The State of Agricultural Commodity Markets 2022


Trade and environmental externalities: Multilateral and regional policy solutions

Issues related to environmental externalities generated by food and agricultural trade have been receiving attention from both multilateral and regional trade perspectives. Non-tariff measures, such as the prohibition of imports that have a negative impact on the environment, or environment-related provisions and standards play a key role in addressing the impact of trade on natural resources, pollution, biodiversity and climate change (see Part 3).

Most of the environmental impacts of trade depend on local conditions, with trade often generating environmental externalities in poorly regulated contexts. Many externalities can be local or regional, such as unsustainable groundwater withdrawals, land degradation or pollution. However, the most challenging environmental externalities are broadly spread. For example, biodiversity loss may be localized but biodiversity and ecosystems are globally valued. GHG emissions represent a truly global externality. For example, agricultural production or deforestation takes place in a region, but the related effects of climate change also occur in a location that is distant from where GHGs have been released into the atmosphere.313, 314 The extent to which environmental externalities are localized or spread globally is important in a trade policy context.

Within a trade policy context, such as the multilateral trade system as it is shaped by WTO rules and regulations, environmental externalities are addressed through the dispute settlement mechanism or domestic regulation that gives rise to a multitude of non-tariff measures and standards covered by the TBT Agreement (see for example Box 3.3 and the discussion in Part 3). Between 2008 and 2019, the number of environment-related non-tariff measures notified under the TBT Agreement increased steadily, and, on average, accounted for approximately 15 percent of all technical regulations and standards used by governments to advance a variety of public policy objectives, including health, safety or environmental protection. The most frequently cited environmental objectives include soil and water pollution abatement, energy conservation, or plant and forestry conservation.315

The heterogeneity of regulations and standards across countries result in significant compliance costs (see Part 2), and deeper RTAs aim toward regulation convergence across trade partners and at harmonizing standards to reduce such costs while addressing environmental issues (see Part 3).

The choice of environmental standards

Addressing the environmental impacts of food and agricultural trade efficiently is challenging, as it may not be possible to tackle the externalities and achieve a globally efficient outcome when countries retain autonomy over their choices for environmental non-tariff measures and standards. Countries differ in their valuations of externalities and choose different standards and, when engaging in trade, they can decide to either recognize the standards of their trade partners or adhere to their own domestic standards.

For example, an agreement, either multilateral or regional, that aims at promoting trade and includes the “mutual recognition” of standards between countries – with domestic standards being set unilaterally by countries and with each country recognizing that trade partners’ standards achieve the same goals – will not provide an efficient outcome in the presence of externalities such as pollution. Governments may prefer to implement standards that are non-stringent to promote exports and maximize the welfare of their farmers. A lower stringency standard implies lower compliance costs but does not reduce the externality sufficiently, as it does not take fully into account the social costs generated by the impact on the environment.316

Similarly, “national treatment” – when countries unilaterally set their domestic standards but treat imported goods no less favourably than domestic ones – may also result in a suboptimal outcome. In this case, governments may set standards with high stringency relative to the cost incurred by the externality. This could result in a prohibition of imports that do not comply with the standard, and for large importers with market power it could result in a reduction in the price of imports that comply with the high standard.317, 318

Globally, environmental externalities can be addressed more efficiently only when trade policies, and standards in particular, are negotiated between countries.319 Attempts to address environmental externalities unilaterally would result in either under-regulation or over-regulation, compared with what would be economically efficient. In the first case, consumers will over-consume the good that generates the environmental externality. In the second, the externality will be ameliorated but at the expense of exporters who comply with the standard. This implies that in the presence of environmental externalities in trade, close coordination between countries on trade policies, convergence of regulation and harmonization of standards and their stringency are of paramount importance for achieving optimal outcomes.

