Climate change, supply chain issues, and geopolitical concerns are sparking new questions about the status quo of trade policies. To meaningfully address these challenges, policymakers must adjust the international trade paradigm that is skewing production and consumption patterns, favoring low-cost production, low-cost labor, and low-cost goods. This strategy of leveraging trade as a tool to address global issues is not new: it is currently used to discourage certain practices like child labor and the harvesting of endangered species. But when it comes to climate change, major policy gaps remain—including an 8-billion-ton hole known as the carbon loophole.
The carbon loophole refers to unaddressed CO2 emissions released through traded goods each year. These emissions are embodied in goods produced in one country and consumed in another. Many climate-ambitious countries are now considering trade policies to reduce the carbon loophole, recognizing that it accounts for about one-fourth of CO2 emissions globally and must be mitigated. Novel policies such as the EU’s CBAM and the Global Arrangement on Sustainable Steel and Aluminum (GASSA), which is being negotiated by the U.S. and the EU, are intended to reduce emissions and the competitive advantage of more carbon-intensive production.
But an often-overlooked piece of the climate puzzle is the significant variation in tariff rates (taxes or duties on imported goods) between countries and products that contributes to the carbon loophole. Reducing the drastic differences in tariff rates on highly traded goods (taxes or duties on imported goods), along with other adjustment mechanisms, can play a vital role in leveling the playing field and ultimately closing the carbon loophole.
The WTO Director-General, Ngozi Okonjo-Iweala, recently emphasized this point, drawing attention to the “skewed import tariffs that plague national borders today.” She called for the elimination of the current bias that favors carbon-intensive goods, indicating that this shift would decrease global carbon emissions by 3.6% while increasing global income by 0.65%. She emphasized that trade is “the missing piece of the climate puzzle,” echoing Joseph Shapiro’s findings in “the Environmental Bias of Trade Policy.”
Shapiro’s novel study found that the variations of tariff rates and non-trade barriers (NTB) on “clean” and “dirty” goods created an implicit subsidy for CO2 emissions in internationally traded goods. Most countries have lower tariff rates and NTBs on “dirty” carbon-intensive goods and higher tariff and NTBs rates on “clean” less carbon-intensive goods. The skewed tariffs rates and NTBs protect cleaner domestic industries while supplementing carbon intensive imports through the price differentiation.
This raises the question– Is there a connection to tariff rates and the carbon loophole? And what role do tariff rates play in the sector most relevant to climate change—Energy-Intensive and Trade-Exposed goods (EITE)?
As the most carbon-intensive sector, EITE goods play an essential role in unlocking the climate puzzle. Here, we turn to data to understand the relationship between tariff rates and the carbon intensity of traded goods.
Data was analyzed from the World Trade Organization’s “Tariff Analysis Online” database to understand how the carbon loophole relates to tariff rates. We assessed goods from the most energy-intensive and trade-exposed sectors, such as steel, iron, mineral fuels, aluminum, and plastics, for key trading partners. These trading partners include some of our G7 partners and major emerging economies: China, India, Brazil, and Russia. All studied countries are WTO members and are eligible for Most Favored Nation rates (MFN). Therefore, MFN rates are the focus of the study.
The results are significant. There are notably different MFN tariff rates for EITE goods from developed versus emerging economies. The variation builds on Shapiro’s finding of strong variations in tariff rates and NTBs between clean and dirty goods. Within the dirty goods sector there is also a strong variation in tariff rates, but this time on EITE goods between countries.
In the chart below, EITE commodities are separated by their global product classification number, harmonized system 2 (HS 2), with the corresponding MFN rate set by each country. As the chart indicates, a significant difference was found between developed and emerging economies’ MFN rates for EITE commodities. The Global North generally had low tariff rates, averaging 2.2% for the US, 1% for Canada, 2.2% for the UK, and 3.5% for the EU. In contrast, emerging economies had much higher tariff rates, averaging 7.1% for China, 6.5% for Russia, 9.26% for Brazil, and 8.74% for India.
|72 Iron and Steel||0.3||0||0.3||0||4.5||10.5||9.5||4.6|
|73 Iron and steel articles||1.2||1.4||1.7||0.3||6.8||14.9||10.5||9.5|
|27 mineral fuels||0.5||0.7||0.8||0.3||5.1||0.4||4||4.4|
|29 organic chemicals||2.8||0||4.5||3.3||5.7||4.8||7||4.2|
|28 inorganic materials, rare earth||2.3||0||4.6||2.5||5||5.1||7.2||4.8|
|70 Glass and glassware||5.1||0.1||5.1||2.6||10.8||12||11.8||10.6|
|38 Misc. chemical products||3.3||1.2||5.5||3||7.3||11.7||8.5||4.7|
|76 aluminum and articles thereof||3.5||1.2||6.4||4.4||6.9||11.3||8.8||8.9|
|25 Salt, sulphur, lime and cement, earth material||0.2||0||0.2||0||3.6||3.9||6.5||4.6|
|40 rubber and articles thereof||1.6||1.6||2.6||2||11.3||12.3||10.5||5.5|
The average tariff rates on EITE sector goods for the countries analyzed is 2.2% for the Global North and 7.9% for the Global South. These rates support the production and consumption cycle of the carbon loophole by reinforcing the roles of countries in the Global South as net exporters and countries in the Global North as net importers. The Global South’s higher tariff rates protect their domestic market and lock in their role as the world’s manufacturers—keeping production in “dirtier” and less regulated markets. The lower tariff rates of the Global North reinforce their role as major consumers and increase the likelihood of offshoring domestic EITE industries. This paradigm has significantly impacted rising emissions. Over two decades, this shift contributed to a 60% increase in global emissions and the doubling of the carbon loophole at 8-gigatons CO2e. The carbon loophole allows countries like China, Russia, and India to protect their dirtier industries while advanced economies like the U.S., Canada, and the EU import these goods at lower costs—effectively off-setting domestic greenhouse gas reductions.
Many countries have charged that the industrial subsidy provisions of the Inflation Reduction Act are protectionist. However, the global trade system is not starting from a level playing field. Wide variation in countries’ subsidies, regulations, production costs, and tariff rates is already distorting the market. To meaningfully address climate change, policymakers must consider these disjointed policies, including MFN tariff rates. A variety of trade tools could be used separately or in combination to achieve this goal, including harmonizing tariff rates, creating a worldwide carbon price, or offsetting carbon intensity differences through mechanisms like a border carbon adjustment. Ultimately, policymakers should harness the power of the market to drive global decarbonization and address the counterproductive advantage given to carbon-intensive goods.