Japan recently announced that consultations had failed to resolve its dispute with Canada over the Province of Ontario’s feed-in-tariffs for renewable energy, and that in mid-June it will be asking the WTO to establish a dispute settlement panel. This is awful news for the multilateral trade system, for which the dispute will be corrosive, seemingly pitting trade against the environment. It is clear that the WTO’s dispute settlement system is the wrong place to forge international consensus on renewable energy support measures, but it is also clear that the right place needs to be found, and quickly.
 
The Japan-Canada dispute began in September 2010, when Japan complained that the province of Ontario had established a feed-in tariff program, several aspects of which violated Canada’s commitments under the WTO’s Agreement on Subsidies and Countervailing Measures (SCM Agreement) and its Agreement on Trade-Related Investment Measures (TRIMS Agreement) (WTO, 2010). Among other things, Japan objected to the fact that the preferential tariffs went only to those power producers that used at least a specified percentage of domestic content. A similar dispute between the US and China, over Chinese wind power subsidies that required domestic content (WTO, 2011), has now been announced as amicably settled in consultations. The terms of the agreement involve China’s termination of the program in question (which in any case had probably served its purpose).

There is, however, no shortage of other potential disputes of this sort. The US complaint was chosen from a petition compiled by the U.S. United Steelworkers that covers a wide range of alleged Chinese violations of trade law in support of renewables. The practice of domestic content requirements is widespread as a condition of support for renewables in both developed and developing countries; in many cases the green jobs argument is the deciding factor that convinces governments to dole out support. And such requirements, if attached to subsidies or investment privileges, violate WTO obligations (Wilke, 2011; Howse, 2009).
 
While there has been much speculation on the legal rights and wrongs in these cases, there has not been enough on what the law should say. What forms of support for renewables are appropriate as countries worldwide strive to green their economies? What WTO rules are appropriate? There are at least four compelling reasons for the international community to answer these questions before more formal disputes crop up:

1. It is critical that green industrial policy be done, and done right

The pace of technological transformation needed to avoid global crises such as climate change is unprecedented, looking like a new industrial revolution. In that context, any policies that successfully foster new entrants and innovators in sectors contributing to the green economy are not only good industrial policy for the home country, but also constitute a global public good.
 
Seen in that light, these are not trade-environment disputes at all; in fact they have no environment-economic tension. The disputed measures are clearly designed to pursue both environmental objectives (reducing the environmental impact of generating electricity) and industrial policy objectives (fostering a competitive domestic renewables sector), and they will either succeed or fail on both objectives in tandem. If the measures are unsuccessful at creating competitive global players in the sector, they will have been a waste of government funds – an economic failure. They will also have been a failure environmentally, since it would have been possible to spend those same funds to greater environmental effect on technologies from more efficient foreign producers. Point Carbon (2008) offers the sobering example of the pursuit of national excellence in wind energy by the Ukraine, the result of which was that as of 2007 the average cost of installed capacity in wind power was 2-3 times higher than average global costs. Clearly not all countries can blossom into globally competitive exporters of the same green technologies, and for some it would be a waste of resources to try.

On the other hand, if the measures are successful in creating competitive domestic players in the sector, there are obvious domestic economic benefits, direct and indirect, in terms of jobs and foreign exchange. Environmentally, a viable new player means more competition in the sector, which inevitably speeds up dissemination.  From a global perspective, it may also mean more agents of innovation, at a time when innovation in renewable energy technology is a critically important global public good.

2. The existing WTO rules on industrial policy are based on out-dated assumptions

If it is true that successful green industrial policy is a global public good, the key question is whether it is possible to successfully pursue industrial policy for renewables, and if so, how. It is worth noting that the predecessor to the SCM—the Tokyo Round Subsidies Code—did not prohibit domestic content requirements, focusing instead on trade-distorting subsidies. The SCM, by contrast, and the TRIMS Agreement, were the product of a policy-making community that had “bought” the Washington Consensus, believing that governments tended to botch industrial policy, and it was better for all if they agreed multilaterally to remove those measures from their toolkits. This despite the fact that many of today’s economic successes in the OECD made judicious use of many tools that are now prohibited by TRIPS, TRIMS and the SCM in their journey to industrialization (Chang, 2002).
 
But we have learned much on the subject of how to do industrial policy in the last three decades, not least from the contrast between successful policies in South-East Asia and the less successful policies of most Latin American countries (Amsden, 2001; Cimoli et al., 2009; Gallagher, 2010). Rodrik (2004) lays out a number of important guiding principles, based on the wealth of research into what works and what doesn’t:

• Incentives should be provided only to “new” activities: If the objective is to support activities that will lead to economic growth, it is important to distinguish between support for existing sectors and those that are genuinely new, and which face a number of barriers specific to new activities.
   
• There should be clear criteria for success and failure: Industrial policy is inherently experimental, and will generate mistakes as well as successes. It is critical to lay out explicit criteria for distinguishing between the two, and for eventually revoking support to those efforts that are obviously dead ends.
   
