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Creating Incentives and Removing Obstacles

This book has analyzed the role of climate change in global economic governance against the backdrop of two central themes: technology diffusion and unilateral responses to multilateral negotiation failure. It has not been possible to reach multilateral agreements with respect to climate change finance, intellectual property rights for plant varieties, a multilateral investment agreement, or international trade in environmental goods and services. Multilateral progress in all of these areas would facilitate technology diffusion and diminish the need for unilateral action.

In the case of the WTO, deadlock at the multilateral level has led to unilateral, bilateral, and regional policy responses. The same may happen with respect to climate change negotiations. Unilateral measures may be taken to address local or global concerns and may be used to create incentives for multilateral action. They may be consistent with international obligations or not, depending on the circumstances ofeach case. Unilateral measures can serve as catalysts for multilateral action on climate change, by prompting the affected economic actors to pressure their governments to seek a solution, through litigation or negotiation. Climate change agreements should either comply with or prompt modifications to international economic law and global models of economic governance.

Existing international economic law places limitations on the right of national and sub-national governments to regulate to address climate change. Given the current difficulty in reaching multilateral agreements, we assume for the most part that countries will have to develop climate change policy and law within the constraints of the existing legal, economic, and financial framework. The shifting fortunes of developed and emerging economies have altered the dynamics of global governance. The ensuing multilateral negotiation paralysis means that unilateral action will be necessary to create incentives to address climate change. However, the risk of regulatory capture needs to be addressed to ensure that these unilateral measures are consistent with international law and economically viable.

The failure to advance in the UNFCCC negotiations prevents advances at the WTO with respect to the compatibility of multilateral and unilateral responses to climate change. Moreover, the climate of uncertainty leads to risk aversion, making it less likely that financing of green technologies will come from the private sector. However, public financing of green technologies will be uneven across countries and could lead to serious market distortions that will create further political and economic instability. As a result, it is important to identify policy issues and options and ways to overcome negotiation obstacles.

One proposal, with respect to WTO negotiations, is to make negotiations less ambitious, by abandoning the rule that “nothing is agreed until everything is agreed,” and to abandon decision-making by consensus. There are precedents for this approach at the WTO, in which a limited number of Members agreed to liberalize specific sectors once enough Members were on board to cover ninety percent of trade in the sector. The most-favored-nation rule extends concessions to all WTO Members and the resulting agreement is left open for other Members to join. The same approach to environmental goods and services would reduce barriers to technology diffusion for climate change. A similar approach could be taken with respect to GHG emissions, by seeking agreement among the countries that account for the overwhelming majority of emissions, and by leaving it open for other countries to join.

Countries may choose to apply taxes that discriminate between different products based on differences in national climate change policies or differences in the carbon footprints of products. Concerns regarding the impact of carbon taxes on competitiveness can lead to the implementation of accompanying border tax adjustments or export subsidies to compensate for a lack of carbon taxes or equivalent measures in trade partners. While some have argued in favor ofimposing countervailing duties against products from countries that do not require emissions reductions, the definition of subsidy would likely preclude such actions unless, for example, a country applied a general carbon tax but then subsidized a specific industry by not collecting the tax. Similarly, antidumping duties cannot be used to counteract so-called “environmental dumping,” since differences in domestic environmental regulation cannot be used as a basis for applying antidumping duties.

However, the Antidumping Agreement and the SCM Agreement’s rules on countervailing duties might serve as a model for regulating this type of unilateral climate change measure. Antidumping duties and countervailing duties are unilateral trade actions. WTO law regulates their use, by imposing substantive and procedural rules on the national investigating authorities that investigate dumping and subsidies allegations and calculate the antidumping and countervailing duties. A limited number of like-minded countries could develop a similar approach to regulate the use anti-carbon duties between them. While such investigations create commercial uncertainty that can disrupt trade, if countries begin to take such measures it would be better to regulate their use. Measurement of carbon footprints may be difficult, but investigating authorities are already set up to measure complex economic and legal issues.

