need to take account of the fact that unless multilateral institutions change in the future (e.g., there is the creation of some sort of global environmental agency), within the framework of current rules and disciplines the WTO will only have a limited role in addressing environmental issues. Its primary function in this area will be to try to ensure that domestic policies designed to address environmental issues (whether based on domestic objectives such as the reduction of local nitrate pollution of water bodies or those based on international commitments, such as those designed to reduce GHG emissions) do not generate trade distortions and trade conflicts.

In focusing on domestic policy options, the traditional approach suggested by economists for dealing with environmental issues is to internalize the costs of negative externalities (ensure that their costs are taken into account in production and consumption decisions) and to provide an incentive for the supply of positive externalities and public goods. Regulation is also an 2

approach that can be used (the generation of the optimal supply of a good by controlling its quantity rather than by influencing prices). Market-based approaches can also be used to ensure the provision of public goods. These center on the creation of property rights so that the suppliers of such goods can be rewarded. In summary, in terms of public policy choice the principal options revolve around the use of “carrots” (incentives) and “sticks” (disincentives) to address environmental quality issues.

In the agricultural context there is probably a limited role for the use of “sticks” e.g., taxes to internalize negative externalities such as pollution. This is because it is often difficult to impose taxes on agriculture. For example, how does one tax GHG emissions from livestock or diffuse (non-point) sources of nitrate pollution from crop production? Some agricultural externalities can be influenced if some of the inputs used by agriculture are taxed, e.g., taxes on fertilizer or agro-chemicals and fuels to reduce the emissions generated in using these inputs. It may also be possible to impose indirect taxes on emissions, e.g., through a headage tax on livestock of through taxes on livestock products. However, in addition to technical problems, a key issue is that there are often political constraints. A tax designed to internalize an agricultural externality may simply be perceived as a tax on farmers per se (particularly by farmers!) and therefore be politically unacceptable. The Polluter Pays Principal (PPP) which has been advocated in certain quarters, e.g., by the OECD, often does not have a lot of traction in the political arena.

For this reason, “disguised sticks” such as regulatory measures are sometimes used to internalize external costs, e.g., the use of permits to control the discharge of animal waste by large feeding operations. Regulatory measures typically impose additional costs on producers. Regulatory costs are sometimes imposed through conditions attached to transfers of public funds to farmers that are designed to achieve non-environmental objectives. One example of this is the environmental cross compliance requirements for the receipt of price or income supports applied in the EU and the US. Regulatory measures can contribute to environmental quality objectives providing that compliance with conditions imposed is monitored and penalties are imposed for noncompliance.

3

By far the most popular approach for countries that can afford it is to provide “carrots” (payments) to farmers to reduce pollution, i.e., a Pay-the-Polluter (PTP) approach. This is also used to stimulate the supply of positive externalities or public goods. Such payments tend to be linked to practice requirements, e.g., restrictions on farmers can do in managing their land.

Where measures generate a private benefit (e.g., lead to lower costs or higher profits for farmers or the avoidance of charges or penalties) it may be sufficient to provide partial payment (a cost share). From society’s perspective an important issue in designing payment schemes is how to obtain the maximum social benefit at the minimum social cost. There is a large and growing literature on agri-environmental program design and how this aim can be achieved.

International Implications of Domestic Policies As indicated above, to the extent that environmental issues in agriculture will be addressed in the WTO the focus will most likely be on how domestic policy measures relate to existing rules and obligations. Blandford and Josling (2009) discuss the relationship between GHG reduction policies for agriculture and the WTO. Blandford (2012) has addressed issues associated with national and sectoral climate change policies. The focus of the discussion in the expert group was primarily on the compatibility of incentive-based domestic policies for agriculture, justified by WTO members on environmental grounds.

WTO members are unlikely to contest the use of explicit or implicit taxes (“sticks”) to internalize negative externalities in other countries, even though this may actually increase food costs for importers if they impose significant additional production costs. Measures that discourage production are not disciplined in WTO agreements. In contrast, Annex 2 of the AoA includes the use of payments (“carrots”) under environmental programs under the green box if they are part of a defined environmental program and are limited to either compensation for the costs incurred in meeting the conditions under such a program or the income foregone through compliance. This raises potential issues for programs that seek to provide an incentive for farmers to participate in environmental programs, rather than simply compensate them for additional costs or loss of income. The group recognized the difficulties of updating Annex 2 to allow for an incentive component in environmental 4

payments, without opening the door to the creation of programs whose principal effect is to provide trade-distorting production support. Income support payments involving production enhancing cross-compliance conditions (e.g., requiring certain types of land use) are particularly problematical in this regard. It was also noted by the group that some environmental programs currently notified as green box may not conform to the conditions specified in Annex 2 (and that this may also apply to some other programs). The lack of challenge to date to such apparently non-conforming programs may reflect the view that, on balance, a shift away from forms of support under the amber or blue boxes to those that may broadly (if not exactly) conform to green box requirements may be preferable. Programs that are clearly trade-distorting are replaced by programs which may be far less so. If, in the future, programs with environmental objectives, e.g., adaptation to climate change or GHG mitigation, tend to proliferate, the conditions attached to such programs and whether they meet green box criteria may generated more scrutiny.

