Could friend-shoring stop protectionism undermining trade and climate change measures?

When considering trade rules and climate change, current developments point towards more protectionism, with the WTO’s role devalued, and progress in reducing emissions at the mercy of government subsidies to national champions. For despite the efforts of numerous individuals recognising the existential nature of the climate emergency and how trade can help, domestic manufacturing is taking over as the political priority.

Something needs to change, quickly, and as a start that has to be the EU and US being more open to discussing their actions at least with each other plus other allies. Otherwise, unilateralism of major powers will become the dominant global trade policy paradigm.

Ironically, concern for maintaining WTO rules and free trade has until now been a factor delaying measures on climate change. While the case for trade continues to be accepted by the vast majority of economists, that does not automatically follow for reducing emissions. There has always been the fear that any agreement at the WTO will in some way impede free trade, particularly by some purists, and at worst be used as an excuse for protectionism.

Yet overall, trade should be strongly positive for the fight against climate change. Environmentally damaging trade exists for sure, the movement of small parts long distances as much as the movement of people short distances on flights. Finding and using scarce resources hastens degradation, and fossil fuels have powered economic growth.

Benefits of trade from the spread of environmentally friendlier goods and technologies at reasonable cost, best practise standards and regulations disseminated, and lower barriers to innovation should outweigh the costs. Indeed, with consumers demanding action on climate change, companies are already responding across borders, arguably faster than most governments, and consistent with how we would expect free markets to behave.

Arguably some years overdue, there now seems to be increasing global consensus that urgent action on climate change is needed. Self-evidently, it is a global problem needing global solutions, including through agreements around trade. What has stopped 2022 being decisive in this regard is the return of protectionism as a serious political imperative, overlapping and distorting the politics.

Warning signs have been present since the global financial crisis of 2008 that a nationalist rejection of trade could happen. Growth across developed economies has been weak, while former manufacturing areas have become increasingly important in national elections.

New trade deals including CPTPP and EU bilaterals have not changed economic fundamentals, given that the benefits of tariff liberalisation have largely been banked, and finding something similar on services or regulations has proven difficult. More recently the EU’s autonomy agenda of instruments such as the anti-coercion instrument have been more prominent than the liberalisation agenda, sparked by concerns about the US under President Trump, and China’s behaviour.

Covid and then Russia’s invasion of Ukraine provided a focus for that trade backlash. Initial forecasts that covid would be a decisive turning point against globalisation were undermined by the speed with which vaccines appeared and supply chains adjusted, but Russia’s invasion has been different. Europe’s dependence on energy imports and the possibility of a future China-Taiwan conflict have boosted protectionists.

Genuine concerns about economic security, from which discussions about levels of dependency could follow, have quickly turned into arguments for greater domestic production using whatever measures necessary. The car industry, totemic in both Europe and the US as the last great manufacturing employer, is a significant example. As last year’s ECIPE study “The Future of EU Leadership in the Car Industry: Still Global” showed, the strength of the sector depends on exports.

Analysing the collective EU trade autonomy instruments showed the risk of retaliatory measures closing markets to EU vehicles was high, with the Carbon Border Adjustment Mechanism a particular problem, and subsidies not far behind. That would exacerbate the considerable transitional challenges of moving to electric vehicles, not least a much-shortened supply chain, damaging the competitiveness of the industry as a whole, for which consumers, governments, workers and quite possibly the environment would likely pay.

Before that could happen though the US passed the Inflation Reduction Act offering subsidies to electric vehicles as long as they were made in, using materials from, North America. The conversation about trade and climate change, incorporating protectionism, suddenly became pressing. Demands for some similar protectionist measures in the EU have grown.

Whatever environmental justifications are offered for US and EU measures so far proposed, they appear at first sight to be obvious undermining of WTO rules. That might be because they are clearly also intended to protect domestic industry and counter perceived Chinese cheating, the latter being generally accepted though worth questioning as to whether their competitiveness is also a factor of commercial focus.

China though has not been the country leading protests about the US scheme, it is South Korea, an FTA partner, and the EU, a close partner in trade terms. Recalling the idea of friend-shoring, of seeking to enhance economic security through co-operation, US (and EU) actions suggest a lack of seriousness in that regard.

Perhaps the car industry is too seminal to the EU and US, or perhaps fears of China too much, but if either is true it is the end of the principles upon which modern trade has been founded, of mutual gain through accepted rules. Neither speaks to climate change as the policy priority either.

Customarily, trade policy specialists would call for talks at the WTO to find solutions. This would indeed be ideal, but the chances of early resolution slim to non-existent. Given that we are talking about climate emergency and the hollowing out of WTO rules, rather more urgency is required.

The EU and US previously agreed to end their trade dispute over steel and aluminium tariffs with a package including discussions over carbon intensity. One option would be to seek a bilateral solution to issues around electric vehicles. The drawbacks are however obvious, this is to overtly state that if the EU and US agree something then this takes precedence over WTO rules.

More palatable if still far from perfect would be to establish a serious ongoing trade and climate change conversation between allies, to attempt to turn friend-shoring into something more substantial. This would demonstrate a continued wish to retain trade rules which benefit many countries, rather than resort to entirely unilateral or bilateral measures.

A climate change and trade agreement would be the aim, an interim measure might be a commitment on all parties to refrain from disputes, with discussions between members as a view to finding mutually agreeable solutions. Climate change waivers at the WTO have been often discussed, and this is just a variant, but one that perhaps stands more chance of being adopted by a smaller group.

Gloom is increasing among the trade community at the prospect of the unravelling of a global order which did so much to boost trade. Global solutions to climate change are also put under strain by unilateralism. Smaller group discussions on climate change and trade are distinctly second-best solutions, but might just provide some impetus towards finding plurilateral or multilateral solutions. The alternative looks like a retreat, a protectionist, unilateralist approach which most likely leads to businesses holding governments to ransom, consumers having to pay more, and ultimately, essential measures to tackle the climate change crisis not taken.