The emissions market failure that still threatens the planet

Nearly 20 years ago, the economist Nicholas Stern, in a groundbreaking report for the UK government, memorably called climate change “the biggest market failure in history”. That sadly remains largely true. Emissions costs are still mostly loaded on to the planet rather than borne by polluters. The OECD says 60 per cent of carbon emissions from the world’s leading economies are completely unpriced, and only 10 per cent are taxed to a level that probably reflects the true cost of carbon.

It’s an indictment of governments and their global institutions that all this time has not produced co-ordinated action. Divisions between and within rich and poor countries, institutional jealousies and an aversion among some big powers (particularly the US) to multilateralism have all prevented progress. Bizarrely, one of the more likely avenues for creating a global carbon pricing regime is a campaign of governments suing each other at the World Trade Organization, an institution whose credibility has been eroding for decades.

The world’s response to climate change and carbon emissions is ineluctably bound up with trade. Without convergence in carbon pricing schemes, or border measures to charge imports for the untaxed emissions created while manufacturing them, there’s a high risk of carbon leakage as production shifts to dirtier economies.

One of the biggest repositories of expertise on climate change and trade is the Paris-based OECD, which conducts research and hosts technical discussions among member governments. But the organisation’s actual policymaking function is essentially a forum for ad hoc negotiations rather than a permanent, binding legal framework, and its history as a club of rich countries weakens its legitimacy. 

The organisation made a promising breakthrough in 2021, for example, when governments struck a draft global deal to reduce tax avoidance by multinational corporations. But the agreement faces strong opposition in the US Senate and among developing countries (led by India, often the chief malcontent in global economic governance issues), which complain that it will reduce their revenues.

The logical place for a binding settlement over carbon and trade would be just over three hours’ train ride away in Geneva at the World Trade Organization. But the WTO’s negotiation function, cumbersome and politically divided, has barely scored any major successes since its creation in 1995. Its member governments are now holding non-binding “structured discussions” on climate and trade.

Where negotiation fails, litigation fills the vacuum. Perhaps the most substantive and immediate conversations are coming from governments (India in particular, again) threatening to bring cases against the EU’s carbon border adjustment measure to the WTO’s dispute settlement process for discriminating against their exporters.

CBAM is being implemented this year and will start levying taxes from 2026. It provides incentives for countries to toughen their carbon regimes by charging imports the difference between their and Europe’s emissions prices, down to the level of individual producers.

Brussels insists it will strive to make the CBAM WTO-compliant. On an optimistic reading this could mean the EU will tweak the border measures to stay legal if and when the rulings start to come down, eventually hammering out a system that commands some acceptance and encouraging other economies to adopt similar schemes. Those frustrated by the lack of EU-style carbon pricing elsewhere, such as the energetic US senator for Rhode Island, Sheldon Whitehouse, have actively encouraged the CBAM’s introduction.

Protracted WTO litigation as a means of reaching consensus isn’t as ridiculous as it sounds. Although a 17-year litigation campaign seems farcical, the legal battle between the EU and US over subsidies to Boeing and Airbus between 2004 and 2021 did somewhat constrain trade-distorting handouts, as both sides made some effort to comply with successive rulings against them.

The colossal difference, of course, is that the US has increasingly turned against the WTO dispute settlement regime. Joe Biden’s administration has maintained Donald Trump’s 2019 decision to paralyse the appeals stage of the process, forcing the EU and other countries to construct their own workaround system.

The outcome of a WTO case would be highly uncertain. There are no direct precedents, and precedent is in any case not supposed to be binding in the system. If CBAM goes to WTO litigation there will be some fierce arguments about the EU taking into account developing countries’ compliance costs and its own historical emissions. Media reports in India seem to suggest Narendra Modi’s government is planning a carbon pricing regime that essentially charges Europe reparations for the industrial revolution.

But apart from a collective fit of conscience among the world’s governments or the sudden emergence of binding negotiations, it’s hard to see what other mechanisms there are to spread the use of emissions controls.

Building out a global carbon pricing regime through slow and iterative litigation in the politically contentious judicial wing of a troubled multilateral organisation is not exactly the kind of global governance the international relations textbooks recommend.

But at the moment it’s basically all we’ve got. Meanwhile, the climate continues to deteriorate, the planet continues to degrade and the market continues to fail.

alan.beattie@ft.com