Trade And Environment: An Update on the Issues

Duncan Brack

The Royal Institution of International Affairs

February 1997

Introduction

The gradual evolution of global trade and environmental regimes continues to raise the possibility of conflict. The international community is in theory committed both to trade liberalization, through the Uruguay Round extension of the General Agreement on Tariffs and Trade (GATT) and the creation of the World Trade Organization (WTO), and to environmentally sustainable development, through the agreements signed at the UN Conference on Environment and Development, the 'Earth Summit' of 1992.

In principle, the pursuit of both objectives should be entirely compatible. According to the theory of comparative advantage, trade allows countries to specialize in the production of goods and services in which they are relatively most efficient. In other words, trade enables countries to maximize output from a given input of resources -- which is a movement in the direction of environmental sustainability. Furthermore, trade liberalization can help to remove distortionary subsidies and pricing policies, improving the efficiency of resource allocation, and encourage the spread of environmentally-friendly technology. The higher rate of growth of income resulting from trade also helps to generate the resources needed for investment in environmental protection -- although this is not an automatic link, and appropriate policies need to be pursued simultaneously.

Given modern systems of economic activity, however, trade can also harm the environment. To the extent that environmental externalities are not incorporated in economic prices and decision-making, trade can act to magnify unsustainable patterns of economic activity, exacerbating problems of pollution and resource depletion. Where externalities are being incorporated (through environmental taxation, for example, or regulation), the process is invariably proceeding at different speeds in different countries. Yet trade rules are set internationally, and the current GATT regulations may fail to allow for such differences in national efforts at achieving environmental sustainability, even when policies are aimed at controlling transboundary or global environmental problems. In addition, a country with strict environmental regulations may fear that its economy will be undermined by competition from other countries with more lax environmental standards (and hence potentially lower production costs).

Trade and environmental policies are therefore inextricably interlinked. Conflict between trade liberalization and environmental protection has already erupted in a number of instances as regulations drawn up in pursuit of the objective of environmental sustainability have been challenged as erecting barriers to trade, notably in several cases brought before disputes panels of the GATT and WTO. The very first dispute under the WTO (which went through both a panel and the Appellate Body) was on a trade-environment case. The WTO itself, on its creation on 1 January 1995, established a Committee on Trade and Environment (CTE), taking forward the work carried out in the former GATT Working Group on Environmental Measures and International Trade (formally created in 1971 but inactive until 1991). Its aim is 'to identify the relationship between trade measures and environmental measures, in order to promote sustainable development', and 'to make appropriate recommendations on whether any modifications of the provisions of the multilateral trading system are required ...'. ₁ The Committee reported to the first WTO Ministerial meeting in Singapore in December 1996, and had its mandate renewed; aspects of its discussions and conclusions are highlighted below.

Many other international organizations, including the OECD, the UN Environment Programme (UNEP), the UN Conference on Trade and Development (UNCTAD) and a large number of academic institutes and NGOs, have also published work in the area. Two new organizations were established during 1996: the International Panel on Trade, Environment and Sustainable Development, established by the World Wide Fund for Nature and sponsored by a number of European governments; and the Geneva-based International Centre for Trade and Sustainable Development, supported by the International Union for the Conservation of Nature.

This briefing paper aims to provide an outline of the major issues involved in the trade and environment debate.

Use of trade measures for environmental purposes

The central aim of the GATT is to liberalize trade between contracting parties. Article I ('most favoured nation' treatment) requires that any trade advantage granted by any contracting party to any product either for import or export must also be applied to any 'like product' originating in or bound for any other contracting party. Article III ('national treatment') similarly requires imported and domestic 'like products' to be treated identically with respect to internal taxes and regulations. WTO members, in other words, are not permitted to discriminate between other WTO members' traded products, or between domestic and international production.

