Follow the Money

As diplomats, activists, and journalists begin to file out of the negotiating halls of the UN Climate Change Conference in Glasgow, or COP26, there is ample evidence that the annual meeting is failing to deliver. Politicians continually declare that the world is in the midst of a climate crisis, but they have proved themselves incapable of taking the decisive action that such a crisis demands. They have fallen short of producing the $100 billion in funding for developing nations promised 11 years ago at COP16. Efforts to finalize the rules of the Paris climate accord, adopted in 2015, have also been unsuccessful. As of this writing, 53 nations have either failed to submit a new pledge to reduce greenhouse gas emissions or have not increased the ambition of initial pledges, as required by the Paris agreement. The flurry of new initiatives rolled out at COP26 amounts to only marginal progress: there is still a huge gap between the current suite of pledges and the goal set in Paris to limit warming to 1.5 degrees Celsius above preindustrial levels. The average global temperature is now on track to rise by 2.7 degrees by the end of the century. 

Quite simply, the current approach to climate cooperation is incommensurate with the gravity of the crisis. Instead of the incrementalism of the Paris agreement, a serious response requires rewriting the rules of capitalism. This new multilateral effort must attack the root cause of climate change: the flow of dollars in the global economy. International trade and finance institutions should replace the United Nations Framework Convention on Climate Change as the locus of climate policy.
 
The UNFCCC treats climate change as a problem that can be solved by measuring and controlling emissions. But the real problem is asset revaluation—recognizing how both climate change and climate policies alter the value of capital and labor. Reforming the rules governing economic activity addresses the problem at its source. By bringing the climate agenda to the halls of the World Trade Organization (WTO), the G-20, and other finance institutions, policymakers have an opportunity both to expand the tools available to them and to rein in climate obstructionists—the fossil fuel and mining companies, heavy industry, and other large emitters that stand to lose from aggressive climate action. And by acting through these bodies, governments can secure the domestic economic benefits that are necessary to build popular support for continued decarbonization. 

TAX POLICY IS CLIMATE POLICY

Policymakers have long debated carbon taxes as a tool of climate policy. But tax reform, in a broader sense, is also climate policy. The current patchwork of national tax systems allows multinational corporations to move their wealth to countries with the lowest tax rates. This practice, called “offshoring,” contributes both directly and indirectly to climate change. Directly, multinational corporations have used offshoring to channel funds to firms that accelerate climate change, such as companies responsible for the deforestation of the Amazon. And indirectly, offshoring lowers tax burdens, keeping the fossil fuel industry flush with profits and capable of sustaining large lobbying budgets. These companies have a long and storied history of first denying the science of climate change and then pressuring legislators to prevent aggressive climate policy. Avoiding their tax obligations helps them do both and deprives states of revenue that could be used for climate programs. A conservative estimate suggests that offshoring costs the world’s governments approximately $500 billion a year in total lost revenue. Low-income and lower-middle-income countries, which will suffer most from the effects of climate change, are particularly vulnerable to corporate tax evasion.  

Increased scrutiny on the practice of offshoring, including through investigative-reporting projects such as the Pandora Papers, has finally spurred countries to action. Last month, after several years of negotiations, 136 nations and jurisdictions agreed to a global minimum corporate tax rate of 15 percent. Pending the successful signing of the treaty, the deal will come into force in 2023. 

The current approach to climate cooperation is incommensurate with the gravity of the crisis.

This agreement can become an important instrument of climate policy. The Organization for Economic Cooperation and Development, which will govern its implementation, estimates that $125 billion of annual taxable profit will be “reallocated”—that is, repatriated to the jurisdiction where the profit is earned, rather than the place where companies book the lowest tax rates. Governments can use additional revenue to invest in climate-friendly technology and infrastructure, as well as increase spending in low-carbon sectors such as health, elder, and child care. There is no guarantee that governments will allocate resources in this way; it will be incumbent on publics to demand that they do.

In its current form, however, the proposed treaty has a number of deep flaws. Notably, the section of the agreement that deals with reallocation includes exemptions for the extractive sector. This measure ensures that developing countries, which often host these industries, are not deprived of tax revenue. But it will also secure advantages for firms in many developed nations, where the extractive industry continues to exercise its political power to slow progress on decarbonization. Future progress on taxation rules, beyond the recent corporate tax deal, should focus on maximizing revenue collection from the extractive sector. 

ENDING INVESTORS’ ADVANTAGE

Reforming foreign investment laws is another avenue to promote decarbonization outside the UNFCCC. The current rules are designed to protect the assets of the fossil fuel industry. Through the set of treaties known as “investor-state dispute settlement” (ISDS), multinational corporations can sue states when they successfully demonstrate that domestic regulations impede foreign investment. Fossil fuel companies have used this mechanism to sue national governments—and seek compensation—when policies meant to protect the climate have hampered investments.