Mitigation and adaptation deal with different aspects of the risks imposed by climate change, but they are interrelated. Since mitigation would prevent the worst- case scenario from occurring, it increases the chances that the remaining climate risks can be successfully managed through adaptation. The benefits of mitigation are global, but the cost of reductions is primarily local. In contrast, adaptation costs and benefits are both primarily local. Mitigation benefits are long-term, whereas adaptation benefits are short and medium-term. Because of these differences, national and international climate change response efforts have followed separate mitigation and adaptation paths, with a major focus on mitigation. However, some climate change impacts are unavoidable now, so adaptation efforts have begun. Nevertheless, the technological and financial capacity of countries to adapt to climate change differs significantly, as does their vulnerability to the effects of climate change. These differences between countries are part of the reason for incorporating the principle of common but differentiated responsibilities into the UNFCCC.

Policy responses that depend on the maturity of financial markets or the robustness of national regulatory institutions may not work in all countries. Differences in levels of economic development influence the design of global solutions both at the negotiation stage and at the implementation stage. However, simply dividing countries into developed and developing is an outdated approach that is not working.

Incentives to take mitigation and adaptation measures are asymmetrical, since the costs and benefits of these measures are not the same for all countries. Discussing the costs and benefits of mitigation and adaptation in terms of developed and developing countries ignores the global nature of the problem, the potential seriousness of the consequences, and the great variation among countries in vulnerability to and capacity to adapt to the effects of climate change.

Dividing the world into developed and developing countries, and using that categorization as a basis for addressing climate change, whether through adaptation or mitigation, is too simplistic. The financial and technological endowments of countries are not frozen in time. It makes more sense to assign responsibility on a scale, based on objective criteria that are in accordance with the governing principles of international environmental law and determine responsibility for the cost of mitigation and adaptation, respectively. These criteria could be used to create an index of countries that evolves as conditions change, what we call the “Climate Sensitivity Index.”

With respect to clean energy technologies, the debate over intellectual property rights, and technology transfer from developed to developing countries is similarly misplaced. This type of North-South debate distracts from the real issues: creating incentives for and removing obstacles to clean energy development and dissemination. For example, fossil fuel subsidies need to be reallocated to clean energy technologies. Developing countries’ fossil fuel subsidies are four times greater than the financing they seek for climate change mitigation and adaptation. The World Bank is prepared to provide technical assistance to developing countries to change these policies. Moreover, developing countries are becoming an important source of clean energy technology, particularly China. Dissemination of clean energy technologies can be facilitated by removing barriers to foreign investment and international trade in clean energy technology and related services. For these reasons, the analysis of clean energy technology transfer should focus on these issues, rather than on an outdated North-South debate over intellectual property rights.

While countries have been debating intellectual property rights and technology transfer in the context of the UNFCCC negotiations, some developing countries have been signing free trade agreements in which they commit to stronger intellectual property rights for plant varieties.[1] This is one area where intellectual property rights are likely to create obstacles to climate change adaptation and where a North-South debate over intellectual property rights would be appropriate. While the World Bank has discussed the importance of new plant varieties for climate change adaptation in developing countries, this discussion has taken place without any mention of the implications of intellectual property rights for the dissemination of these biotechnologies. This is an example ofwhere existing WTO law strikes the right balance, by maintaining policy flexibility. But this flexibility is being eroded in bilateral and regional negotiations.

Subsidies law is an area where WTO law does not strike the right balance, by facilitating fossil fuel subsidies, discouraging clean energy subsidies and facilitating the application of countervailing duties against imports of clean energy technologies.

International jurisprudence has become an increasingly important source of international law and plays an important role in the interpretation of treaties. However, there are limits to what WTO jurisprudence can do to correct deficiencies in the SCM Agreement. Moreover, international climate change regulation involves many different fields of international law, and WTO tribunals are limited to WTO law. In addition, the multiple sources of international climate change regulation make the process of interpreting and applying international climate change law particularly complex.

General international law can sometimes be used to fill in the gaps in treaties. However, general principles cannot displace clear treaty language. Moreover, while some principles have been recognized as forming part of customary international law, others have not. A treaty interpreter must take care not to exaggerate the importance of non-binding principles, which can guide actions without obligating governments, and to carefully consider the role that they might play in the interpretative process. At the same time, a treaty interpreter must avoid conflicting interpretations of obligations in different fields of international law, and general principles may prove useful in this regard. In general, the current status of the principles ofinternational environmental law that are relevant to climate change are compatible with WTO law: sustainable development, the precautionary principle, common but differentiated responsibility, environmental impact assessment, responsibility for transboundary environmental damage, and the duty to cooperate to address transboundary and global environmental problems.