The GATT does permit, however, certain unilateral trade restrictions in the pursuit of environmental protection under particular circumstances. Article XX ('General Exceptions') states that:

Subject to the requirement that such measures are not applied in a manner which would constitute a means of arbitrary or unjustifiable discrimination between countries where the same conditions prevail, or a disguised restriction on international trade, nothing in this Agreement shall be construed to prevent the adoption or enforcement by any contracting party of measures:

(b) necessary to protect human, animal or plant life or health;

(g) relating to the conservation of exhaustible natural resources if such measures are made effective in conjunction with restrictions on domestic production or consumption.

Countries can, therefore, ban or restrict the import of products which will harm their own environments, as long as the standards applied are non-discriminatory between countries and between domestic and foreign production. Environmental grounds have indeed become more widely cited as an objective and rationale for applying trade-restrictive regulations including, most notably, measures aimed at controlling air pollution and hazardous chemicals. ₂ Any agreement permitting a restriction in trade, however, runs the risk of capture by protectionist interests using environmental justification as a disguise. To that end, the CTE has spent some time discussing transparency requirements for such measures. The Uruguay Round agreement incorporated many improvements in the requirements for notification of measures under the Agreements on Technical Barriers to Trade (TBT), Sanitary and Phytosanitary Measures, and Subsidies and Countervailing Measures. While considering that no further modifications to WTO rules were necessary, the CTE concluded that the establishment of a central database of trade-related environmental measures would be helpful. Relatively little analysis has in fact been carried out on the impacts of such measures, but at least one study has concluded that they are relatively inexpensive, tend to be short term and are often well worth the cost in terms of environmental benefits. ₃

Product requirements

Generally speaking, environmental regulations apply either to products or to processes. Product requirements, as well as outright bans, include regulations and/or voluntary agreements governing labelling, packaging, recycling and recycled content. Increasingly such requirements are based on life-cycle assessments of the product's environmental impact during production, consumption and disposal. Although these can be valuable instruments of environmental policy, the application of such requirements to imported products can pose significant difficulties. Information, particularly in life-cycle assessment cases, may be wholly or partially lacking. Characteristics chosen for labelling may reflect domestic environmental priorities, and criteria used in different national schemes may vary widely. Schemes which focus only on particular products (e.g. tropical timber) may create artificial advantages for products which are not subject to similar requirements (e.g. temperate timber or substitutes such as plastics or metals) but whose consumption and production nevertheless have environmental impact. Packaging regulations which require recovery and reuse (e.g. returnable bottles) clearly create problems for non-domestic producers. Foreign governments and industries are highly unlikely to be involved in designing and implementing such schemes. Not only do these problems combine to create barriers to trade (particularly for developing countries) but they may also lead to resource misallocation and potentially inappropriate environmental policies.

The TBT Agreement aims to ensure that regulations such as these do not create unnecessary obstacles to international trade; environmental protection is singled out as a legitimate objective of technical requirements and standards. The Agreement requires, inter alia, that all such measures should be as transparent as possible and based on international standards where feasible. The CTE, which spent most of its time under this item discussing voluntary ecolabelling schemes, stressed the importance of sticking to the Agreement's provisions and ensuring fair access to foreign producers. It is unclear, however, whether recycling and waste management requirements, and labelling schemes incorporating information about production processes, are covered by the Agreement, and the CTE will consider these issues further. The OECD has proposed a series of steps to minimize disruption to trade, including transparency; transitional adaptation periods; sensitivity to non-domestic conditions and particularly to the special needs of developing countries and economies in transition; greater harmonization of life-cycle methodologies; and a requirement for genuine environmental justification for all such measures. ₄

A specific issue related to the trade in products is the export of domestically prohibited goods. Goods which are restricted in domestic markets, on the grounds that they present a danger to human, animal or plant life or health or the environment, may often be legally exported. This may cause a problem for the importing country where information is lacking on whether and why the product is banned: exporters may make false declarations, customs authorities (particularly in developing countries) may lack adequate product testing facilities, and undeveloped or ineffective consumer protection legislation may, for example, enable products to be marketed beyond their expiry dates. Trade in hazardous waste is covered by the Basel Convention, and the negotiation of further multilateral environmental agreements (MEAs) may prove the best way to make progress on this issue. A legal requirement for 'prior informed consent' for export is increasingly common within the European Union (for example for the export of restricted chemicals) and this may also provide a way forward. As with many other trade-environment topics, transparency of measures, and the provision of technical assistance to developing countries, are key issues.