Since 2013, roughly 20 percent of all cases that pass through ISDS have involved the fossil fuel industry. And some of these cases have resulted in handsome payouts. For example, a long-standing dispute between Chevron and the government of Ecuador over concession contracts in the Amazon ended in 2011 with Ecuador paying more than $70 million in compensation to one of the world’s largest fossil fuel companies. In July 2021, TC Energy, an oil and gas infrastructure firm, filed a notice that it will seek $15 billion after the administration of U.S. President Joe Biden revoked construction permits for the Keystone XL oil pipeline. The case has yet to be decided, but success in ISDS could yield a windfall for TC Energy. 

It is important to note that companies need not win their cases for the system to slow decarbonization policy; the threat of lawsuits is sufficient to create a “regulatory chill” that discourages countries from phasing out the use of fossil fuels. If countries are serious about reaching their Paris goals, they should withdraw from the Energy Charter Treaty and other agreements that contain ISDS provisions and do not explicitly consider sustainable development. Short of full withdrawal, the parties to these treaties should introduce reforms allowing states to invoke climate regulations as a legitimate basis for barring investments.

GOOD TRADE DISCRIMINATION

WTO reform, too, can shift the momentum of multilateral climate policy. The trade body currently prevents nations from protecting their fledgling renewable industries from foreign competition. Sustainable energy programs that require the use of local components run afoul of WTO rules. For example, Ontario established a tariff program in 2009 that sought to vastly expand renewable energy capacity in the province while providing jobs through a local procurement requirement. Along with similar programs developed elsewhere, the Ontario policy was brought before the WTO’s dispute settlement system and found to be in violation of the global trade rules. Yet evidence shows that the employment and other economic benefits of “build local” provisions can expand public support for further climate policy. Allowing countries the flexibility to make green investment decisions with these goals in mind can accelerate decarbonization—but only with the reform of the global trading system. 

Some have advocated carbon border tariffs as a useful, WTO-compliant tool to strengthen climate policy. Such a system would permit states that have adopted a carbon price to levy tariffs on imports from nations without an equivalent carbon price. The idea is to create a level playing field where countries are not punished for climate ambition; countries with lax domestic policies must either raise their own carbon prices to match those of their trade partners or face import tariffs. 

This kind of “climate club” came a step closer to reality this summer when the European Union announced its intention to establish a carbon border tariff. Its implementation will be a mammoth regulatory undertaking. With the exception of California’s rules regarding electricity imports, an equivalent policy has never been enacted—and certainly not one on the scale the EU has proposed. A robust system will require strong sector-specific benchmarks to estimate the amount of carbon “contained” in products, as well as a large and competent bureaucratic agency to estimate tariffs and issue allowances.

The rules of international trade and finance must be rewritten.

In the end, the carbon tariff will be only as effective as the policies of the most determined members of this new “club.” Carbon prices must be set high enough that the tariffs they generate will drive other jurisdictions to pursue more ambitious policies. So far, however, carbon prices have remained astonishingly low, and evidence suggests they have produced limited reductions in emissions. In short, until a series of conditions is met, a carbon tariff will be little more than another procedural hurdle in the global supply chain. 

The trade regime can also catalyze significant climate action through the removal of tariffs. On the eve of COP26, the United States and the EU announced what amounts to an international decarbonization policy targeting the steel sector—the first policy of its kind. After a trade dispute during the administration of U.S. President Donald Trump that saw both sides ratchet up import duties, the United States and the EU have each agreed to cut tariffs on the other’s steel and aluminum products, while continuing to apply tariffs to countries that produce “dirtier” steel (such as China). Two of the world’s largest economies are effectively engaging in green trade discrimination, gambling that their combined weight will allow the policy to clear any legal cases brought before the WTO. Importantly, the U.S. steel industry and its union back the measure, demonstrating that trade policy can be a politically popular means of enacting what is effectively climate policy. And there may be more opportunities to wield trade deals in this way. Reaching a similar agreement with China, the world’s largest steel producer, to reduce tariffs contingent on climate action could do even more to advance emission goals.

MOBILIZING FOR THE CLIMATE

If decarbonization is to proceed at the pace demanded by the urgency of the climate crisis, the Paris agreement cannot continue to be the principal forum for international cooperation. The rules of international trade and finance must be rewritten to build an ambitious and politically viable climate agenda. This means reforming tax policies to ensure that wealthy and powerful actors that are obstructing climate policies pay their fair share. It involves removing outdated regulations that provide undue investment protection to the multinational corporations that contribute to environmental degradation. And it requires loosening trade restrictions in order to let countries establish discriminatory trade practices that advance decarbonization. 

Shifting climate policy to trade and finance institutions has a key advantage over the current multilateral process: the potential to build broad political support. Any successful climate action must start with political mobilization at the domestic level. Most people do not hold strong views about atmospheric concentrations of carbon dioxide, but they care deeply about secure employment, affordable health care, and clean air and water. Public demand, coupled with a recognition of the increasing severity and rising costs of climate change, offers the best chance of spurring governments to action commensurate with the scale of the crisis. Taxing large corporations, providing secure employment, and promoting clean energy are policies with broad support in many nations. They need not be framed as climate policies, but they must be advanced with climate goals in mind. In the end, a climate policy that offers material benefits for the working class, rather than one that demands austerity, can both expand political support for decarbonization and establish the foundation for a global agenda that ensures a habitable planet for future generations.