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China Climate

Climate Trade Wars: China’s WTO Dispute with the E.U.’s Carbon Border Tax

Background

In July 2021, the European Union proposed to implement a Carbon Border Adjustment Mechanism (CBAM), otherwise known as a carbon border tax. The goal of the CBAM is to increase the cost of importing six categories of carbon-intensive goods from foreign nations: steel, iron, cement, aluminum, fertilizers, and electricity generation. This policy was introduced as part of the E.U.’s legislative mandate to reduce 55% of its emissions by 2030 and reach carbon neutrality by 2050[1].

After the announcement, several countries complained that the measure created discriminatory barriers for World Trade Organization (WTO) members to access the E.U. market. The nation most affected is China – the E.U.’s biggest trading partner, and the world’s largest exporter[2].  

When questioned about the CBAM proposal, Liu Youbin, a spokesman for the Chinese Ministry of Ecology and Environment, said that it was “essentially a unilateral measure to extend the climate change issue to the trade sector. It violates WTO principles … and will seriously undermine mutual trust in the global community and the prospects for economic growth.”[3]

If the CBAM enters into force on January 1st, 2023, as is currently proposed[4], China could choose to retaliate by imposing their own tariffs against European goods and sue the E.U. through the WTO’s Dispute Settlement Body to acquire legal relief from complying.

China’s Own WTO Compliance and its Legal Case Against CBAM

Despite valid concerns about the CBAM, China does not have much credibility to levy accusations of unilaterally flouting international trade law. Since joining the WTO in 2001, China’s compliance has been popularly described as “mixed” or “complex.”[5]

Though they have liberalized the economy in some areas, there remain a range of issues where China has not met its commitments, including industrial subsidization, intellectual property protection, forced joint ventures and technology transfer, and market access to the services industries[6]. Between 2009 and 2015, China-related complaints accounted for 90% of the cases brought to the WTO by the U.S., E.U. and Japan[7].

There are three issues where China could allege the CBAM violates the WTO[8], but its own practices also run afoul of those same trade principles.

First is Article I’s most-favored-nation treatment rule, which requires that any advantage granted to an imported product from one WTO member must be granted to all other members.

China could argue that the E.U. is discriminating against them by selectively choosing an arbitrary set of products it must buy emission certificates for based on how dirty its manufacturing process is compared to other countries.

At the same time, China has spent decades selectively treating intellectual property (IP) owned or developed by other WTO members in a different way from IP developed in China. The result is coerced joint ventures with Chinese firms which result in involuntary IP transfer and a siphoning of technology and trade secrets from other countries[9]. A 2019 report found that one in five North American companies had their IP stolen from China just that year[10].

Second is Article II’s tariff schedule which lays out the maximum level of tariffs that a country can apply against another country’s exports.

If the cost of the CBAM emission certificates exceeds the ceiling on customs duties that the E.U. agreed to, also known as the bound rate, then China could argue this would be a violation of Article II. While the final certificate costs have not yet been finalized, it’s likely that the price will rise over time to meet the E.U.’s ambitious emission targets.

However, Chinese tariffs on U.S. imports today already exceed the bound rate on more than 128 products, breaching its obligations under Article II[11]. Moreover, China’s expansive use of subsidies effectively undermines its tariff reduction commitments by offsetting the cost of domestic production.

Last is Article III’s national treatment rule which requires that imported products not be given less favorable treatment than domestic products.

Today, almost 43% of the E.U.’s emission certificates are given for free to the manufacturing, power, and airline industries[12] – sectors which are harder to abate, but whose free allocations are expected to decline and be phased out. European industries are lobbying hard to keep their free allocations, but if they are not phased out before the CBAM goes into effect then China can argue its products are at a competitive disadvantage by paying a carbon price that the E.U.’s manufacturers aren’t paying.

Again, China provides massive subsidies to its domestic industries including semiconductors, solar panels, steel, aluminum, glass, and auto parts. That also provide an unfair advantage to its domestic products. For example, 95% of Chinese technology firms received R&D subsidies in 2015 accounting for almost a quarter of their total R&D investment[13]. Since joining the WTO, subsidies have financed nearly 20% of China’s manufacturing capacity every year[14].

CBAM and China’s Approach to International Law

The contradictions between China’s potential legal case against the CBAM with its own trade practices fits into its larger approach towards international law: a set of norms and practices to be obeyed when practicable and overlooked when they cannot[15]. By accusing the E.U. of doing that which it is also guilty of, China would continue a trajectory of acting as a “selective revisionist” in the international system looking to promote its own economic interests through exceptions and special conditions[16].

If the CBAM is taken to court, the E.U. could seek justification under Article XX’s general exceptions, arguing that the CBAM is “necessary to protect human, animal or plant life or health,” by tackling climate change[17]. But even if the WTO rules in favor of the E.U., China has a long history of either failing to adhere to decisions or creatively interpreting them in way that thwarts thwart the purpose of the ruling itself[18].