Process and production methods

Environmental regulations based on process and production methods (PPMs), as opposed to product standards, cause more complex interactions with trade. Although the GATT's 'like product' provisions were not drawn up with environmental issues in mind, a GATT dispute panel applied them in the case of the well-known US-Mexico tuna-dolphin dispute in 1991. It ruled that the trade restriction in question (the US import ban on Mexican tuna caught with dolphin-unfriendly nets) was in breach of the GATT because it discriminated against a product on the basis of the way in which it was produced, not on the basis of its own characteristics -- i.e. it discriminated against a 'like product'.

The meaning of 'like product' has become one of the most difficult issues in the trade-environment arena. In 1994, another GATT panel, ruling on an EU-US dispute over car imports, slightly relaxed the definition, considering that vehicles of different fuel efficiency standards could be considered not to be like products. However, it placed strict boundaries on this conclusion, arguing that Article III of the GATT referred only to a 'product as a product, from its introduction into the market to its final consumption'. ₅ Factors relating to the manufacture of the product before its introduction into the market were, therefore, still irrelevant. Another panel in 1996 found that chemically identical imported and domestic gasoline were like products regardless of the environmental standards of the producers. ₆

Even if one does not adopt the panels' viewpoints, PPM-based environmental trade measures can be difficult to justify. Different parts of the world vary widely in their ability to assimilate pollution, depending on factors such as climate, population density, existing levels of pollution and risk preferences. Environmental regulations suited to industrialized nations, with high population densities and environments which have been subject to pollution for the past 200 years, may be wholly inappropriate for newly industrializing countries with much lower population densities and inherited pollution levels -- and yet trade measures based on PPMs could in effect seek to impose the higher standards regardless. Carried to its logical extreme, enforcing similarity of PPMs could deny the very basis of comparative advantage, which rests on the proposition that countries possess different cost structures for the production of various goods. It is hardly surprising that many developing countries view the motives of those wishing to introduce this issue to the debate as protectionist. Another argument rests on practicalities. By their very nature, PPMs cannot generally be determined by inspection of the products. Importers wishing to apply PPM-based controls must therefore enjoy the cooperation of the exporting country or country of origin in certifying how the goods are produced.

PPM-based measures are, however, becoming increasingly important in strategies for environmental sustainability. Particularly where the use of energy is involved (as it is in virtually every manufacturing and processing activity), the pollution caused stems from the PPM and not the product. Life-cycle approaches have similarly focused attention on the way in which products are manufactured, grown, and harvested as well on product characteristics themselves. In terms of trade measures, an important distinction can be drawn between PPMs which cause pollution that is restricted to the country of production, and those which cause pollution that is transboundary or global. In the latter case, differentiating, as the panels' interpretation of the GATT effectively does, between pollution associated with the consumption of a product and that associated with its production is more difficult to justify, and would rule out any trade measure aimed at protecting a country's environment, or any aspect of the global commons, from damage caused by transboundary pollution originating from production.

Inclusion of PPM-based trade measures in MEAs may provide a solution, and in fact the Montreal Protocol (on ozone-depleting substances) includes provision for such measures, though they have not so far been deployed. The OECD has accepted that in some cases PPM-based trade restrictions may have a place in MEAs. Recognizing the difficulties involved in determining the PPMs used from physical inspection of the product, it has called for the development of verification and certification systems and mutual recognition of such systems.

The negotiation of international treaties is frequently, however, a difficult and slow process. A number of participants in the debate ₇ have therefore called for the GATT to be amended to set out objective criteria under which trade measures directed against PPMs could be taken (including requirements such as non-discriminatory and transparent measures and evidence of significant transboundary environmental problems), subject to challenge under normal GATT rules. This issue does not feature explicitly on the agenda of the CTE, but underlies many other areas of concern, and is likely to feature increasingly in trade disputes. Recent debates over actual or potential trade restrictions against fur caught in leghold traps, genetically-engineered maize, and shrimps fished by methods which kill sea turtles, all focus attention on processes, not products.

