On Carbon-Linked Trade, Start with the Basics

Audio Brief

A short, spoken-word summary from CSIS’s Allegra Dawes on her commentary with Cy McGeady, On Carbon-Linked Trade, Start with the Basics.

Audio file

Global trade and climate policy are increasingly entwined. Across the globe, policymakers seek to drive investment into domestic green industry, reduce emissions, and avoid carbon leakage, all while preserving the efficiencies of global trade. The foundation for policy that navigates these issues is emissions accounting. Policymakers seeking to secure domestic economic competitiveness amid a global landscape of rapidly evolving decarbonization policy must take the basic steps today to create policy options tomorrow.

The PROVE It Act, a bipartisan bill released June of this year, would lay the groundwork for any future U.S. policy linking trade and emissions intensity. The bill would require the Department of Energy (DOE) to study and determine emissions intensities of nearly two dozen products made in the United States, G7 countries, free trade agreement partners, and foreign countries of concern, including China. The PROVE It Act is the first attempt to have the government quantify the United States’ carbon advantage, reflecting the belief that U.S. firms produce goods with lower carbon intensity than competitors abroad. This carbon advantage is the cumulative effect of a range of voluntary investments and local, state, and federal policy actions. Because of these hidden costs and investment, policymakers worry that U.S. manufacturers are susceptible to carbon leakage and hope to use trade policies to prevent it.

Small But Effective First Steps

The PROVE IT Act is the first step toward using a carbon advantage to guide trade policy. The bill would establish how the United States will account for its own industrial emissions. Any emissions-linked policy, whether aimed at protecting domestic manufacturers from dirtier, cheaper imports or aimed at international competitiveness, depends on a robust measuring, reporting, and verification system. Ensuring international competitiveness will become more significant for the private sector with the incoming European carbon border adjustment (CBAM). Importers of covered products will need to report the emissions associated with their products under EU accounting rules and, starting in 2026, will have to pay for those emissions at the border. 

While the United States does not export significant volumes of the goods covered by the CBAM, the growing links between trade and emissions intensity highlights the absence of a standard emissions accounting methodology across U.S. industry or the global economy. A major hurdle toward a unified standard is the basic fact that different methodologies benefit different industries and different entities within an industry. The PROVE IT Act creates a path through this challenge. The DOE study will establish a credible and neutral accounting methodology to inform U.S. trade diplomacy.

Furthermore, this methodology, established through federal legislation and validated by the DOE, will have improved standing with capital markets. This will allow private sector firms to track and report progress on internal emission goals using a methodology more resilient to scrutiny and litigation. This is a major boost for the private sector, which has seen net-zero pledges proliferate and now seeks guidance on emission policy. Another issue for the private sector is the question of ambition: how deep should voluntary emission reduction targets be and on what timeline? In a world market headed toward net-zero, a basic ambition of U.S. industry could be global leadership on carbon intensity. The DOE study would provide a suitable pacing framework for this goal.

A First Step Unlocking Many Paths

The basic ambition of the PROVE It Act is to prove that the United States holds a carbon advantage. Policymakers on both sides of the aisle see articulating that advantage as the first step to protect domestic industry from cheaper and more carbon-intensive imports. The next policy step towards this goal is less clear. The data collection and reporting required by the act is effective early groundwork for several potential policy directions.

Some policymakers in the United States already back a domestic carbon price, which would then allow a border adjustment akin to the EU CBAM. Others support industry-based standards, which would regulate the emissions intensity in different sectors. Another pathway would be to set up a carbon club, in cooperation with other countries, that would benefit trade between partners with agreed-upon domestic policies. Each of these would need additional political support.

In lieu of a domestic price on carbon or multilateral agreement on climate clubs, a fourth option would be a carbon border fee. This proposal would place a carbon-weighted fee on imported goods with emissions intensities exceeding that of domestic industries. The fee would reflect the domestic investments in lowering emissions such as the Inflation Reduction Act, regulations, voluntary actions, and implied carbon prices. However, accurately reflecting that mixture of policies with a price will be challenging in terms of analysis and politics. Internationally, such a policy begins to look like a tariff rather than an adjustment and could instigate significant diplomatic and economic backlash.

Uniting these policies is the belief in the value of a U.S. carbon advantage. Beyond the risk of carbon leakage, a carbon advantage is important for domestic U.S. industry in a world in which carbon-linked trade policy is set to proliferate. The EU CBAM is expressly designed to instigate carbon reducing policy in major EU trade partners. Any significant carbon pricing, tax, or compliance scheme introduced abroad will likely be paired with carbon-linked trade policy. U.S. industry needs to position itself to compete in this environment.

Maintaining a carbon advantage is likewise an important objective for U.S. policymakers. It creates an advantageous position, diplomatic leverage, one could call it, as policymakers engage in international climate and trade policy discussions. A robust and public reporting system demonstrating global emissions intensity leadership will enhance bargaining power in these conversations, which are set to intensify and proliferate in the decades to come.

Assisting the Private Sector

Carbon pricing is the best way to incent the broad private investment necessary to maintain a carbon advantage in the future. However, its political fortunes are cloudy. It is the same for directly regulated sectoral emissions standards: these are slow and controversial to implement, and subject to abrupt shifts when administrations change in a way that introduces uncertainty for U.S. firms and foreign partners. Certainty of direction and stability of policy are key to driving private investment.

In the absence of a carbon price, voluntary actions from industry may be needed to maintain a carbon advantage. Attention naturally turns to the rapidly growing voluntary carbon market landscape. Two key questions must be asked of this space. First, can a voluntary market give rise to a price on carbon recognized by the EU CBAM and other international trade authorities? And second, can a voluntary price effectively incent the investment necessary to maintain the U.S. industry’s carbon advantage over time? That is, will it be respected by capital markets?

CSIS research shows that today’s voluntary carbon markets are not up to the task. However, a clear takeaway from the CSIS brief on voluntary carbon initiatives is the importance of the long-term signal of support from the national government. The ACCU in Australia and GX League in Japan are both explicitly tied to government climate targets and Nationally Determined Contributions commitments, creating the long-term stability necessary for market growth and private investment. Tying voluntary carbon markets to government standards and targets introduces credibility and neutrality into systems struggling with a lack of trust and collective action problems. The PROVE IT Act’s introduction of a neutral methodology and a standard of ambition—U.S. global leadership in carbon intensity—creates new conditions in which a voluntary carbon market might thrive.

Conclusion

As U.S. policymakers simultaneously pursue a revitalized U.S. industrial sector and an ever-cleaner economy, trade policy addressing carbon leakage will be critical. Innovative and creative policymaking is needed to chart a path towards a carbon pricing system that can cohere domestic and international climate policy and keep U.S. industry competitive. Domestic industry desperately seeks certainty on climate and trade policy, even if that means starting with the accountants.

Cy McGeady is an associate fellow with the Energy Security and Climate Change Program at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Allegra Dawes is an associate fellow with the CSIS Energy Security and Climate Change Program.

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5McGeady
Fellow, Energy Security and Climate Change Program
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Allegra Dawes
Associate Fellow, Energy Security and Climate Change Program