The polluter-pays principle has not been applied effectively in either climate change law or WTO law, which also avoids incompatibility between these two areas of law, though not in a positive way. The polluter-pays principle, which forms part of international environmental law, has encountered political resistance in international climate change law. In particular, the wide use of fossil fuel subsidies and the disincentives to subsidize clean energy technology reveal a need to change the multilateral regime, particularly the WTO SCM Agreement. This represents a weak point, where multilateral consensus is lacking and unilateral measures might begin to fill the gap.

International environmental law and WTO law both permit unilateral trade measures to conserve transboundary or global resources. They should be preceded by good faith efforts to reach a negotiated solution, be applied flexibly to take into account different conditions among countries (but not a simplistic division between developed and developing countries), and comply with transparency and procedural fairness. However, the degree of urgency may be a factor that requires much greater or lesser effort to reach a negotiated solution, particularly with respect to the time frame involved. The need for climate change mitigation and adaptation is now urgent, which buttresses arguments in favor of unilateral action.

While the precautionary principle might be used to persuade countries that they should reach international agreements to address effectively the risks from climate change, it is far less important than the actual terms of those agreements. Nevertheless, the precautionary principle may serve as an additional argument to justify unilateral and multilateral measures taken to mitigate or adapt to climate change measures based on limited or insufficient scientific proof, both in WTO law and in international investment law. In both areas of international economic law, it would be relevant to arguments regarding the nature of the measure. In the case of international investment law, it could support an argument that the measure relates to environmental protection, not investment, and is not subject to the provisions of the international investment agreement. In the case of WTO law, it could be used to support the same argument, that the measure is an environmental measure, and that any discrimination is neither arbitrary nor unjustifiable.

The EU Aviation Directive demonstrates how a unilateral climate change measure can create incentives to make progress on climate change multilaterally. The same is true with respect to WTO law. WTO Members are free to eliminate trade barriers unilaterally, as long as the MFN rule is observed, and bilaterally or plurilaterally, as long as they comply with the exceptions for regional trade agreements in GATT Article XXIV and GATS Article V. In the case of climate change, however, the regime is less developed and there is greater uncertainty regarding the compatibility of unilateral and regional approaches to mitigation and adaptation. It might be useful to add explicit provisions to the UNFCCC, to reduce the uncertainty regarding the consistency of unilateral, bilateral, and plurilateral approaches to climate change regulation. As with the WTO, unilateral, bilateral, and plurilateral approaches can complement multilateral approaches, by pushing countries to follow suit multilaterally. The UNFCCC already incorporates the language of GATT Article XX regarding arbitrary or unjustifiable discrimination between countries, but this is insufficient to address this issue.

Regulatory capture creates risks that unilateral measures will serve as disguised restrictions on international trade rather than legitimate efforts to combat climate change. For this reason, unilateral measures should be designed and applied in accordance with GATT Article XX, to minimize the risk of unilateral measures that constitute arbitrary or unjustifiable discrimination or disguised restrictions on international trade. In this regard, it is helpful that this same language has been incorporated into international environmental law and the UNFCCC. The political and economic context that has led to multilateral negotiation paralysis means that unilateralism may represent the future of climate change regulation, at least in the short to medium term. However, this does not mean that we cannot use the multilateral consensus that has been achieved so far to regulate the use of unilateral measures.

The ongoing implementation of climate change policies could raise several unresolved issues in WTO law. GATT Article XX will play an important part in determining the WTO consistency of climate change measures. The scope of paragraphs (b) and (g) in GATT Article XX still needs to be defined in many aspects, as does the relationship between these two paragraphs. Multilateral environmental agreements on climate change will probably be relevant to determining the consistency of climate change measures with GATT Article XX and the provisions of the TBT Agreement. However, it is unlikely that GATT Article XX will be applied to the SCM Agreement, the Agreement on Agriculture, or the TBT Agreement. Its application to provisions in other agreements in Annex 1A will have to be analyzed on a case-by-case basis.