Economic instruments

Economic instruments -- taxes and charges, tradeable permits, deposit refund systems and subsidies -- are playing an increasingly important role in environmental policy as complements to regulatory instruments and voluntary agreements. In principle, they aim to ensure that environmental externalities are incorporated in decision-making, and in general they are more efficient and more transparent than simple regulatory measures. The GATT agreements already cover to a certain extent the impact of economic instruments on trade. Subsidies are dealt with in the Agreement on Subsidies and Countervailing Measures, which permits government assistance to promote adaptation of existing facilities to new environmental requirements, as long as this is limited to 20% of the cost.

WTO members are permitted to adjust tax rates at the border -- i.e. to impose taxes on imports and rebate taxes on exports so that domestic producers and exporters are not undercut by foreign producers -- inasmuch as these are applied to traded products. Following the discussion on PPMs above, it would appear that taxes and charges related to processes and production methods cannot be so adjusted, though the GATT is not completely clear on this and a Working Party on Border Tax Adjustments in 1970 failed to draw any conclusion on so-called taxes occultes (consumption taxes on materials and services used in the production and transport of other goods). ₈ The 1987 GATT dispute panel on the US Superfund regulations ruled that import taxes applied to certain chemicals and to derivatives of them were permissible, since US chemicals and derivatives were subject to similar taxes. It has been argued that the same case can be made for energy consumed in the production process, and that border tax adjustments for carbon or energy taxes should therefore be permissible. In fact the Subsidies Agreement explicitly provides for special treatment for rebating indirect taxes on energy, fuels and oils used in the production process for exports.

There are, however, very severe problems involved with the practicalities of border tax adjustments, including the valuation of the appropriate level of tax, the likely wide diversity in national tax rates (given, as noted above, that environmental costs vary not only with products and processes but with location) and the difficulty of verifying PPM-based damage from inspection of products. The CTE undertook only a preliminary examination of some of the issues in this complex and controversial topic, and called for further work.

Multilateral environmental agreements

As Principle 12 of the Rio Declaration states, international agreement is clearly preferable to unilateral action in tackling transboundary or global environmental problems. More than 180 MEAs already exist, of which about 20 incorporate trade measures. These include three of the most important: the Basel Convention on hazardous waste, the Convention on International Trade in Endangered Species (CITES), and the Montreal Protocol on ozone-depleting substances. In the absence of any comprehensive framework of global environmental law, the negotiation of further MEAs -- such as the protocol to the Climate Change Convention currently under discussion -- will form an increasingly prominent part of the international agenda.
On the face of it, however, there would appear to be some conflict between current GATT rules and MEAs which contain trade provisions. The Montreal Protocol, for instance, permits parties to ban imports of chlorofluorocarbons and other controlled substances from non-parties, which breaches the 'most favoured nation' and 'national treatment' clauses of GATT. It is widely accepted, however, that the inclusion of this measure in the Montreal Protocol has contributed significantly to its success in attracting signatories, ₉ and future MEAs may similarly benefit from the inclusion of trade restrictions.

This topic became one of the most important items of debate on the CTE, with members putting forward proposals designed variously to define under what conditions trade measures taken pursuant to an MEA could be considered to be 'necessary' under the terms of GATT's Article XX, or to establish a degree of WTO oversight on the negotiation and operation of trade provisions in future MEAs. ₁₀ No consensus was reached about the need for modifications to trade rules. The CTE noted, however, that:

Trade measures based on specifically agreed-upon provisions can also be needed in certain cases to achieve the environmental objectives of an MEA, particularly where trade is related directly to the source of an environmental problem. They have played an important role in some MEAs in the past, and they may be needed to play a similarly important role in certain cases in the future. ₁₁

The Committee also recognized that a range of provisions in the WTO can already accommodate the use of trade measures in MEAs; these include the provisions of Article XX, and also of Article XXV, which permits the waiver of other GATT provisions, though on case-by-case and time-limited bases. NGOs have tended to argue for amendment to the GATT to create a presumption of compatibility with MEAs, ₁₂ following the example of the North American Free Trade Agreement. It is worth noting, however, that no complaint has yet arisen within the GATT or WTO with respect to trade measures taken in pursuit of an MEA, and this may well continue to be the case; in instances such as the Montreal Protocol, where the trade provisions were designed to encourage countries to accede, this has been so successful that there are virtually no non-parties left against whom trade measures could be taken in any case.

