Trade-Friendly Climate Policies: The Promise of "Interoperability"

Climate policies that interact with international trade tend to have some administration linked to the quantification of carbon intensities in traded goods. Administrative costs—and transaction costs more broadly—can undermine trade or raise costs for society. As climate-and-trade policies, such as border adjustment mechanisms, gain in popularity, the potential for burdensome red tape also increases, especially for countries that have less developed carbon-accounting policies.

“Interoperability” of carbon intensity quantification is shorthand for the ability of nations to design trade-related climate policies without creating barriers to trade in terms of administrative costs. Pursuing interoperability is a way to limit transaction costs and improve policy efficiency. Interoperability in the context of climate-and-trade policy does not mean trying to harmonize policies. Countries understandably adopt policy designs that fit their national political and economic circumstances. Interoperability should be seen more as a bottom-up process that leads to gradual alignment on methodologies and processes while allowing countries to pursue distinct policy goals and designs.

The potential for administrative burdens to harm trade is well recognized. Brexit provided an almost ideal natural experiment in what happens when administrative complexity in conducting trade suddenly increases. It has led to an overall reduction in trade volumes between the European Union and the United Kingdom, and some small parties decided to stop trading altogether. Conversely, reducing barriers to trade that arise from different standards and processes (i.e., technical barriers to trade) can boost trade more than tariff reductions do.

Quantifying carbon intensities involves measurement, calculation, or both. The carbon intensity of a product is often the result of a specific production process, so some of the quantification is linked to facilities. Industrial facilities are often already regulated under carbon policies. How to move from facility-based to product-level carbon accounting is one challenge in achieving interoperability.

Similarly, carbon-accounting policies often come with distinct system boundaries—that is, the boundary of a production process or value chain within which greenhouse gases will be counted. These system boundaries often make sense for a domestic policy, but comparability between carbon-accounting systems using different system boundaries can be challenging. Examples include whether to include the emissions associated with consumed electricity and heat (“Scope 2” emissions) or exchanges of waste heat between industrial facilities. Under US and EU facility-level reporting (the Greenhouse Gas Reporting Program and EU Emissions Trading System, respectively), only Scope 1 emissions—the direct emissions from sources controlled by the firm—are counted, whereas environmental product declarations typically require reporting of the entire life-cycle emissions. Upstream issues such as methane leakage and emissions linked to mining are another example.

Ideally, policymakers should agree on technical indicators and methodological approaches that do not impinge on the political aims of a policy, but for which mutual recognition might be feasible. Even if some broader carbon-accounting standards, guidelines, and initiatives already exist with the GHG Protocol and within the International Standardization Organization, interoperability becomes more challenging when addressing product-level accounting, reconciling significant policy differences, involving dissimilar countries.

We suggest that policymakers consider the following issues as they incrementally build interoperability:

• Distinguish between the technical and the political. Some climate policies have goals for innovation, security or competitiveness that do not strictly target emissions reductions. This is likely to be reflected in policy design.
• Confidentiality and trust matter. Some data required to quantify carbon intensities is sensitive corporate data. Companies need to have trust that this data will be handled safely, both vis-à-vis competitors and regulators.
• Product-level carbon intensity disclosure is not yet common. Broadening carbon-accounting systems’ focus to facilities and basic and intermediate industrial goods would aid comparability and interoperability.
• Anticipate the challenges posed by developments in decarbonization, for example, hydrogen, carbon capture and sequestration, and mass-balancing A method for estimating a product’s carbon intensity when dealing with energy and material inputs of varying carbon intensities. accounting issues. As economies progress towards net-zero, new carbon accounting and interoperability challenges will arise—anticipate them and discuss them before they become critical.
• Variety is a fact of life in the climate policy world. The Paris Agreement and UN Framework Convention on Climate Change itself are based on nationally determined contributions and assume that countries move at different speeds. The potential of decarbonization technologies differs widely among regions, and the industrial clusters of the past may not be the same in the future. Hence, the pursuit of interoperability should not become a straitjacket that constrains domestic climate policy action.

Perhaps the most important question to be answered in the short term—once policymakers and stakeholders agree on its importance in the first place—is where the discussion should be pursued. Of the many candidates, two organizations stand out: the Organisation for Economic Co-operation and Development (OECD) and the International Energy Agency. Both have the technical capacity to analyze and compare industrial processes, methodologies, and policies. With its Inclusive Forum on Carbon Mitigation Activities, the OECD seems to have a good setup. What is needed, however, is a truly inclusive forum where emerging and developing countries participate on equal footing. These countries potentially have the most to lose from transaction costs, and their domestic climate policy approaches tend to look different from those of countries that have the greatest incentive to pursue climate and trade policies.