If processing and production methods are relevant to determining the issue of “like products” in GATT Articles I and III, the SCM Agreement, the Antidumping Agreement, and the TBT Agreement, then this may provide an alternative analytical approach to determine the WTO consistency of climate change measures. Again, this will have to be analyzed on a case-by-case basis in light of specific climate change measures. However, if environmental subsidies are designed so that they are not specific to certain enterprises, they will be not be subject to multilateral action under Part III or unilateral action under Part V. If the subsidies apply to agricultural products, they will have to comply with the commitments ofMembers under the Agreement on Agriculture. In the case of export subsidies, compliance with the Agreement on Agriculture may shield subsidies on agricultural products from action under SCM Agreement Article 3.1(a). However, opinion differs on this issue. In the case of subsidies contingent on the use of domestic products, it will be necessary to comply with both the SCM Agreement and the Agreement on Agriculture.

With respect to WTO non-discrimination obligations, “less favorable treatment” requires a determination of whether the contested measure modifies the conditions of competition to the detriment of imported products. However, the existence of such a detrimental effect is not sufficient to demonstrate less favorable treatment if the detrimental impact on imports stems exclusively from a legitimate regulatory distinction, provided that it is evenhanded. Thus, the “legitimate regulatory distinction” test serves as a defense to allegations of WTO-inconsistent discrimination, where risks are addressed in an evenhanded way, for example where distinctions in treatment are based on evidence that the risks are different in different situations and therefore the different situations need to be addressed in different ways to achieve the ultimate policy goal. With respect to climate change, emissions from different fuels could be subject to different taxes where the different emissions pose different risks, for example due to the nature and quantity of GHG emissions for each fuel or the GHG emissions from their productions processes. Different treatment of products, based on their processing and production methods, also might not constitute less favorable treatment, for example due to differences in their carbon footprint. The difficulty is that carbon footprints may be difficult to measure and the design of carbon labeling programs runs the risk of being distorted to benefit domestic industry lobbies. De facto discrimination, which creates incentives for private actors to choose domestic inputs over imported ones, could be incorporated into some element of the design of a regime of carbon taxes and border tax adjustments, for example where the taxes themselves do not discriminate but the reporting or filing requirements are more burdensome for the imported products.

At the end of the day, multilateral climate change regulation will likely prove insufficient to tackle climate change effectively. This gives WTO Members an argument to adopt unilateral technical regulations, since the international standards, if any exist, will be ineffective, in light of the growing scientific evidence of the urgency of addressing climate change. Multilateral negotiation paralysis, and the dramatic changes in the economic growth, technological capacity and GHG emissions of developing countries since 1992, has made the UNFCCC approach outdated and ineffective to address climate change adaptation and mitigation. Moreover, new evidence indicates that the climate is changing faster than expected.

International investment agreements could prove problematic, not because of the substance but due to the lack of predictability in the outcomes of arbitrations. The language of international investment agreements is sufficiently flexible to accommodate climate change regulation. While international investment tribunals do not create precedent that is binding upon other tribunals, this jurisprudence does influence other tribunals. However, the approach of different international investment arbitrators to similar issues can vary considerably, which creates a degree of uncertainty regarding the outcome of international investment litigation.

Governments must strike a balance between regulation that discourages foreign investment and foreign investment protection that discourages regulation. If countries implement international agreements or domestic climate change policies in a way that violates the rights offoreign investors, they may have to pay compensation to the foreign investors. This risk can create disincentives to regulation, particularly in countries where the responsible government officials are unsure of the scope of their obligations to foreign investors. At the same time, foreign investment is an important source of knowledge and technology diffusion, together with trade in goods and services. Thus, it is important to create adequate incentives for foreign investors to transfer best practices and technologies that can address climate change adaptation and mitigation. This means that governments must provide adequate protection to foreign investors. International investment agreements can lower regulatory and political risks for foreign investors, and thus lower the cost of and create incentives for foreign investment in clean energy or other carbon mitigation technologies.