In this regard, the group agreed that there is a need for greater transparency in agri-environmental policies in the WTO. One requirement could be for full and regular reporting on environmental programs to include assessments conducted at the national level (the EU is expanding this type of activity in the context of Pillar II expenditures under the CAP, which includes agrienvironmental programs). Increased domestic scrutiny of programs and enhanced reporting to the WTO would help to facilitate challenges by other members, where the compatibility of programs with WTO rules and disciplines is questionable.

The group recognized the important role to be played by research and development (R&D) in addressing environmental issues in agriculture, particularly the challenges posed by climate change. Greater domestic and international effort in this regard will be needed (e.g., for developing countries through the CGIAR mechanism). In the context of developing countries, governments may have to play a major role in the provision of infrastructure to facilitate adaptation (e.g., the expansion of irrigation), even if part of the cost can be borne privately. In this context, co-financing provisions for obtaining international funds for infrastructure projects may prove a barrier to adoption.

Perhaps the adaptation of the “aid for trade� approach to place a priority on

5

investments that increase the resilience of agriculture in the face of climate change could provide a way forward.

Most of the discussion of the group focused on domestic policy measures oriented to agricultural production to deal with environmental issues, but there are also consumption issues. There are likely to be few international protests if a country chooses to impose a tax on high-emission foods (red meat) for example in order to promote the consumption of vegetables or lower-emission meats (such as poultry). There may be more concern about other initiatives, such as the promotion of local food, much of which receives support from farm groups and governments and could be viewed as a way to increase self-sufficiency and discourage international trade.

The issue of green labeling raises particular concern, particularly since there seems to be a lack of standardization in approaches used to determine the carbon footprint or other environmental attributes of products. Much of the impetus for green labeling seems to be coming from retailers – private standards are becoming a key determinant of what is traded. The group had a lively discussion on this issue and the role of governments in relation to private actors in determining standards that influence trade. It is clearly the responsibility of national governments to ensure that consumers are not presented with misleading information on labels, but at the international level perhaps CODEX alimentarius could be used as a vehicle for the development of an agreed, universally applicable methodology for determining carbon footprint or other environmental attributes. This would enable labeling to be scientifically based and reduce the risk of discrimination against imports.

The group had a very limited discussion on biofuels and their relationship to environmental issues. There was general agreement that many first generation biofuels (such as ethanol from maize) have dubious environmental benefits.

The estimation of indirect land use effects, the estimation of reductions in GHG emissions, and the use of various sustainability criteria at the national level seem to be creating trade tensions and have the potential to create trade conflicts. Similarly, the application of blending or consumption mandates for biofuels can create trade distortions, both through the impact of implicit subsidies on production as well as the trade effects of possible imbalances in domestic supply and demand.

6

Finally, there was some discussion of linkages between policies and trade in inputs of importance to agriculture, such as fertilizer. The application of carbon taxes is likely to have implications for the use of inputs and possible implications for future intensification of agriculture, environmental quality and food security. Increasing soil quality and productivity is a particular challenge for many African countries, for example, and there has been some progress in increasing productivity through higher usage of inorganic fertilizer. It is unclear how the carbon footprint of organic fertilizers, the use of which is being promoted in certain quarters, compares to that for inorganic fertilizers and the extent to which inorganic fertilizers can generate necessary increases in productivity.

In conclusion, it is probably fair to say that the widespread application of domestic policies designed to reduce the environmental footprint of agriculture is likely to have implications for the global trading system. The use of such policies raises issues that may not be easily addressed within existing multilateral institutions, if at all.

WTO actions – a summary There is a need for continued emphasis on the elimination of trade-distorting policies in agriculture in order to allow the relocation of production in areas that are best suited to producing food most efficiently. The completion of the Doha Round of WTO would make a contribution in this regard. Stronger disciplines on biofuels policies would also be useful. The argument has primarily focused on hidden domestic subsidies to farmers, but biofuels policies also have environmental implications. Most important, it is essential to avoid the use of barriers to trade on alleged environmental grounds (tariffs and import restrictions). The correction of environmental distortions at the domestic level is the approach that needs to be adopted, rather than trying to address such distortions by imposing barriers to trade.

Recognizing the art of the possible – that it will only be possible to make modest changes in WTO agreements and processes to address environmental issues – the group suggests that consideration be given to the following four aspects:

7

1. A re-evaluation of provisions governing environmental payments in agriculture (e.g., in Annex 2) to address the issue of allowable incentive payments.

2. Enhanced reporting and scrutiny of agri-environmental programs and payments that have environmental provisions to ensure that these are minimally trade distorting. Particular emphasis needs to be placed on existing forms of support that are being re-justified in terms of environmental objectives.

3. Examination of criteria for environmental labeling through CODEX with a view to deriving internationally acceptable methods for determining carbon footprint and other environmental attributes.

4. Adaptation of aid for trade to incorporate an environmental dimension to promote environmentally-friendly trade expansion in developing countries and also to facilitate adaption to the effects of climate change.

References D. Blandford and T. Josling. Greenhouse Gas Reduction Policies and Agriculture: Implications for Production Incentives and International Trade Disciplines. Issue Brief No. 1. International Centre for Trade and Sustainable Development, Geneva, August 2009. http://ictsd.net/i/publications/52335/ D. Blandford. Climate Change Policies for Agriculture and WTO Agreements. In J. McMahon and M. Desta (eds.). Research Handbook on the Agriculture Agreement. Cheltenham, UK, Edward Elgar, 2012.

8