Environmental policy, market access and the removal of trade distortions

In what is probably the only area of broad consensus, it is generally agreed that the ending of economically distortionary practices such as subsidies for agriculture or energy would benefit both trade (improving allocative efficiency) and the environment (removing support for environmentally unsustainable activities). Similarly, ending the practice of tariff escalation, by which developing countries face higher tariffs against exports of manufactured and processed goods than for raw materials and primary products (common particularly in the timber and wood products sector), would encourage economic diversification and help end environmentally damaging systems of resource extraction. The GATT Uruguay Round made progress on this issue in the areas of agriculture and textiles, where the system of quotas on developing-country exports known as the Multi-Fibre Arrangement is due to be phased out over a ten-year period. CTE discussions on this item focused in particular on the needs of countries which are currently marginal participants in world trade, and on small and medium-sized enterprises.

International competitiveness

The impact of environmental regulation on economic competitiveness is much debated. Firms in countries with high environmental standards and costs of compliance may fear that they will be undercut by competition from companies based in countries with less strict regulation and lower costs. In theory, this may lead to entire industries departing for countries with lower standards, the so-called 'pollution havens'. Solutions which have been advocated in order to avoid a general lowering of environmental standards include the equalization of costs through countervailing duties. The purpose of these measures (sometimes referred to 'ecodumping' duties or 'ecoduties') is to level the playing field by ensuring that products imported from countries with lower environmental standards are subject to duties or tariffs to offset the implicit subsidy they enjoy from lower environmental costs.

In practice, however, there does not appear to be much evidence for industrial migration. For most industries, costs attributable to environmental regulations rarely exceed about 1.5% of the total. Countries with initially low environmental standards are not immune to pressures to raise them. Indeed, it can be argued that in a dynamic business environment, higher environmental standards may in practice act as a spur to innovation and competitive success. Trade may be a key factor in the ratcheting-up of standards, as manufacturers seek to expand markets for the products they are required to produce for countries with the higher standards. Nevertheless, it has been argued that concerns over competitiveness may become more relevant as the costs of environmental compliance rise, particularly for sectors such as energy-intensive manufacturing and processing.

Unsurprisingly, this topic does not feature in the work programme of the CTE. Although it could be argued that a failure to incorporate environmental costs is equivalent to an implicit subsidy, and should be countervailable under GATT's Article VI if the subsidized imports cause material damage to domestic production, the Subsidies Agreement carefully defines a subsidy as 'a financial contribution by a government or any public body' ₁₃ -- i.e. not an implicit subsidy arising from lower environmental standards. Even ignoring this, the concept of ecoduties raises many practical problems, including the appropriateness of the standards being defended, the danger of capture by protectionist interests, the possible removal of competitive pressures on domestic industry and the ever-present fear of retaliation. The practical problems of border tax adjustment have been considered above. Nevertheless, some participants in the debate ₁₄ have argued that it may be necessary to contemplate countervailing duties to defuse industrial opposition to higher environmental standards and prevent concerns that loss of competitiveness may become a significant drag on environmental legislation. The OECD, while affirming its opposition to countervailing duties, considered that further research on the extent of the problem would be helpful.

Dispute settlement

The World Trade Organization's Disputes Settlement Understanding established a unified system which applies to all WTO agreements. It operates to stricter time limits and is more transparent than the GATT system it replaced, and the findings of disputes panels are adopted automatically by WTO members unless they decide by consensus otherwise: the reverse of the previous position. The Understanding also enables panels to request written advisory reports from expert groups, and CTE members have underlined the importance of following this procedure in areas of trade-environment interaction -- while recognizing that it is not within the mandate of panels to question the merits of national or international environmental objectives. In general it is believed that the new system is a considerable improvement on the old, and panel findings have certainly been published much more speedily than before. CTE discussions largely concentrated on the interaction between WTO and MEA disputes settlement mechanisms but, as with the wider question, failed to reach any conclusion.