Traditionally, debates regarding climate change and financial and technology flows have been framed as North-South. However, this has changed, with the emergence of new low-carbon technology companies in developing countries, such as China and India, which could diffuse clean technology nationally and internationally. In addition, the financial crisis has limited the financial capacity of major developed countries, notably the United States, European Union, and Japan. Moreover, investment banks (including the World Bank) can help to mobilize capital for low-carbon technology, making their own investments and structuring investments for classes of investors with different risk-reward profiles and return expectations. This paradigm shift in financial and technology flows should inform debates regarding both.

In relation to environmental regulation, there are some important differences between international trade agreements and international investment agreements. In particular, only governments have access to the dispute settlement system of the WTO (and comparable dispute settlement systems in free trade agreements). This filters out challenges to some measures. In contrast, private investors can file claims directly against host governments under international investment agreements. Private investors may be less likely to question the wisdom of challenging governments’ right to regulate than governments themselves. Moreover, the majority of international investment agreements do not contain references to environmental concerns. This highlights the importance of determining the extent to which environmental regulation is subject to the disciplines contained in these agreements.

International investment agreements do not eliminate a State’s right to regulate in the public interest. Legitimate environmental measures should not be subject to international investment agreements, since they would not qualify as measures “relating to” investments. A key issue is the legitimacy of the disputed environmental measure. One way to define legitimacy is by asking whether the measure serves the public interest or a private interest. Of course, a measure can simultaneously serve both public and private interests. The real question here is whether the evidence demonstrates bad faith, protectionist intent, or intent to harm foreign investors on the part of the legislator or the judiciary. The majority of State practice is consistent with the view that international investment agreements do not negate the right to regulate climate change. Moreover, customary international law does not require a State to maintain a stable legal and business environment for investments. The customary international law standard does not prevent a public authority from changing the regulatory environment to take account of new policies and needs, even if some of those changes may have far- reaching consequences and effects, and even if they impose significant additional burdens on an investor. It does not provide a guarantee against regulatory change or entitle an investor to expect no material changes to the regulatory framework within which an investment is made. Governments can change, and policies and rules can change. The rules of customary international law only protect against egregious behavior and do not require a legal and business environment to be set in stone. The minimum standard of treatment of foreign investors under customary international law has to be interpreted in accordance with evolving customary international environmental law. The obligation to avoid activities causing significant damage to the environment of another State is likely to encompass regulations to address climate change. Thus, legitimate climate change regulation would not be inconsistent with the minimum standard of treatment. To conclude otherwise would create a conflict between customary international investment law and customary international environmental law.

The general body of precedent usually does not treat regulatory action as amounting to expropriation, because expropriations tend to involve the deprivation of ownership rights and regulations a lesser interference. Under customary international law, where economic injury results from bona fide regulation within the police powers of a State, compensation is not required. Thus, as a general matter, States are not liable to compensate foreign investors for economic loss incurred as a result of a nondiscriminatory action to protect the public interest. However, once an expropriation has taken place, compensation is due even if it is for an environmental purpose. In the context of NAFTA Article 1110, if there is a finding of expropriation, compensation is required, even if the taking is for a public purpose, non-discriminatory and in accordance with due process of law and Article 1105(1). However, not all government regulatory activity that makes it difficult or impossible for an investor to carry out a particular business is an expropriation. Given the economic and environmental consequences of climate change, it seems that bona fide climate change regulation should take precedence over investors’ rights, though the correct balance likely will have to be decided on a case-by-case basis. It is also important to protect foreign investors from unfair or arbitrary treatment by governments who are motivated by short-term political interests rather than longterm environmental risks. For this reason, we emphasize that we are referring to bona fide climate change regulation.

Striking the right balance between the regulatory risks that investors face and the litigation risk that governments face is not the same for all markets. Larger markets can have a greater degree of regulatory risk and still attract foreign investors. In contrast, smaller, less economically attractive markets may need to strike a balance that is more in favor of investors’ rights and reduces regulatory risk to a greater degree, in order to attract foreign investment. Larger markets are also a greater source of GHG emissions, so the balance should favor climate change regulations over compensation to foreign investors, in order to limit the risk of regulatory chill and to enhance the right to regulate. Science-based regulatory decisions should withstand scrutiny, even if the science was preliminary, when there is sufficient scientific evidence of the potentially serious environmental effects to support the regulation. There is sufficient scientific evidence of the potentially serious effects of climate change to justify climate change regulation, even if it also has the effect of diminishing the value of some foreign investments.

