Climate Change Policies and the WTO | 1

Not Fair
Climate Change Policies and the WTO

October, 2009
University of the Philippines
College of Law

Maria Ester B. Vanguardia

2002-64812
 Climate Change Policies and the WTO | 2

Introduction

All around the world, Scientists and the Intergovernmental Panel on Climate

Change have reached a consensus that indeed the world is warming. During the past

150 years, the global surface temperature has increased by an average of O.76°

Celsius1. It may sound like a negligible number, however; as we see from recent

events the effect of this gradual warming of the earth’s atmosphere has produced

catastrophic effects in the form of rises in sea levels, the melting of the arctic sea ice,

melting of the glaciers and permafrost, increase in instances of extreme drought,

changes in hurricanes (typhoons) frequency and strength, more frequent cases of heat

wave etc.

Under the United Nations Framework Convention on Climate Change (UNFCC)

and the Kyoto Protocol, the approach to mitigation of climate change is based on a

commitment made by states which bind themselves to reduce the levels of the GHG

emissions to pre-agreed levels. This binding commitment between state parties is

based on the concept of shared and differentiated responsibilities. Under the Kyoto

Protocol, however; the policies which the State-Parties may use in order to achieve the

emissions reductions under the treaty are not specified nor is there any provision in the

treaty which favours one policy instrument over the other; what the Protocol contains is

merely a list of policies which states may choose to employ to achieve emissions

1
IPCC, 2007
 Climate Change Policies and the WTO | 3

reductions.2 These policy strategies may be pursued either way through direct

regulatory measures through the imposition of caps in emissions, mandating renewable

energy, or through a system of incentives in the form of subsidies in order to motivate

market forces to engage in behavior that leads to lower emissions.

Under the International Energy Agency (IEA) database, a distinction is made to a

range of policies which are deemed to have elements of subsidy; including: incentives

and subsidies in the form of direct payment to market actors); Research and

Development and Public Investment. These policies are further divided into those

supporting renewable energy and those in support of energy efficiency. In the regime

of economics, subsidies are employed in the correction of market failures, for example

the capture of the public goods dimension in Research and Development, or for

renewable energy, reflecting positive externalities that would be left uncaptured in the

choices of market actors in their decision between renewable and other more costly

forms of energy. The use of subsidies in meeting the cap imposed by the Kyoto

Protocol has been expressly recognized in the body of the treaty itself, which lists

among the kinds of measures that may be employed to implement the Kyoto

Obligations: removing subsidies and other market imperfections for environmentally-

damaging activities.

2
Promoting renewable energy, carbon sequestration, and other environmentally-sound technologies, removing
subsidies and other market imperfections for environmentally-sound technologies; encouraging reforms in
relevant sectors to promote emissions reductions; tackling transport sector emissions; and, controlling methane
emissions through recovery and use in waste management.
http://unfcc.int/national_reports/annex_i_natcom/pams/items/3458.php.
 Climate Change Policies and the WTO | 4

Indeed, the Kyoto Protocol marks an important first step undertaken by the

international community to internalize the climate change externality and embodies

what would potentially represent a global effort towards putting the concept of

sustainable development into practice. Aside from its’ direct effect on the reduction of

atmospheric GHG, the commitment of Annex 1 countries to meet emissions reductions

targets will certainly have a direct bearing on world trade affecting the cost of

production of traded products and consequently their competitive positions in the global

market. Addressing what may so far be the biggest sustainable development challenge

to date3, the measures necessary to address climate change must achieve compatibility

with the bigger ambitions of the international community: economic growth and human

advancement. As a part of the overall architecture of multilateral cooperation the WTO

provides a framework of disciplines facilitating global trade and providing for a forum to

negotiate further trade openness. Although not in itself a part of the issue in the WTO’s

programme and with no specific provisions which pertain to climate change, the WTO is

relevant because due to its’ scale climate change measures and policies intersect with

international trade in several ways.

