5 Environmental Policies and Trade Given the lack of a global agreement on specific economic measures to reduce carbon emissions, both policy makers and the private sector are under increasing pressure to introduce measures that will reduce their country’s or company’s carbon footprint. This chapter reviews emerging measures and assesses their implications for trade flows, especially those of low-income countries.
The Carbon Border Adjustment Mechanism and low-income-country trade The Paris Agreement allows countries to work from highly different starting points and with different ambitions toward the common goal of achieving zero net emissions. While the agreement is aimed at global convergence of mitigation efforts, in the first years of implementation, different starting points and ambitions entail both variety and asymmetry in the use of mitigation instruments. Firms in countries with high a mbitions for mitigation fear an erosion of competitiveness under this scenario. Steelmakers in the European Union (EU), for example, must buy emissions allowances in the EU Emissions Trading System (ETS);1 if the price of these allowances becomes significant, steelmakers fear that they will be unable to compete with steelmakers in countries not subject to such costly carbon regulation. As a result, there is a risk that production may shift to unregulated countries. This concern over a loss of competitiveness without an accompanying gain in the global fight against climate change intersects with the concerns that environmentalists have about carbon leakage. Carbon leakage occurs when carbon emissions rise in countries with weak carbon regulations because stricter regulations in other countries make unregulated markets more attractive and competitive. So far, there is no conclusive evidence to support this perceived risk.2 Carbon border adjustments3 are being explored as one solution to the problem of carbon leakage.4 Such adjustments add a price to imports that corresponds to the price of carbon emissions that domestic firms pay. This adjustment is designed to nullify the cost advantage that firms producing in an unregulated country enjoy when selling in a regulated country. Border adjustment is often envisioned as a tax levied at the border, but it may also occur by other means;
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