World Trade Rules Need An Exemption For Green Energy

The leak to the media of a confidential preliminary decision issued by a panel of judges for the World Trade Organization condemning the trade discrimination in Ontario’s green energy program is the latest example of a new global collision between trade and the environment.

According to media reports, the WTO panel has concluded that Europe and Japan are correct in claiming that the domestic content requirements of Ontario’s “feed-in tariffs” are inconsistent with Canada’s WTO obligations, but that they did not meet their burden of proving that those “feed-in tariffs” are subsidies in violation of WTO rules. These panel rulings will be official in another month, and will then be subject to appeal for a final decision three months later by the WTO Appellate Body.

The Ontario case is a harbinger of still more trade conflicts to come. International trade disputes over green energy are multiplying and intensifying in the WTO as countries worldwide struggle to find more effective ways to move toward climate-friendly -- but expensive -- renewable energy, and move away from climate-threatening -- but much cheaper -- fossil fuels.

Not only is Canada is busy battling claims made by Europe and Japan that Ontario’s “feed-in tariff” program for promoting renewables is unfair to foreign suppliers. The United States, China, India, and Europe are immersed in a number of increasingly contentious trade disputes over subsidies for wind energy and solar energy that are likewise alleged to unlevel the green energy playing field.

The likelihood that the U.S. Department of Commerce will soon impose additional duties on imports of Chinese solar cells only adds to the international trade tensions and to the widening temptation to engage in tit-for-tat trade litigation in the WTO over green energy.

Adam Smith would be appalled at the proliferation of subsidies for renewable energy in the world. As he would hasten to tell us if he were here, governmental subsidies are inherently suspect. They substitute political judgments for those of the marketplace. Politicians are not well placed to predict market decisions. Inevitably, in granting subsidies, they make mistakes that waste some taxpayers’ money (or, as we say in today’s political parlance, result in “the picking of winners and losers.”)

Moreover, political judgments are often influenced by pressures for protection from local producers or suppliers seeking an unfair advantage in the market. Governmental subsidies lower costs for local manufacturers and thus let them sell their products for lower prices. This can reduce access to local markets for competing foreign companies, and it can give local manufacturers an unfair advantage in exporting to other markets. Subsidies distort trade by distorting competitive forces in the domestic and global marketplace.

For these reasons, the WTO rules restricting subsidies are generally true to Smith. The rules on which all WTO Members have agreed provide that governmental support may not be conditioned on exporting or on using domestic over imported goods, and may not be targeted to specific domestic industries in ways that have adverse effects in the marketplace. This is good for consumers, good for competition, and good too for spreading and maximizing the bountiful benefits of trade worldwide.

But Adam Smith was not a climate scientist. He lived in the 18th century, not the 21st. He saw only the beginnings of the carbon age. He never faced, as we must, the increasingly clear fact that the carbon emissions from the fossil fuels that fire our civilization are causing an accelerating climate change that threatens catastrophic consequences for civilization. If Smith were here today, he might be inclined to qualify his qualms about governmental subsidies just a bit.

Because the crux of our challenge in moving away from our common addiction to carbon is the simple fact that carbon-emitting fossil fuels are cheap when compared with renewable energy, and they may get even cheaper. Fossil fuel technologies have revolutionized what we now know about the extent of hydrocarbon reserves and how they can be produced. Oil and coal remain abundant, and new discoveries of oil and natural gas, along with new ways of extracting it, promise to prolong the carbon age.

Ordinarily, for all the reasons Smith gave us, subsidies should be avoided, and the matter of sorting out our sources of energy should be left to free trade and to free competition in the marketplace. But far more is at stake here than on other market issues where price alone is the principal consideration. And, given the price gap between renewable and fossil fuels, if we rely on market forces alone, the inevitable age of renewables may be indefinitely postponed to the detriment of mankind.

Far better than governmental subsidies would be some form of a carbon tax that would provide significant economic incentives for energy consumers to switch away from fossil fuels and toward renewable sources of energy. Unfortunately, in almost every part of the world, politicians lack the political will to exercise the visionary leadership needed to impose a carbon tax.

So, in the near term, the only practical alternative for producing renewable energy that can hope to compete with carbon on price seems to be to have government subsidize it. Grants, tax incentives, and other governmental subsidies can begin to help us diminish our dependency on carbon and thus combat climate change by narrowing the considerable price differential between renewable and fossil fuels. But such subsidies cannot succeed so long as WTO rules make them illegal under international law.

In the absence of any real prospect for carbon taxes, it makes sense to support subsidies that ease the necessary transition to low-carbon economies. Thus it makes sense to change WTO rules to permit such green subsidies. An exemption for green subsidies that further the fight against climate change should be created by the members of the WTO.

This is not a new idea. As agreed in the Uruguay Round of trade negotiations that established the WTO nearly two decades ago, subsidies rules allowed some forms of assistance to promote adaptation to “new environmental requirements.” Regrettably, this enlightened WTO permission slip for green subsidies expired in 2000.

Today, to say the least, the challenge of climate change justifies the restoration of space under WTO rules to meet “new environmental requirements.” Precisely how to do this -- precisely where to draw the legal lines between the permissible and the impermissible under WTO rules -- should be determined by the members of the WTO. The limits of a green space for governmental subsidies and perhaps other similar governmental preferences under WTO rules should be the subject of multilateral negotiations.

The questions to be asked and answered in those negotiations about the right balance between trade and environmental considerations will be many. Some questions can be answered without changing the current rules.

Forcing companies to buy equipment from local manufacturers as a condition of the price breaks they get through “feed-in tariffs” is certainly bad policy. As Adam Smith would doubtless tell us, too, such domestic content requirements are out-and-out protectionism.

Discrimination against foreign producers should not be needed to spur investments in the production of renewable energy. Indeed, such discrimination is undoubtedly counter-productive. It denies local consumers and local economies the innovations and the many other benefits of international competition. It slows the global transition to green energy.

Domestic content requirements such as those in Ontario’s “feed-in tariffs” are also inconsistent with international law. If media reports are accurate, the WTO panel is correct in concluding that those requirements clearly violate current WTO rules relating to trade in goods and to trade-related investment measures.

But we also need some new rules.

What of the many other complicated questions about the interrelationship between trade and green energy? Not all of them can be answered fully in legal proceedings in WTO dispute settlement, where WTO judges are rightly confined by the boundaries of the existing WTO rules. And not all of the existing rules necessarily draw all of the right lines in all of the right ways.

If not domestic content requirements, then what forms of trade discrimination, if any, should be allowed by the WTO for the sake of fighting climate change? Is it possible to support renewable energy without distorting trade? Can we minimize trade distortions while maximizing climate returns? Can we craft new WTO rules in ways that will encourage climate-friendly subsidies and other climate-friendly governmental measures without permitting them to become pretexts for protectionism?

All of this should be negotiated by the members of the WTO. And yet few current governmental decision-makers are even asking, much less answering, these critical questions. Changing the rules to create an exemption for green energy is not yet on the WTO negotiating agenda. It should be.

James Bacchus is a former Member of the Congress of the United States, and a form Chairman of the Appellate Body of the World Trade Organization. He chairs the global practice of the Greenberg Traurig law firm, and the Global Agenda Council on Governance for Sustainability of the World Economic Forum.