3
Aside from being a challenge for sustainable development, Climate Change has also been referred to as an
extreme case of market failure i.e. the failure to incorporate the damage done by GHG emissions into the prices of
goods and services. Since the classic role of governments is in the correction of market failures and at the same
time be able to retain the approval of the electorate, governments opt for measures which balance the need to
correct market failures and at the same time politically acceptable. Charnovitz (2003) Charnovitz, Steve.
2003. Trade and Climate: Potential Conflicts and Synergies. Washington: Pew Center on
Global Climate Change. Cited in Hufbauer GC and Kim, J (2009) The World Trade Organization and
Climate Change: Challenges and Options. Online at:
http://www.iie.com/publications/interstitial.cfm?ResearchID=1301
 Climate Change Policies and the WTO | 5

CAP-and-Trade vs. Fair Trade

Thanks to the energy, greenhouse emissions practically exist in every economic

sector as a result of the production process – from raw materials procurement, to the

transportation used to get these products into the market. These embedded emissions

are reflective of the climate change policies and energy sources embraced by their

country of origin.

The Kyoto Protocol4 – in the accepted means and state policies – encourages a

system of discrimination i.e. distinguish greenhouse-gas intensive products from cleaner

alternatives and in the end favouring the process that results in lower GHG emissions.

In addition to regulatory measures which are necessary in meeting the Kyoto targets,

initiatives on the national, regional and multilateral level must inevitably deal with the

adoption by governments of price based policies such as tariffs, taxes, and subsidies.

On the other hand, a stark contrast may be gleaned from the provisions of the WTO,

wherein the aim is to prevent discrimination among products in International Trade on

the basis of manufacturing methods or country of origin. Among the list of other

mitigation and adaptation policy options which countries have introduced or have

contemplated may as well have trade implications, examples of which include border

tariff allowances and other border adjustment mechanisms and product or performance

4
This apparent conflict may be reconciled under Art 2.3 of the Kyoto Protocol which states: The Parties
included in Annex I shall strive to implement policies and measures under this Article 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 country Parties
and in particular those identified in Article 4, paragraphs 8 and 9, of the Convention, taking into account
Article 3 of the Convention. Online at: http://unfccc.int/kyoto_protocol/items/2830.php
 Climate Change Policies and the WTO | 6

standards like labeling requirements or energy efficient standards may be viewed as

technical barriers to import

Aside from the issue of discrimination as regards products produced through

processes which result to lower GHG emissions, another feature of the Kyoto Protocol

which would run counter to the policies of the WTO is the issue of subsidy. Under the

Agreement on Subsidies and Countervailing Measures (SCM Agreement) of the World

Trade Organization (WTO), the definition of subsidy contains three elements: (i) a

financial contribution (ii) by a government or any public body within the territory of a

Member (iii) which confers a benefit. These three elements must concur for a subsidy

to exist. The SCM agreement puts forth two types of subsidies, that is, those which are

prohibited and those which are actionable. The category of prohibited subsidies are

further divided into two: subsidies contingent, in law or in fact, whether wholly or as

one of several conditions, on export performance i.e. export subsidies and subsidies

contingent, whether solely or as one of several other conditions, upon the use of

domestic over imported goods i.e. ‘local content subsidies’. The rationale behind the

prohibition of these two types of subsidies is that they directly affect trade and hence

the likelihood of adverse effects on the interests of members. A broader group of

subsidies, however; are categorized as “actionable”; these subsidies are not per se

prohibited although they may be subject to challenge.

However, although the WTO agreement went to the extent of breaking down

subsidy into three elements the concept of ‘benefit’ which would lead to considerable

uncertainty as to what subsidies are susceptible to challenge as amounting to market

 Climate Change Policies and the WTO | 7

distortions and whether, even when subsidy is used as a means to correct a market

failure, such subsidy may still be deem actionable as providing benefit under the SCM

Agreement. According to economist Alan Sykes, ‘the concept of benefits’ under the

SCM agreement appears in large measure to abstract from the effects of the full range

of government activities on the market into which the subsidy is an intervention.’ This

definition of benefit, and consequently what may be actionable under the WTO, is

specifically relevant to subsidies provided to environmentally harmful subsidies or

‘negative’ subsidies that stem from a failure to include in the cost of production

environmental costs associated with a specific industry. Another requirement in the

agreement to constitute an actionable subsidy is that of financial contribution which is

where a ‘charge into the public account’ was made, that is such must be made by or at

the direction of a government or any public body within the territory of the member.

