Trade and Environment

The Trade-Environment Tension

Trade and the environment exist in an uneasy relationship. Trade increases economic activity, which can mean more emissions, resource extraction, and pollution. Shipping goods around the world burns fossil fuels -- international shipping alone accounts for roughly 3% of global CO2 emissions. At the same time, trade can spread green technologies, improve efficiency through specialization, and raise incomes to the point where countries can afford better environmental protection.

The 'pollution haven' hypothesis suggests that when environmental regulations differ between countries, polluting industries relocate to jurisdictions with weaker standards. Evidence for this is mixed -- some industries do relocate, but firms also value political stability, infrastructure, and proximity to markets. The 'race to the bottom' has not been as dramatic as feared, but neither is it a myth. Carbon-intensive industries have demonstrably shifted from countries with carbon pricing to those without.

Greening the Trade Rules

The EU's Carbon Border Adjustment Mechanism (CBAM), which began its transitional phase in 2023, represents the most ambitious attempt to align trade policy with climate goals. CBAM imposes a carbon cost on imports of steel, cement, aluminum, fertilizers, and electricity based on their embedded emissions. The aim is to prevent 'carbon leakage' -- European firms losing competitiveness to importers from countries without carbon pricing.

Developing countries have reacted strongly against CBAM, calling it green protectionism that violates WTO principles. Mozambique, which exports aluminum to the EU, argues that it should not be penalized for using its hydroelectric power differently than European smelters. India has called CBAM discriminatory. The legal question of whether CBAM is WTO-compatible under Article XX(b) (measures necessary to protect human, animal, or plant life or health) remains unresolved and could produce a landmark dispute.

Worked Example: Pricing Carbon at the Border

CBAM sounds abstract until you cost a single tonne of steel. The charge equals the embedded emissions of the good multiplied by the EU carbon price (the EU ETS allowance price), minus any carbon price already paid in the country of origin.

Assume:

• Embedded emissions of one tonne of primary (blast-furnace) steel: about 1.8 tonnes of CO2.
• EU ETS allowance price: about 80 euros per tonne of CO2 (a typical 2023-24 level).

Two things jump out. First, a producer that already prices its own carbon pays less at the EU border -- CBAM rewards home carbon pricing, which is exactly the incentive the EU wants to create. Second, cleaner production (row 3) is charged far less, so the mechanism advantages low-carbon exporters. That is also why developing countries like Mozambique -- exporting aluminium made with hydropower -- argue the rules must fully credit their clean energy, or CBAM becomes 'green protectionism.' CBAM's transitional (reporting-only) phase began in 2023; financial charges start in 2026.