A critical question is whether this deep trade integration to tackle environmental impacts could be achieved at the multilateral or the regional level, or both. A study, analysing the choice of standards in the presence of an externality within a comparative advantage framework, suggests that differences in relative productivity are a necessary but not a sufficient reason to trade when countries value the environmental impact differently and, therefore, their standards differ in terms of stringency.320 In this context, leveraging comparative advantage and taking the different standards under consideration, a country would import only if the gain from trade more than compensates for the differences in the valuation of the externality. In this case, an agreement would balance the economic benefits from trade with the environmental outcomes and a harmonization of environmental standards would be possible through mutual concessions in border measures and the stringency of standards.

However, given a global externality, when the valuations of the environmental impact differ widely across many countries, a multilateral agreement on the harmonization of standards could result in non-stringent standards and minimal environmental gain. It is more likely that such an agreement will be feasible for a smaller number of like-minded countries, where the valuations of the environmental impact are more similar to each other. Although the principle of comparative advantage plays out better multilaterally, the presence of externalities and the choice of standards to address them could explain the emergence of deep trade agreements that aim at regulatory convergence and the harmonization of standards.

Across countries, differences in the valuation of several factors that can affect the environment, but also food safety and health, animal welfare, or labour rights are important in a market where the focus lies on non-tariff measures and deep trade integration. Deep RTAs tend to be signed by countries that have convergent preferences towards issues such as pollution or labour welfare issues. Although RCEP does not cover any environmental issues, CPTPP includes a comprehensive environmental chapter and is not strictly defined in terms of geography. In this way, regionalism, which depends on geographic conditions, opens to other like-minded countries that may be in other regions, thus forming large trading blocs across regions but with similar or converging social characteristics and levels of development.

Climate change: Addressing a global externality through trade policies

Foresight exercises suggest that between 2012 and 2050 food and agricultural production will have to increase by 50 percent to provide food for a growing and progressively wealthier population.321 Such increases in production could also result in increases in global GHG emissions unless agrifood systems become emissions-efficient and generate lower emissions per unit of output. Food and agricultural trade can play an important role in both adjusting to the effects of climate change (adaptation) and reducing GHG emissions from agriculture (mitigation).

Trade as an adaptation mechanism

The impact of climate change on agriculture is expected to be uneven across regions. Low-latitude regions such as the Near East, Northern Africa, sub-Saharan Africa and Southern Asia would be adversely affected, whereas high-latitude regions such as Northern America, parts of South America, Central Asia and Eastern Europe are expected to experience largely positive impacts on agricultural production.322, 323, 324 Trade can be seen as an adaptation strategy to lower the impact of climate change on global food and agricultural markets and can be an important avenue for ensuring food security and nutrition. Food imports by relatively more adversely affected (often developing) countries will have to come from those countries (often developed) that are relatively less adversely affected.

Indeed, most studies integrating biophysical and economic models project a stronger role for trade as a result of climate change at the global level.325, 326, 327, 328, 329, 330, 331 While a substantial part of adapting to climate change would come from production adjustments, the possibility of changing sourcing patterns that trade offers is as important as changes in the crop mix in determining a country’s ability to cope with the negative effects of rising temperatures.332 Indeed, more trade links between countries allow for the diversification of sourcing patterns, making the global food and agricultural market more resilient to weather shocks and to the adverse effects of rising temperatures on agricultural production (see Part 1).

However, the role of trade in adapting to climate change and ensuring food security, could be constrained by trade policies and trade costs. Many studies suggest that freer trade could offset part of the welfare losses from climate change.333, 334, 335 Open markets could also contribute towards food security, especially in adversely affected regions that are already characterized by a high prevalence of undernourishment. The reduction of trade costs, which are significant in low-income countries worldwide and particularly in sub-Saharan Africa, can significantly strengthen the climate change adaptation role of trade (see Part 2).