The Agreement likewise contains a list of the types of measures that represent a

financial contribution, e.g., grants, loans, equity infusions, loan guarantees, fiscal

incentives, the provision of goods or services, the purchase of goods.5

The list of subsidies in the SCM Agreement includes subsidy in the form of direct

transfers, loan guarantees, fiscal incentives in the form of tax holidays and tax credits,

provision of goods and services and direct payments to a mechanism of funding; for

legislations addressing climate change these provisions are provided as well – as

mechanisms of reducing GHG emissions. Moreover, it is likewise recognized that in

5
WTO Subsidies and Countervailing Measure. Available online:
http://www.wto.org/english/tratop_e/scm_e/subs_e.htm
 Climate Change Policies and the WTO | 8

order for Annex 1 Countries to meet their national emissions targets mechanisms such

as fuel substitution and technical innovation may be essential to the success of such

efforts. The development of Renewable Energy, including the shift to more fuel

efficient and ‘greener’ technology, proves capital and knowledge intensive with the

technology not being at par yet in terms of competitiveness with conventional

technologies. Hence, due to these restrictions unless producers are encouraged to

undertake the development of cleaner energy in the form of subsidies, Annex 1

countries may be unable to meet their emissions reductions target. With the

ambiguous definition of ‘benefit’ under the WTO and the absolutist requirement that in

order to constitute subsidy – which would have justified the interpretation that the

current subsidy and regulatory measures are imposed merely to correct a prolonged

subsidy made to fossil fuel industries and hence correct a market failure – a positive

action on the side of the government in the form of disbursements is necessary.

The negotiated SCM Agreement provides for a specific type of energy, which

when revived, may provide hope in reconciling an apparent conflict between the

provisions of WTO on subsidies and the means allowed in the Kyoto Protocol on how

Annex 1 countries may meet their emissions reduction targets. Under the now expired

Article 8.2.(c) of the SCM agreement6 a provision for ‘green subsidy’ is made, this type

of subsidy under the agreement was considered non-actionable and consistent with

6
The Agreement as it originally entered into force contained a third category — non-actionable subsidies.
This category (along with a provision establishing a presumption of serious prejudice in respect of certain
specified types of actionable subsidies) applied provisionally for five years ending 31 December 1999, and
pursuant to Article 31 of the Agreement, could be extended by consensus of the SCM Committee. As of
31 December 1999, no such consensus had been reached. Source: WTO website --
http://www.wto.org/english/tratop_e/scm_e/subs_e.htm
 Climate Change Policies and the WTO | 9

WTO rules, however; it is limited only to one-time subsidy introduced to offset

increases in production costs for firms in order for them to adjust to new environmental

regulations. This exception to subsidy, when reinstated in its’ original or in modified

form may provide a useful exception for companies in Annex 1 countries which would

inevitably bear the brunt of adapting to new environmental compliance regulations that

will be imposed in order to meet the Kyoto reduction targets. Indeed, such proposals in

amending the GATT articles and other parts of the WTO has been conceived, however;

this course of action may prove difficult since within the WTO, legal text may be

amended only when a consensus between the members have been achieved i.e. only

when no member objects. A similar proposal of waiver, instead of an amendment to

the legal text, was likewise proposed. Under the waiver proposal it was submitted that

the WTO members approve a waiver to WTO obligations for trade commitments written

in a climate change commitment. Although less daunting than a consensus

requirement, the requisite three-quarters vote may still prove to be a challenge.