• There should be sunset clauses for support: One way to ensure that long-term support is not provided where it is not needed is to limit the timeline for support.
   
• Support should target activities, not sectors: Public support should aim to correct particular market failures, such as lack of incentive to train new staff, or lack of necessary infrastructure. Support to an entire sector is a waste of resources, but support in areas that are the root of market failure – training, infrastructure development, feasibility studies – is an efficient use of resources.
   
• Supported activities must have good potential for spill-over benefits: Spill-over benefits in terms of knowledge and information should be possible not only to other sectors within the economy, but to subsequent entrants to the new sector.

Based on distant and recent historical experience, it is possible to successfully pursue industrial policy (though, as noted above, there will inevitably be losers as well as winners).

3. Some green industrial support can actually be thought of as market correcting, rather than market distorting

Another rationale for prohibiting subsidies in service of industrial policy is that they are trade distorting, moving market share and investment away from those countries that do not or cannot match the subsidies offered. But subsidies for green industrial policy arguably internalize environmental benefits not captured in the market price for green energy: primarily clean air and reduced GHG emissions. It is an empirical question whether the subsidies in any given case match the external environmental benefits, but at some level they will actually correct market distortions caused by under-pricing of environmental benefits.

4. Allowing more such disputes to come to the WTO is not in anyone’s interest

The current rules with respect to these sorts of green subsidies are clear. Many of the types of support used to foster renewable energy would probably be found to be WTO-illegal. There are particularly strong grounds to question those that are conditional on domestic content, or export performance. Whatever the merits of any particular case, if the WTO rules against renewable energy subsidies it will be accused of being anti-environment. At this delicate point in its history, the Organization can ill afford to alienate major constituencies such as environmentalists in both developing and developed member states.
 
Furthermore, following the arguments made above, and in view of prevailing practice, there is an urgent need to revisit the existing rules. But the WTO’s dispute settlement regime can only function on the basis of the rules as they are; it is not a negotiating forum. It is absolutely the wrong place to address issues of law where there is no international consensus on what the law should say.

Where does this leave us?

None of these four arguments suggest we need carve outs for any and all subsidies claiming to be green. Rather, the point is that the current rules need to be revisited in the light of what we now know about how to do industrial policy, and about the growing urgency of global environmental challenges.

The WTO’s objectives are rooted in the desire to improve human welfare. As such, in the face of one of the greatest challenges in human history—climate change—we need to think long and hard about what kind of trade regime can help foster the needed transition to a low-carbon economy. The rules governing support for green industrial policy are a particularly salient case in point. Whether and how the multilateral trading system can reach such agreement, in light of its current difficulties, is the subject of another essay entirely. But the need is undeniable.
 
Aaron Cosbey is an environmental economist specializing in the areas of trade and sustainable development, international environmental governance, and climate change. He works on two of IISD's program areas: trade and investment, where he serves as Associate and Senior Advisor, and climate change and energy, where he serves as Associate. He manages IISD’s program of work on trade, investment and climate change. 

He is a past Member of International Trade Canada's Market Access Advisory Group, past Member of the Deputy Minister for International Trade's Academic Advisory Council on Canadian Trade Policy, and of the Minister for International Trade's Environmental Sectoral Advisory Group on International Trade, where he chaired the SAGIT's Working Group on the FTAA.

References

Amsden, Alice H. (2001). The Rise of the Rest: Challenges to the West from late-industrializing economies. Oxford: Oxford University Press.
Chang, Ha-Joon. (2002). Kicking Away the Ladder: Development strategy in a historical perspective. London: Anthem Press.
Cimoli, Mario, Giovanni Dosi and Joseph E. Stiglitz (Eds.). (2009). Industrial Policy and Development. New York: Oxford University Press.
Gallagher, Kevin P., and Roberto Porzecanski. (2010). The Dragon in the Room: China and the future of Latin American industrialization. Palo Alto, CA: Stanford University Press.
Howse, Robert. (2009). Subsidies to Address Climate Change: Legal issues. Winnipeg: International Institute for Sustainable Development.
Point Carbon. (2008). Clean Energy Investment in the Former Soviet Union (Ukraine and Kazakhstan): The Domestic Context. Winnipeg: International Institute for Sustainable Development.
Rodrik, Dani. (2004). Industrial Policy for the 21st Century. Faculty Research Working Paper No. RWP04-047. John F. Kennedy School of Government, Harvard University.
Wilke, Marie. (2011). Feed-In Tariffs for Renewable Energy and WTO Rules. Geneva: International Centre for Trade and Sustainable Development
WTO. (2010). Canada - Certain Measures Affecting the Renewable Energy Generation Sector: Request for consultations by Japan. (WT/DS412/1). September 16.
WTO. (2011). China – Measures Concerning Wind Power Equipment: Request for consultations by the United States. (WT/DS419/1). January 6.