In the context of CBAM, this could look like Chinese manufacturers obfuscating or falsifying the total extent of carbon emissions for their products, as has been done before[19], and artificially buying a lower number of emission certificates.  These actions would further reinforce the tension between China’s desire to promote its own interests and its desire to be seen as a responsible member of the multilateral order.

Conclusion

The E.U.’s CBAM would be the first carbon border tax implemented at an international level, but it has already set off discussions in Germany, Japan, the U.S. and Canada about implementing similar policies. In response, it looks likely that China will contest CBAM policies as unilateral actions that violate international trade law, if nothing to buy time as they hopefully push Chinese firms to quickly decarbonize their manufacturing processes.

While China could make a number of valid legal arguments against the CBAM, it will be throwing stones from a glass house. Given China’s complex track record of compliance with past WTO rulings and conditions for entry, many of the complaints China could allege would apply to several of its own trade practices.  

Contradictions notwithstanding, the WTO represents the only arena of international relations where China has agreed to resolve foreign conflicts through an international court[20]. Thus, how the China-E.U. CBAM dispute gets settled will have significant ramifications on the ambition of future carbon reduction policies and the cooperation of the world’s largest trader and carbon emitter to support these efforts.


[1] Council of the European Union, “Council agrees on the Carbon Border Adjustment Mechanism (CBAM)”, March 15th, 2022, https://www.consilium.europa.eu/en/press/press-releases/2022/03/15/carbon-border-adjustment-mechanism-cbam-council-agrees-its-negotiating-mandate/ .

[2] Eurostat, “China-EU – international trade in goods statistics,” February 2022, https://ec.europa.eu/eurostat/statistics-explained/index.php?title=China-EU_-_international_trade_in_goods_statistics.

[3] Muyu Xu and David Stanway, “China says EU’s planned carbon border tax violates trade principles,” Reuters, July 26th, 2021, https://www.reuters.com/business/sustainable-business/china-says-ecs-carbon-border-tax-is-expanding-climate-issues-trade-2021-07-26/.

[4] Ibid. 1.   

[5] Timothy Webster, “Paper Compliance: How China Implements WTO Decisions,” Michigan Journal of International Law, Volume 35, Issue 3, 2014, https://repository.law.umich.edu/cgi/viewcontent.cgi?article=1064&context=mjil.

[6] Stephen Ezell, “False Promises II: The Continuing Gap Between China’s WTO Commitments and Its Practices,” Information Technology & Innovation Foundation (ITIF), July 26th, 2021, https://itif.org/publications/2021/07/26/false-promises-ii-continuing-gap-between-chinas-wto-commitments-and-its.

[7] Mark Wu, “The ‘China, Inc.’ Challenge to Global Trade Governance,” Harvard International Law Journal, vol. 57, no. 2, Spring 2016, https://harvardilj.org/wp-content/uploads/sites/15/HLI210_crop.pdf.

[8] James Bacchus, “Legal Issues with the European Carbon Border Adjustment Mechanism,” CATO Institute, August 2021, https://www.cato.org/briefing-paper/legal-issues-european-carbon-border-adjustment-mechanism.

[9] Ibid. 6.   

[10] Eric Rosenbaum, “1 in 5 corporations say China has stolen their IP within the last year: CNBC CFO survey,” CNBC, March 19th, 2019, https://www.cnbc.com/2019/02/28/1-in-5-companies-say-china-stole-their-ip-within-the-last-year-cnbc.html.

[11] United States Trade Representative (USTR), “CHINA – ADDITIONAL DUTIES ON CERTAIN PRODUCTS

FROM THE UNITED STATES,” May 2nd, 2019, https://ustr.gov/sites/default/files/enforcement/DS/US.Sub1.(DS558).(public).pdf.  

[12] European Commission, “Free Allocation,” https://ec.europa.eu/clima/eu-action/eu-emissions-trading-system-eu-ets/free-allocation_en.  

[13] Ibid. 6.  

[14] Ibid. 6.  

[15] Michael J. Mazarr, Timothy R. Heath, Astrid Stuth Cevallos, “China and the International Order,” RAND Corporation, 2018, https://www.rand.org/content/dam/rand/pubs/research_reports/RR2400/RR2423/RAND_RR2423.pdf.

[16] Ibid. 16.

[17] Gary Clyde Hufbauer, Jisun Kim, Jeffrey J. Schott, “Can EU Carbon Border Adjustment Measures Propel WTO Climate Talks?” Peterson Institute for International Economics, November 2021, https://www.piie.com/publications/policy-briefs/can-eu-carbon-border-adjustment-measures-propel-wto-climate-talks.

[18] Ibid. 5.  

[19] Muyu Xu and David Stanway, “China slams firms for falsifying carbon data,” March 15th, 2022, Reuters, https://www.reuters.com/world/china/china-slams-firms-falsifying-carbon-data-2022-03-14/.

[20]Gregory Shaffer and Henry S. Gao, “China’s Rise: How It Took on the U.S. at the WTO,” Singapore Management University School of Law Research Paper No. 14/2017, March 20th, 2017, https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2937965.

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