The future of trade agreements must be cleaner but also fairer

The latest Intergovernmental Panel on Climate Change (IPCC) report has sounded a red alarm that the planet could be warmer by at least 1.5 degrees Celsius even before 2040, unless action is not taken to immediately cut global greenhouse gas emissions. It is well understood that adaptation to climate change relies on coordinated efforts of countries. Environment and climate change norms are already becoming an important component of trade agreements and trade negotiations now. The USA and the EU are already pushing for environmental standards in trade agreements. The EU, for instance, is seeking commitments on clean energy, climate change and deforestation from Brazil, other Mercosur countries and India to push forward a trade agreement.

There is, however, some skepticism that environmental standards may have emerged as non-tariff barriers (NTBs), in disguise, to block import competition from developing nations. This has two major ramifications for developing countries. One, the opportunities of market access will be compromised, leading to low trade-led growth prospects. Lower growth in turn implies lower capacity to adopt cleaner technologies of production. Secondly, environmental standards that act as NTBs encourage “greenwashing” of trade, which means, in order to gain market access, firms may label their products to be environment-compliant even if they are not. In both these cases, the ideas of trade and economic openness are defeated.

Consider the case of free trade negotiation between India and the EU, that started in the year 2007 but came to a grinding halt in the year 2013. One of the points of discord between the two parties has been climate change and environmental sustainability. India’s stance — to focus on per capita emissions rather than on emissions in absolute terms — has been against the EU’s insistence on fixing binding targets for reduction of carbon emissions. India has been of the view that European environmental standards will impinge on India's efforts of inclusive growth. Thus, EU’s insistence on the inclusion of environment standards in its trade agreements appeared to be an NTB for India.

Last month, the European Commission introduced ‘Fit for 55’- comprising legislative proposals aimed at meeting its legally binding GHG emissions reduction target of at least 55 per cent over the 1990 level by 2030. Fit for 55 also includes the carbon border adjustment mechanism (CBAM). Under the CBAM policy, a levy will be imposed on imports based on the carbon emitted in their production process. This will affect India’s exports of products such as steel and aluminium to the EU. Therefore, even as India and the EU are looking to rekindle trade negotiations, CBAM will be a thorny issue for India.

In a recent Financial Times article, Martin Sandbu argues against the view that imposing standards on production processes amounts to protectionism by invoking NTBs. Trade in goods and services, the production of which flouts standards practiced in the domestic market, does not translate into welfare gains, writes Sandbu. Inclusion of standards in trade policy, according to Sandbu, is a form of ‘progressive globalization’ that keeps markets open while limiting import competition from foreign firms that undermine norms and rules.

In my view, it is not as simple as it sounds, when considered from a developing country’s point of view. Production processes in developing countries lack adequate financial and technical capacities, making it difficult to adhere to environmental standards set by developed countries. Also, specifying non-discriminatory standards and implementing them is not devoid of challenges. Then, is there a way to make trade work for the environment without thwarting the possibility of gains from trade for the developing countries?

One way forward is for countries such as India to bring climate financing to the centre of climate and trade agreements, as suggested by India’s former Planning Commission chief, Montek Singh Ahluwalia, in a recent article. What could complement such efforts are ‘deep trade’ agreements between India and key partner economies such as the EU and US. Such agreements open the path for partner countries to set domestic environmental standards, taking into account the environment-friendly-production-capacity of the export sector in the foreign country.

A new research paper by Jere Lehtomaa and Jean-Philippe Nicolai, economists at ETH Zurich, suggests precisely such an approach. Assuming that the domestic policy sets the minimum standards that both domestic and foreign firms need to abide by in order to supply in the domestic market, the authors argue that the optimal domestic policy is less stringent in deep rather than shallow trade agreements (for a primer on deep trade agreements or DTAs, read this earlier post). This means that country A exporting to country B will face less stringent environmental standards in B’s market if it has a deep trade agreement with B.

Under a shallow trade agreement, when tariffs are lowered, countries are more likely to use inefficiently high environmental standards as non-tariff barriers against foreign competition. However, within the ambit of DTAs, countries can negotiate not only mutual lowering of tariffs but also the stringency of their domestic standards. Thus, the decision of each country is hinged on maximizing the joint welfare of the countries involved in the trade agreement. Hence, countries will set domestic environmental standards, taking into account the environment-friendly-production-capacity of the export sector in the foreign country, the authors suggest.

There is therefore a strong case for India to negotiate DTAs with its key partners including the EU to boost India-EU cooperation on sustainable growth, and focus on agreed upon deliverables. For instance, as a part of DTA, India and the EU can agree to strengthen the already existing EU-India Clean Energy and Climate Partnership and promote investment in renewable energy and cooperation in R&D; and enhance technology transfer. Such cooperation in turn may lead the EU to better appreciate India's need to preserve its space for growth and development while adopting clean technology.

The catch here is that India has relatively high tariffs which makes it difficult for the country to negotiate DTAs with partner countries such as the EU, which expect lower tariffs post such agreements.