Conclusion

The trade-environment debate is not going to go away. On the contrary, the combination of the growth in trade anticipated from the implementation of the Uruguay Round agreements and the accumulating evidence of global environmental degradation, together with the pressure for international action which will result, seems likely to lead to more, and more serious, conflicts. Set against this background, the findings of the first report of the World Trade Organization's Committee on Trade and Environment -- which were little more than that more work was needed -- were a disappointment to many.

It may be, however, that the CTE will never be able to conclude very much by itself. The GATT/WTO regime tends to progress through negotiating 'rounds' (such as the Uruguay Round, the most recent) covering a very broad sweep of topics; trade-offs are then possible which ensure that every participant benefits directly from at least some of the elements of the final package. It may be that progress on the trade-environment issue will have to wait until the next WTO round, for which there are already calls.

More fundamentally, it may be that the WTO by itself, even in the context of a new trade round, will not be able to resolve the trade-environment conflict. One of the problems inherent in this issue is that debates are conducted within, but rarely between, two separate communities, each encompassing governments, international organizations, NGOs and businesses: those motivated by trade liberalization and those motivated by environmental protection. These two groups of people possess different assumptions, values and modes of operating, and tend to lack a full understanding and appreciation of each other's position.

Where the two sides can be brought together -- as they can, for instance, within the European Union, where the European Court of Justice is enabled to strike a balance in disputes between the two Treaty of Rome objectives of trade and environment -- then the pursuit of their two objectives can be brought into harmony. Forums for joint discussion, such as the OECD's Joint Session of Trade and Environment Experts, are clearly valuable. As yet, however, there is no global institution which is clearly capable of resolving the conflicts inherent in the pursuit of trade liberalization and environmental protection.

Notes

Note 1: World Trade Organization: Trade and Environment Decision of 14 April 1994 (see Appendix for extracts). Back.

Note 2: International Trade 1990-91 (Geneva: GATT Secretariat, 1992), p. 32. Back.

Note 3: James Lee, Antonio Santiago, Ali Ghobaldi and Roland Mollerus, 'Trade-Related Environmental Measures: Sizing and Comparing Impacts' (Global Environment and Trade Study, June 1996). Back.

Note 4: See Report on Trade and Environment to the OECD Council at Ministerial Level (Paris: OECD, 1995). Back.

Note 5: US: Taxes on Automobiles (1994): Report of the Panel, para. 5.52. Back.

Note 6: US: Standards for Reformulated and Conventional Gasoline (1996). Back.

Note 7: See in particular Paul Ekins, Harnessing Trade to Sustainable Development (Oxford: Green College, 1995), pp. 10-11; and Natural Resources Defense Council/Foundation for International Environmental Law and Development, Environmental Priorities for the World Trading System (Washington DC: NRDC, 1995), p. 9 Back.

Note 8: For a full discussion, see Steve Charnovitz, 'Free Trade, Fair Trade, Green Trade: Defogging the Debate', Cornell International Law Journal 27:3, 1994, pp. 498-505. Back.

Note 9: See Duncan Brack, International Trade and the Montreal Protocol (London: RIIA/Earthscan, 1996) for a full discussion. Back.

Note 10: For a good analysis (from an environmental point of view), see World Wide Fund for Nature, Trade Measures and Multilateral Environmental Agreements: Backwards or Forwards in the WTO? (Gland, Switzerland: WWF, 1996). Back.

Note 11: Report (1996) of the Committee on Trade and Environment, para 173. Back.

Note 12: See, for instance NRDC/FIELD, Environmental Priorities for the World Trading System, p. 17. Back.

Note 13: Agreement on Subsidies and Countervailing Measures, Article 1.1(a)(1). Back.

Note 14: Ekins, Harnessing Trade to Sustainable Development, p. 17. Back.