Green Trade Tensions

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Thesis: Green industrial policy (e.g., the US Inflation Reduction Act) will drive decarbonization but may generate significant trade tensions and protectionist pressures that could fragment global clean-technology markets.
Central tension: Policies that boost domestic clean-industrial capacity (subsidies, domestic sourcing, final assembly requirements) can accelerate emissions reductions while straining World Trade Organization (WTO) rules and diplomatic relations.

The Inflation Reduction Act (IRA) was crucial to enabling the US pledge of reducing US emissions 50–52 percent by 2030.
Political incentives that produced the IRA are not unique to the United States; many countries will mix subsidies, tariffs, and regulations to maintain domestic support.
Europe’s response includes the Green Deal Industrial Plan and the Net-Zero Industry Act (NZIA), which:
- Loosen state aid rules to cover more clean energy projects.
- Feature funding measures and prioritize workforce training.
- Propose a European Sovereignty Fund and an Innovation Fund to finance domestic manufacturing and demonstration projects.
- Emphasize domestic manufacturing targets across technologies: wind turbines, solar photovoltaic panels, heat pumps, batteries, and electrolyzers.

The EU finalized its carbon border adjustment tariff mechanism (CBAM) in December of last year; as proposed, it will eventually impose tariffs on countries that do not have a domestic carbon price, including the United States and most developing economies.
US proposals (for example, the Global Arrangement on Sustainable Steel and Aluminum, GASSA) to impose tariffs on carbon embedded in imports are likely to provoke strong responses from developing countries, especially given lack of comparable fees on many domestic producers.
Developing-economy responses may include:
- Limiting imports of clean energy technologies.
- Imposing export controls on raw materials and critical minerals to gain political and economic leverage.
- Calling for increased climate financing, including for loss and damage—a demand that gained momentum at COP27.

A protectionist trajectory could produce:
- Walled markets that impede diffusion of low-cost clean technologies across borders.
- A subsidy arms race that emerging market economies cannot match.
- A deluge of tit-for-tat WTO cases and retaliatory tariffs that fragment the global clean technologies market and decelerate climate action.
Trade-offs: Subsidies paired with domestic content requirements might raise decarbonization costs compared with a hypothetical cost-effective pathway with unfettered free trade, but political feasibility may require sacrificing some economic efficiency to prompt speedy government action given the dwindling carbon budget.

Establish “guardrails” to preserve international trade rules while enabling effective green industrial policy.
Negotiate comprehensive “rules of the road” for climate-focused industrial policy to avoid protectionist escalation that raises collective costs or slows decarbonization.
Promote coordinated investment and supply chain cooperation among allies to spur climate progress without fragmenting markets.
Direct concessional financing and technology assistance toward developing economies to:
- Support deep decarbonization in emissions-intensive heavy industry sectors (for example, steel).
- Help partner developing economies with inexpensive renewables potential and critical minerals develop global supply chains and move up the value chain.

WTO reform:
- Update WTO rules to create room for carbon tariffs, limited green sourcing provisions, and spending programs for emerging innovative technologies.
- Consider aligning rules for domestic supply sourcing with a clear environmental component based on Article XX (General Exceptions).
- Recharge efforts toward a comprehensive environmental goods agreement to lower trade barriers for clean energy technologies.
- Note: Article XX’s environmental clauses were agreed to almost 30 years ago in 1994 and are viewed as vague relative to current climate urgency.
G7 / climate clubs:
- The G7 agreed to establish a climate club under the German presidency; Italy, which next holds the G7 presidency, should begin developing a provisional working agreement on trade in emissions-intensive goods with active participation from developing economies.
- A climate-club approach could start with sectors like steel where products are sold in homogenous markets and are heavily exposed to international trade.

Early signs of cooperation: US, Japanese, and EU leaders seeking compromise; the US Treasury has interpreted IRA supply chain rules liberally so far; Biden and European Commission President Ursula von der Leyen reaffirmed commitments to address IRA and CBAM concerns when they met in Washington in March.
The Biden administration has stretched the definition of “free trade agreement” to include critical mineral agreements with Japan and likely with the European Union soon, but one-off deals are no substitute for comprehensive coordination—especially if concessions are limited to the wealthiest countries.

The IRA’s full potential depends on alleviating constraints on:
- Transmission.
- Labor.
- Upstream commodity inputs.
The global impact of the IRA, the EU’s NZIA, Emissions Trading System, CBAM, and other future policies will be shaped by international responses; choices today will determine whether the trajectory becomes a “virtuous race to the top” or a “vicious spiral to the bottom.”

Italicized source: Green Trade Tensions — F&D Magazine, NOAH KAUFMAN, SAGATOM SAHA, CHRISTOPHER BATAILLE, June 2023.

Green Trade Tensions
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