For low-income countries, that are sourcing a small part of their food consumption requirements through trade, climate change and higher average temperatures will negatively affect productivity in agriculture more than in other sectors of the economy. Food imports would not only safeguard food security, they would also facilitate a structural transformation with labour moving towards those nonagricultural sectors that are relatively less affected by climate change. However, when trade integration is limited, subsistence food requirements in many developing countries could drive specialization towards, rather than away from agriculture, thus exacerbating losses from climate change.336

Trade in climate change mitigation

Climate change is a truly global environmental externality. Its impacts are indivisibly spread around the entire planet; it affects many economic activities, including agriculture which is responsible for 21 to 37 percent of all GHG emissions; its costs are not accounted for by markets; and the benefits from mitigating its impact cannot be divided and claimed by any one country.337, 338

Several policy incentives can help improve emissions efficiency and lower GHG emissions per unit of output. For example, taxing GHG emissions is a way to “internalize” their cost to the society that produces them.bc However, it is difficult for national governments to unilaterally impose a carbon tax on food and agricultural products. If a country introduced a carbon tax on food and agricultural products, domestic prices would increase and, without trade, this increase would weaken demand, resulting in a decline in production and a reduction in emissions. In the longer term, the tax would provide incentives to farmers to adopt technologies and climate-smart agriculture practices that reduce carbon footprint and promote climate change

With trade, the unilateral action to impose a carbon tax could put the mitigating country at a competitive disadvantage. The carbon tax would make exports from the mitigating country more expensive in the global market. It would also lead to the displacement of lower carbon footprint domestic products by cheaper and higher carbon footprint imports from countries that do not take similar measures to reduce emissions. With more high carbon footprint imports, emissions would leak back to the mitigating country, and international trade would undermine the effectiveness of the carbon

Specific trade policies can help address the emissions leakage. Together with carbon taxes, a country could implement border tax adjustments so that the same rate applying to the carbon footprint of domestic products would be applied to imports. In this case, low-emitting suppliers would face a low tax and would be able to compete with the domestic product. High-emitting suppliers would face a high tax, which could potentially make them uncompetitive. In this way, trade will be shaped not only by comparative advantage but also by the relative emissions efficiency.

The design and implementation of a carbon tax on food and agricultural products would face several challenges. It would require a complete assessment of the costs incurred by the society from the GHGs emitted during agricultural and food production – the carbon footprint. Carbon footprints need to be quantified and to include the emissions generated by agricultural production processes and the emissions associated with transportation, processing, storage and delivery of products to consumers.339 Agricultural production involves many different sources of emissions that need to be covered and their sources are often diffuse, difficult to monitor and can vary by location.340 For example, fertilizer use is a major source of nitrous oxide emissions, but measuring the emissions from a given area of land depends on factors other than the amount of fertilizer applied, many of which are site-specific (e.g. management practices, soil types and weather).

Even if these technical challenges were overcome, in practice, it would be difficult to achieve consensus by all countries on a carbon tax mechanism for food and agriculture (see previous section). There would be a need to agree on the carbon accounting mechanisms and the carbon footprint for all food and agricultural products produced worldwide. There would also be a need to agree on the price of carbon in order to set the tax and avoid international trade disputes.

A smaller carbon tax mechanism in the context of a RTA between countries with similar valuations of climate change impacts and similar preferences towards carbon accounting also would not be possible. Although imports from non-signatories into such a climate trade bloc would be subject to the carbon tax, exports from signatories would be more expensive in the global market, resulting in a loss of profits. Few studies have analysed the possibility of forming such regional agreements on carbon tax mechanisms and trade between countries of different sizes, different trade patterns and with a range of complementary trade policy instruments.341

Climate clubs are seen as a bottom-up approach to creating a global response to climate change, as compared to a top-down approach, such as the Kyoto Protocol which sets binding emission reduction targets for a number of developed countries and economies in transition but has not succeeded in forming an internationally harmonized and binding system for The stability of such climate clubs in terms of membership is also crucial, as well as their size, and some studies suggest that they would tend to be small and fragile.342 Although more research is needed on the links between policies to address global externalities and trade, an international agreement would be necessary for trade to expand the reach of climate change mitigation policies.

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