Trade and Prosperity | Policy Briefing | July 2021

July 23, 2021

Carbon border adjustments: Getting real

Two proposals, half the detail. Two major economies made announcements around carbon border tariffs over the past few weeks. The European Commission finalised its proposal for its Carbon Border Adjustment Mechanism which, at this stage, is slated to apply to steel, iron, fertiliser, cement and electricity. The US Democrats have outlined a budget proposal that will include a ‘polluter import fee’, with very few details. There are indications it will apply to fugitive methane emissions, signalling that it may be focused on energy.

What does this mean for Australian exporters? At this stage it’s not of major significance. Australia’s fertiliser exports tend to go to Asia; similarly iron and steel exports stay in the region or go to the US. The details will be significant to Australian companies going forward –  how the pricing works, and how any carbon price within the EU Emissions Trading System (ETS) can dovetail with systems elsewhere.

A leaky level playing field. There are, however, longer term risks. CBAM is designed to prevent ‘carbon leakage’ from the EU ETS, which EU stakeholders say is undermining European manufacturing and making it less competitive. CBAM is part of Brussels’ bigger play to ‘level the playing field’ on environmental regulation. The proposal still has some way to go through the European Parliament and Council of the EU.

Negotiations between the three arms of the EU could give rise to regulatory creep. For example, European farmers will likely pay higher prices for fertiliser. Will they therefore demand that agriculture is somehow incorporated into CBAM to level the playing field further? This could have an impact on Australian exports.

Supply chain reactions. On the other hand, Australia may find itself much closer to an Asia-oriented value chain. Global steel supply chains are already fragmented between geographical areas; carbon pricing – and a broader reluctance among Asian governments to support it – may fragment them further.

Companies may reorient their supply chains accordingly to supply markets with the lowest costs; many firms already excel in this form of regulatory arbitrage. A good example was how companies pivoted in the face of Trump’s China tariffs. Sure, carbon tariffs aren’t Trump tariffs, but they are still a cost to be borne by businesses.

Businesses simply need to factor this emerging policy area as part of a ‘new trade reality’ – along with greater scrutiny on labour and human rights in supply chains.

Or perhaps another way. How about liberalising trade rather than taxing it? An example is APEC’s approach to reducing barriers to environmental goods. This has recently been emphasised by Australian trade minister Dan Tehan. Is it more effective in terms of environmental outcomes? That’s hard to say, but it’s definitely more politically palatable for global trading partners.   

A US Indo-Pacific digital trade deal?

An Indo-Pacific starter. The Biden administration is reportedly considering plans for a digital trade deal with economies in the region. This follows comments by Kurt Campbell, US National Security Council coordinator for Indo-Pacific affairs, that the US is “quietly exploring” potential trade initiatives with Indo Pacific countries. The administration has made clear its priorities are focused on domestic recovery, vaccines and addressing China – analysts point out that smaller, sectoral trade deals are more prospective than engagement in multilateral or regional FTAs at this point.

Take your FTA pick. A digital trade deal could build on outcomes of the various digital agreements in the region. The USMCA and CPTPP agreements both cover digital trade. The more recent Digital Economy Partnership Agreement (DEPA) involving Singapore, Chile and New Zealand provides a broader framework, as does the Singapore-Australia Digital Economy Agreement (SADEA). APEC has a Cross Border Privacy Regime for data flows (CBPR). Australia’s FTA with the US – the 2005 AUSFTA – does not include provisions on digital trade, and is yet to be updated.

No TPA needed? Trade Promotion Authority (TPA), a necessary legislative precondition for a full FTA, expired in July (see below), making any US FTAs requiring more than executive authority almost impossible. Could a US digital trade deal be negotiated as a ‘trade executive agreement’ (agreements between executive branch agencies and other governments that have some relationship to trade but are not subject to congressional review like an international treaty)?

Recent research reveals the US has in place more than 1,200 ‘trade executive agreements’ with 130 countries that create binding commitments, build on or clarify FTAs and serve as the foundation for later binding arrangements. In recent years there have moves by the US towards more executive trade deals, including the US/China Phase One agreement, as well as arrangements with India and Brazil. The 2019 US Japan Digital Trade Agreement was passed as an executive agreement.

More Asia Pacific digital deals on the way. In June Vietnam and Singapore agreed to set up a joint technical working group on Digital Partnership, examining the potential for developing a bilateral agreement. Singapore is also negotiating digital agreements with Korea and the UK. Disciplines governing digital trade are also likely to be considered as part of ‘upgrades’ of older bilateral agreements with trading partners in the region – for example the review of the AANZFTA between Australia, New Zealand and ASEAN.

Good timing. Cross border data restrictions aren’t going away. The Information Technology and Innovation Foundation points that the number of countries restricting the flow of data across borders has nearly doubled over the past four years, rising from 67 barriers across 35 countries in 2017 to 144 restrictions in 67 countries. More measures are under consideration – a good time for digital economy agreements that support open rules for data flows, create mechanisms for cooperation and encourage regulatory interoperability.

In brief

FDI falls as screening policies, tax uncertainty rises. A new report of Global Trade Alert reveals that foreign direct investment screening mechanisms have proliferated in recent years, becoming less conducive to foreign direct investment. It ‘contends that if multinational enterprises are to play a greater role then policy needs to be reset to restore the commercial viability of FDI.’ The Tax Foundation notes uncertainty for global FDI remains high, with the ongoing international tax negotiations at the OECD being a contributing factor. The recently released annual UN World Investment Report shows that foreign direct investment (FDI) fell by a third in 2020 compared to 2019, well below the low point reached after the global financial crisis a decade ago.

TPA expires, will it return? Trade Promotion Authority (TPA), the legislation that enables the US to sign new trade agreements following a straight up-or-down vote from Congress, has expired. Politico points out that there is no sign that the Biden administration intends to ask Congress for a renewal anytime soon. USTR Tai views TPA as a longer-term objective – the focus is on setting a broad agenda and addressing issues with respect to China. The last time the legislation expired, in 2007, it was eight years before Congress renewed it.  TPA’s expiry is not good news for the UK’s ongoing negotiations with the US, now effectively on hold, nor any potential future US trade agreements outside of the executive branch.

China takes Australia to WTO. China has responded to Australia’s WTO complaint about Chinese anti-dumping tariffs on wine by bringing its own challenge to Australia’s anti-dumping duties on Chinese wind towers, railway wheels and steel sinks. The move comes as Wine Australia reports that China’s punitive duties have resulted in a 45% reduction in exports for the year to June 2021.

Thailand progresses ‘mini’ trade deals. Thailand signed an MoU in July for a ‘mini trade deal’ with Kofu City in central Japan. It is advancing similar deals to ‘form deeper trade partnerships’ with Hainan, China, Telangana, India and Gyeonggi province in Korea. Alongside this, Thailand is seeking to move ahead with broader bilateral FTA negotiations with the EU, as well as EFTA, the EAEU and the UK. It is still considering accession to the CPTPP, and exploring the potential for an agreement with Hong Kong.

US and Mexico resolve first USMCA labor complaint. The US and Mexico have reached a resolution in their first labor dispute under USMCA over alleged violations of auto worker protections in Mexico. A remediation plan was negotiated under the agreement’s ‘rapid-response mechanism.’ As noted by Politico, the plan is a first for USTR, and it allows the governments to avoid a labor dispute settlement panel that could have resulted in harsher penalties.

The UK and Australia have just concluded an ‘in principle’ agreement for a free trade agreement. Efforts by UK farmers lobbying the Johnson government not to give Australia greater market access for red meat seem to have been overcome.