Another provision in the SCM Agreement which potentially will allow for a certain

degree of flexibility as regards subsidies is Article 2.1 (b). The article provides an

exception, rendering the subsidy non-actionable, when such subsidy is not considered

specific i.e. if there are objective and legally enforceable criteria which govern eligibility

for, the amount of, with the subsidy being automatic for any company meeting the

criteria, and then such subsidy may be deemed as not specific and therefore not
 Climate Change Policies and the WTO | 10

actionable7. An additional condition is that these criteria need to be neutral: not

favoring certain sectors over others, and the application is horizontal and economic in

nature.

The effects of climate change, though Global in nature, impact some countries more

than others. The Philippines being an archipelago situated in the tropics - where

typhoons are commonplace, having an economy which is heavily reliant of agriculture

and a growing population below the poverty line and situated in flood-prone and coastal

areas -- is specifically impacted by changes in the climate despite not being a major

Greenhouse Gas emitter. As such, although under the doctrine of shared but

differentiated responsibilities under the Kyoto Protocol, it is imperative that the

Philippines employ effective mitigation and adaptation measures. As a country which

stands to sustain a relatively higher economic damage in terms of loses in the GDP8, the

Philippines must adopt policies which would reduce its internal GHG emissions and

encourage adaptation efforts, albeit not being included in the list of countries who have

committed to reduce their emissions under the Kyoto Protocol.

In the 2009 working paper of Hufbaur and Kim9, it was recognized that there is

an absence of clearer guidelines which may serve as a benchmark in ascertaining

whether a certain policy option is compatible with WTO rules. Examples cited in the

7
Assuncao L. and Zhang Z. (2001). Domestic Climate Change Policies and the WTO. Source:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=288273
8
2009 ADB Report, Economics of Climate Change.
9
Hufbaur GC and Jisun Kim. The World Trade Organization and Climate Change: Challenges and Options.
Online at: http://www.iie.com/publications/interstitial.cfm?ResearchID=1301
 Climate Change Policies and the WTO | 11

paper which are considered as uncertain are border adjustments and whether or not

they are allowable for carbon taxes or permits on the basis of energy consumed or

carbon emitted. It remains unclear as well whether the Agreement on Technical

Barriers to Trade (TBT) would allow standards and labeling requirements based on

production and processing methods (PPMs) that do not affect the physical

characteristics of the product.

Under the WTO, freer trade must not be viewed as an end in itself; rather, as

captured in the WTO’s founding charter the Marrakesh Agreement10, it must be tied to

crucially important human values and welfare goals which include – raising standards of

living, optimal use of the world’s resources consistent with the objective of sustainable

development, and protection and preservation of the environment. As such, a liberal

interpretation as regards WTO policies which may potentially hamper measures and

policies employed by State-parties in the Kyoto protocol relating to issues of subsidies,

taxes, tariffs and other regulatory measures is called for. Unless of course that this

policy of liberal interpretation is included in the WTO tool-boxes of relevant rules, and

noted in the succeeding negotiations and possibly in the potential revival of the ‘green

exemption’ on actionable subsidies, it is posited that measures undertaken by state-

parties in the Kyoto Protocol may run afoul of the provisions of the WTO. It is not to

say, however; that the WTO may operate as an evil that would abate laudable efforts of

10
In the Marrakesh Agreement establishing the WTO, members established a clear link between
sustainable development and disciplined trade liberalization in order to ensure that market opening goes
hand in hand with environmental and social objectives. Online at:
http://www.wto.org/english/docs_e/legal_e/04-wto_e.htm
 Climate Change Policies and the WTO | 12

Annex 1 countries, nor would it serve as a scapegoat for some countries to reject the

ratification and legislation of certain policy measures under the guise of contravening

WTO provisions it is important to note that in terms of making policy decisions for state

countries who are parties to the protocol to take note of WTO provisions which – in the

interest of trade openness – can help in the mitigation and adaptation measures for

climate change. Examples of positive effects of a freer trade may be found in the

promotion of efficient allocation of the global resources which includes natural

resources, by raising the standard of living thereby resulting to a higher demand for

better environmental quality and improving access to environmental goods and

services.11

11
The Multilateral Trading System and Climate Change. Online at
http://www.wto.org/english/tratop_e/envir_e/climate_intro_e.htm