International investment law has the potential to have a chilling effect on climate change regulation, by raising issues regarding the risk that climate change regulation will expose host states to claims from foreign investors. Our analysis shows that legitimate climate change regulation should not trigger liability to compensate foreign investors. However, this may not eliminate the chilling effect, since it is costly for States to defend against such claims even if they do not succeed. Awards of costs against investors who file such claims may discourage such claims, but this may not be sufficient to overcome the chilling effect in the short term. Moreover, the lack of a system of precedents for tribunals permits tribunals to reach different conclusions on similar issues, which increases the uncertainty regarding the outcome of litigation. Nevertheless, there is room in international investment law for striking an appropriate balance between the right to regulate climate change and rights of foreign investors to seek compensation for arbitrary and discriminatory governmental actions. Striking the right balance will facilitate the mobilization of foreign investment as a source of climate finance and technology dissemination.

However, to stabilize GHG emissions (mitigation) would require a significant reduction of emissions both in the developed and the developing world. This calls for large-scale investment in energy infrastructure and other large-scale mitigation projects. Multilateral funding channels may be the best option for such large-scale financing in developing countries. However, private, bilateral, and multilateral funding sources are not mutually exclusive. For example, the World Bank can play a role in creating incentives for private-sector investment, by investing in pilot projects and lowering political risk for private investors. However, bilateral and multilateral climate financing could be found to be a prohibited export subsidy under the SCM Agreement.

Multilateral cooperation and financing will continue to be an essential element in climate finance. The WTO will have to adapt subsidies rules, via judicial interpretations on a case-by-case basis or via a negotiated response to agreements reached in other multilateral organizations. The increasing number of actors in climate finance activities will require more coordination and adaptation of roles among institutions such as the World Bank and the Green Climate Fund. The activities of these institutions will have to be coordinated with those of the private sector participants as well.

In the current political and economic context, multilateralism is not working in the UNFCCC and WTO systems. This requires unilateralism, but in a well- considered approach that creates economic incentives to engage the private sector and to push governments into effective multilateral agreements. For example, funding for adaptation and technology transfer should be made conditional on recipients implementing PPP-based mitigation measures, in order to channel funding and technology to combat climate change. This can be accompanied by unilateral trade measures on goods and services to create political will in developing countries; the private industry that opposes climate change action based on competitive concerns might change their stance if unilateral trade measures begin to affect market access and competitiveness. However, unilateral measures to combat climate change need to be taken in a manner that is consistent with existing obligations and principles of international environmental and economic law, as far as possible, in order to more effectively address this urgent global issue.

A single country or a single region cannot reduce the greenhouse gas emissions of other regions or countries. It may be possible to create incentives for other countries, for example with unilateral trade restrictions or foreign aid that is conditional upon emissions reductions. However, trade restrictions do not just impose costs on the exporting country. They also impose costs on the importing country, where importers are affected by the increased cost of inputs. In addition, few domestic markets are large enough for trade barriers to have an economic impact that would be sufficient to create an adequate incentive to reduce emissions. Foreign aid that is conditioned upon the use of inputs from the donor country also may violate WTO law. Moreover, foreign aid costs money for donor countries, too. Even ifwe resolve the problems ofcost and WTO consistency oftrade barriers and foreign aid, they remain partial solutions only because they will not achieve the desired level of emissions reductions.

We can estimate the future concentrations of greenhouse gases and we can estimate the probability of a range of temperature increases, but we cannot say precisely what the temperature increase will be, how that temperature increase will vary from one part of the planet to another, and what the ecological and economic effects will be. What we do know is that the risks are grave. Debating whether we have underestimated or overestimated the proximity and severity of those risks misses the point. We need to address those risks through mitigation and adaptation. To do so effectively will require creating incentives for multilateral action and removing obstacles to financing the dissemination of the technologies needed for mitigation and adaptation.

  • [1] Members of the International Union for the Protection of New Varieties of Plants, Statuson December 5, 2012 (accessed January 9, 2013).
 
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