Kyoto protocol

Simon Watt, Partner | Friday 22 February 2002

Kyoto - a new era of trade protectionism?

Domestic implementation of the Kyoto Protocol can be described as "complex but manageable". Internationally, however, the tension between environmental and free trade objectives needs to be addressed and reconciled.

The government has signalled its intention to ratify the Kyoto Protocol this year. If enough other countries ratify, the resulting obligations to reduce greenhouse gas emissions will create a whole new dynamic for the New Zealand and world economies. Business groups and unions are concerned at the potentially negative economic impact of New Zealand ratifying the Protocol. There is both a domestic and international dimension to that impact.

Domestic dimension

Within the domestic economy, energy intensive businesses and other greenhouse gas emitters face additional costs from the impact of emission reduction obligations. These could be direct costs such as carbon charges, levies or requirements to hold tradable emission units. This in turn may lead to longer-term costs if the businesses affected attract less investment.

These costs are balanced by opportunities, depending on the mix of policies adopted by the government. A company could profit from an emissions trading regime if it is cheaper for it to reduce emissions than to hold its allocation of emission units. Owners of forests planted post-1990 may make windfall gains from carbon sink credits. A marginal renewable energy project could become economically viable. Enterprises working on the science and technology of emissions reduction are likely to attract additional investment and find new markets.

The sectors most affected - agriculture, forestry, energy and natural resources, manufacturing and transport - will of course pursue their sectoral interests. For example farmers argue, and the government has acknowledged, that a mechanism such as a carbon tax is a far from optimal incentive for changing behaviour given the lack of technology for reducing methane emissions from animals.

Participants within each sector can also be expected to advocate whatever is in their immediate interest when it comes to such issues as where new obligations should be imposed (for example, at the level of the oil refinery, petrol wholesalers, retailers or motorists). Within a sector such as forestry there will also be winners and losers according to when and where forests are planted. New dynamics and market imbalances, within and across sectors, will emerge from the adoption of Kyoto obligations.

While some sectors or participants in the economy might escape immediate emission reduction obligations, few will be untouched by the changes. If new obligations are imposed at the oil refinery level, ultimately this is likely to trickle down to increased costs for motorists at the petrol pump. If the agricultural sector comes off lightly in terms of any carbon charge, levy or emissions trading regime, it will still feel the effects indirectly of any costs imposed on the energy sector. To some extent this will spread the burden of complying with Kyoto across the economy.

The government has other options to soften the impact within the domestic economy, such as recycling revenue raised from any carbon charges imposed or from any auction of emission units. What's more, the credit side of New Zealand's Kyoto balance sheet (in the form of forests sinks) exceeds its debits (in the form of emission reduction obligations). The government may retain some proportion of that credit for itself, which would provide it with further flexibility to ensure a more equitable distribution of the impacts of Kyoto obligations across the economy.

To see the domestic situation as complex but manageable perhaps requires a leap of faith for business. The government has at least signalled, in releasing its National Interest Analysis on the Kyoto Protocol, that it will aim for low cost policies. In any event, it is critical for business to engage in, and seek to influence, the current process of policy development. Fortunately there is time before obligations really begin to bite in 2008. The clearer signals now emerging from government put business in a better position to plan for what lies ahead, to manage its risks, as well as to identify and pursue the opportunities.

International trade dimension

The international dimension is another issue altogether. The burden of Kyoto obligations would be more palatable if it was spread more evenly across the global economy. The effect of the Kyoto Protocol on the international competitiveness of New Zealand exporters and domestic producers is a key issue. No doubt impacts on international competitiveness will be factored in when the government is deciding how to implement Kyoto obligations domestically. But there are worrying scenarios. These include:

New Zealand exporters facing additional costs that reduce their competitiveness relative to exporters from developing countries with no such Kyoto obligations;

New Zealand exporters being similarly disadvantaged relative to their competitors in countries like the United States, which has pulled away from the Kyoto Protocol, or Australia, which has signalled its reluctance to ratify;

New Zealand export industries becoming less attractive to investors or migrating to countries without Kyoto obligations;

Domestic producers being less able to compete with imports from non-Kyoto countries.
The Kyoto Protocol does not satisfactorily address these sorts of trade impacts. The relationship between the climate change convention and international trade rules needs more attention. The assumption seems to be that the Kyoto obligations must simply sit alongside international trade obligations; and that it is largely a matter of New Zealand and other countries having to comply with WTO and other agreements - which have free trade as their premise - while labouring under the burden of Kyoto commitments.

Yet there will surely be attempts by countries with Kyoto obligations to protect their domestic industries and exporters against competition from industries in countries without equivalent Kyoto commitments. For instance, the European Union taking restrictive trade measures to shield its domestic industry against American competition seems entirely foreseeable.

A number of WTO agreements contain exceptions that allow discriminatory trade measures where they can be justified on legitimate environmental grounds. For example, a country could seek to implement technical regulations or standards in a way that discriminated against products manufactured according to processes that it considered to be unduly emissions intensive. Another possibility is that a country subject to Kyoto obligations might seek to compensate its export industries with additional support in the nature of a subsidy. Some subsidies to allow businesses to adapt to new environmental requirements are permissible.

One can expect countries affected by Kyoto obligations to pore over the exceptions within free trade agreements, looking for opportunities to protect their industries against the adverse impacts. There are likely to be trade issues even between countries that have ratified the Protocol, as some countries shield certain sectors from Kyoto obligations to maintain their competitiveness where others have not. Countries with competitive disadvantages having nothing to do with Kyoto may even seize on the Protocol as a convenient excuse to erect new trade barriers.

Rules may be exploited beyond their original intention, affording significant protection to domestic industry while legal challenges take time to run their course through the relevant dispute mechanisms. There is nothing new there. While reliance on particular environmental exceptions could be entirely appropriate, New Zealand exporters may not take a lot of comfort from existing trade rules and exceptions in the sorts of scenarios referred to above.

Over time, the distortions of international trade and risks to competitiveness for countries adopting Kyoto obligations could be so significant that they pursue discriminatory measures on an unprecedented scale. This would run counter to the existing efforts to pursue greater trade liberalisation through a new round of WTO negotiations.

The tensions between environmental obligations associated with the Kyoto Protocol and free trade rules and remedies need to be addressed and reconciled. Without new trade rules, or clear understandings about how existing free trade rules and exceptions will apply in the Kyoto context, the entry into force of the Kyoto Protocol could herald a new era of protectionism.

Business would benefit from a dialogue with government about how existing trade rules and remedies would apply in a Kyoto-constrained world. This dialogue would also help to identify what trade measures or new rules are needed