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After COP26, are economies finally confronting the emissions they cause elsewhere?

After COP26, are economies finally confronting the emissions they cause elsewhere?

There have been many pledges and commitments on scores of issues at the 26th Conference of the Parties at Glasgow (COP26) these last weeks. Two sets of announcements – those on trade policy and on financial policy – may be particularly groundbreaking.

On trade, the US and EU agreed on greener production standards for steel and aluminum. The two countries may also raise border tariffs on imports whose production and consumption emit high levels of greenhouse gas (GHG) pollution. At the same time, governments celebrated their commitment to the Paris Agreement by introducing regulatory reforms in their finance sectors.

For example, Central banks pledged to scrutinize firms for their climate-related financial risk. Market regulators like the UK Financial Conduct Authority and the US Securities and Exchange Commission (SEC) indicated that companies seeking capital in their respective markets will likely soon be required to inform investors of their views about the low-carbon transition and plans to manage it.

These announcements were each powerful in their own right: here at ClimateWorks we’ve long worked on climate financial reform and clean buying standards. Together they also suggest that we are at the beginning of a new era in which the political path to a zero-carbon global economy will be faster, irreversible and more comprehensive. Why?

Because these commitments may break through the longstanding assumption that societies and governments are not responsible for their consumption-based climate emissions.

Pollution emitted from production and consumption

The United Nations Framework Convention on Climate Change, assigns responsibility to each country for the emissions produced from activities within their borders – production-based emissions. The Paris Agreement, collectively negotiated under the convention, calls for individual countries to gradually diminish their production emissions. The process has long assumed that decarbonization came at a considerable cost to the economy, and therefore each country would only seek to reduce their production-based emissions if others pledged to do the same.

Another assumption, perhaps even reinforced by the above framework, was that no society would want to take responsibility for GHGs created from the goods and services they consumed – consumption-based emissions – especially when produced in other countries. Such emissions would be other nations’ problems. Thus, consumption-based emissions have been left out of our treaties and conventions and less frequently discussed within civil society.

It turns out these assumptions weren’t quite right. Evidence shows that domestic interests drive decisions to decarbonize.

Under the right circumstances, constituencies can see decarbonization as in their own interest and actively pursue it. Domestic sectors may see the strategic advantages in transitioning to the low-carbon economy – emerging clean energy or electric vehicle industries, for example – and can propel shifts in the power and transportation sectors. Furthermore, societies-at-large may begin to prioritize decarbonization (climate change is, after all, an existential threat), individually and collectively taking responsibility for emissions both within and outside their own borders.

At least, in principle they could. But where is the evidence that they are?

Expressing domestic climate values globally

There are two ways in which an economy causes extraterritorial emissions: consuming goods and services that result in polluting activities abroad and investing and lending money that enables polluting activity abroad. The trade and financial policies now on the international climate agenda show that countries are beginning to the regulate GHG emissions produced by their consumption and financing.

By imposing tariffs on foreign goods and services with a higher GHG profile, countries are “pricing in” the cost of emissions – emissions represented in domestic consumption and production abroad. Trade policy experts have long derided most border tariffs as ineffective. They typically claim that such tariffs are intended to impose a penalty on foreign industries, but their actual cost is mostly borne by domestic consumers.

This is what critics ignore: by increasing prices on products, constituencies exercise their legitimate interest in reducing the climate impacts of goods manufactured abroad by pricing in carbon at the border.

Europe’s Carbon Border Adjustment Mechanism (CBAM) tariff provides an example where a confluence of civic attention to climate change and government appetite for scaled action have led to efforts that price in consumption-based emissions.

A cynic might assume CBAM is largely motivated by domestic protectionism. A less cynical view would hold the tariff as enabling domestic industries to decarbonize without having to compete with cheaper, polluting foreign substitutes. The fact that the EU had the political license to pursue CBAM at all may be evidence that Europeans are so concerned about climate change, they’ve chosen to take more responsibility for their consumption-based emissions. It is European consumers who would pay the direct economic costs of these emissions if the CBAM were imposed.

Financial policy also breaks down the border between domestic and extraterritorial emissions. A foreign company that seeks money in a domestic market would be subject to the same climate accountability rules as a domestic company, even if that company seeks capital for business abroad. Regulated financial firms are subject to financial supervision and regulation even when they are investing and lending abroad. And, of course, any investor – whether institutional or retail – that wishes to make their investments climate-aligned would need to address their international holdings.

Transforming the pace of decarbonization

Prioritizing consumption-based emissions alongside production-based emissions would mark a big change in climate policy, and thus pave the way for a more holistic and wide-reaching approach to emissions reduction. This could transform the pace of decarbonization for two reasons:

  • First, the trade and finance policies discussed in this article may reflect states’ ability and willingness to introduce domestic policies that have global impacts. The fact pattern for CBAM reflects this potential: EU consumers were willing to bear what was effectively an EU-domestic tax on polluting US steel imports. This in turn resulted in the US raising its green standards.
  • Similarly, a rule requiring climate disclosures from the US SEC would impact any foreign issuer seeking investment in the world’s deepest capital markets. Requiring domestic and foreign companies to disclose whether and how they are planning for the low-carbon transition allows investors to be informed consumers of public securities, aware of the climate related risks those companies carry wherever they operate.

In leveraging society’s climate consciousness and drive to find solutions, a nation’s trade and financial policy can have an amplified impact, as its effects ripple outward. This would be subtly seismic.

Published November 22, 2021

Ilmi Granoff

Senior Director, Sustainable Finance