28 April 2022
As the world hurtles faster and faster towards 2 degrees Celsius of warming, countries have finally gotten the message – it’s time to step up their climate ambition. Amidst the post-COP26 international wave of net zero commitments, methane pledges and renewable energy promises, policymakers, scholars and activists alike are searching for ways to harness this green momentum to deliver even more ambitious climate action. Climate clubs, many believe, are one way to do so. Initially proposed in 2015 by Nobel laureate William Nordhaus, the idea has recently taken center stage in many climate policy discussions. From academic webinars to the German G7 presidency priorities, discussions on combatting global climate change invariably seem to ask the same question: is it time to create an international climate club?
For many, this question begets far more basic ones: what is a climate club, and are we close to having one?
The Climate Club
A climate club aims to tackle the especially wicked dilemma of international environmental free-riding. While the costs of reducing greenhouse gas (GHG) emissions are felt domestically, the benefits are enjoyed internationally. Countries, therefore, have an incentive to wait for others to act rather than foot the bill for expensive abatement efforts themselves. Such free-riding not only impedes the development of climate mitigation in many countries, but also can lead to unpleasant consequences for countries with strong climate policies. Companies that have to pay for the right to emit GHGs or that face costly regulation may try to improve their competitiveness by relocating to countries with laxer climate measures, a phenomenon known as carbon leakage. This leakage poses a double problem, both hurting the economies of countries with ambitious climate policies and failing to reduce the level of global GHGs in spite of these policies.
Ambitious international climate action, it seems, will not come to pass until these problems are resolved. Enter climate clubs.
Nordhaus argues a club structure can overcome free-riding. He defines a climate club as “an agreement by participating countries to undertake harmonized emissions reductions.” Within this agreement, some kind of benefit is created for “members” that can be excluded from “non-members.” Examples of such a benefit, or “club good,” could be easy access to member countries’ markets (from which non-members have restricted access via trade barriers), green technology transfers, and access to climate finance. Nordhaus emphasizes the exclusion of these benefits to non-members is a critical feature of a successful climate club.
It’s important to emphasize that, though climate clubs are a hot topic in the international climate policy space, no such club exists today or has existed in the past.
Foundations for a Climate Club: Carbon Pricing & BCAs
Many discussions on how to establish an international climate club center on carbon pricing. The idea is simple: members agree on a common (minimum) carbon price and impose sanctions on countries below the price threshold. Members receive protection from carbon leakage and enjoy barrier-free access to fellow members’ markets (and potentially other “club goods”), while the sanctions make joining the club attractive to non-members. Many influential international organizations – among them the OECD, the WTO and the IMF – have advocated for some kind of international coordination on carbon pricing.
A global carbon price could be combined with another policy instrument popular in the climate clubs discussion: the border carbon adjustment (BCA). BCAs apply a price on imports that corresponds to their carbon intensity. They are designed to preserve the competitiveness of industries that face costly carbon prices or regulation by levelling the playing field between them and foreign counterparts that face lower climate-related production costs (in essence, combatting carbon leakage).
A BCA includes many design options that, when harmonized across multiple countries, could give the coordinated instruments the function of a climate club. Countries could jointly determine which goods to cover, a system for calculating products’ embodied emissions, how to use revenue, and which countries (if any) to exempt. The mechanism also links neatly with carbon pricing; the implementing country uses its domestic carbon price as the basis for the fee it charges exporters. If exporting countries have a carbon price of zero, they pay the full fee; if their carbon price is lower than the importing country’s, their fee is adjusted to reflect the difference. As with the BCA design features, member countries could jointly establish a minimum carbon price on which membership to the climate club is predicated.
BCAs skyrocketed into the international spotlight in December 2019 when the EU released the proposal for its flagship European Green Deal, which contained the bloc’s intention to establish a carbon border adjustment mechanism (CBAM). The CBAM has been turning international heads ever since, and by the time the European Commission formally proposed the measure in July 2021, Canada and the United States had announced they were considering implementing BCAs of their own.
Is a climate club based on carbon pricing realistic?
A climate club premised on carbon pricing, though appealing in its simplicity, overlooks significant implementation problems. For many countries, putting an explicit price on carbon, either through a carbon tax or an emissions trading system, may not be a feasible approach to decarbonization. For some economies, achieving Paris Agreement goals may be better achieved through standards and regulation; for others, carbon pricing is a political impossibility. In the United States, pricing carbon is politically infeasible for the foreseeable future, and a climate club that predicates membership on a carbon price would either face strong opposition from the US (likely hindering the club’s establishment) or exclude one of the world’s largest economies and greatest emitters (diluting the club’s efficacy and the incentive to join).
An alternative to basing a climate club on an explicit carbon price would be to instead use an implicit carbon price. Low-carbon standards and regulations impose compliance costs on producers, increasing their goods’ prices. An implicit carbon price captures these costs: it is the difference between the price of a good facing regulation and the price of that good without regulation. Allowing membership to extend to countries with implicit carbon prices would make the climate club more inclusive, broadening the scope of countries that could join and not appearing punitive against countries that, for legitimate reasons, have not implemented carbon pricing policies. Furthermore, implicit carbon pricing can still be combined with a BCA, leaving this potential framework for a club intact.
However, club membership predicated on any type of carbon price may still be unrealistic. Beyond concerns of carbon pricing making a climate club too exclusive or unattractive to potential members, coordination on both explicit and implicit carbon prices poses a host of considerable administrative and methodological problems. Carbon taxes and emissions trading systems vary greatly in their design, making it difficult to directly compare one carbon price to another. An implicit carbon price presents an even greater challenge, as it is unclear how such a price would be calculated. No jurisdiction has yet to devise such a metric, and even if various countries did establish implicit carbon prices, they would face the same comparability problems as explicit ones.
Are there Contenders for an International Climate Club?
BCAs in the European Union, Canada and the United States
Many have argued that the transatlantic space has the potential to host the world’s first climate club. After the development of the EU CBAM, Canada announced in fall 2020 that it would start a consultation on establishing a BCA and working “with like-minded economies” on its implementation. Shortly afterwards in 2021, two US congressmen introduced the FAIR Transition and Competition Act, which would establish a BCA on carbon-intensive imports.
However, though the EU, Canada and the US are considering implementing similar mechanisms, their harmonization presents immense logistical and political difficulties. To begin, the EU seems poised to only recognize explicit carbon pricing for exemption from its CBAM (though the Commission’s draft proposal seems to leave the door open for bilateral agreements with third countries on crediting for foreign climate policies). While Canada has carbon pricing policies in place, the US does not and is unlikely to have a carbon price anytime soon. The US’s BCA, in contrast, would calculate its fee based on the cost of regulatory carbon compliance (an implicit carbon price). Furthermore, the US proposal explicitly states it will provide exemptions to the BCA only to countries that “[do] not impose a border carbon adjustment on products produced or manufactured in the United States.” This effective singling out of the EU – the only jurisdiction with a BCA in proposed legislation – suggests a BCA-based climate club involving the US and EU is not on the horizon.
EU-US Deal on Steel and Aluminum
The trade deal on steel and aluminum between the EU and US has also generated climate club buzz. In addition to easing American tariffs on EU products, the deal, announced in October 2021, would create a “carbon-based sectoral arrangement on steel and aluminum trade.” Though specific details of the agreement are not yet available (it will be finalized in 2024), the US and EU aim to restrict dirty steel and aluminum from entering their markets and limit access to countries that contribute to their worldwide overproduction. The arrangement will likely take the shape of an external tariff on carbon-intensive steel and aluminum imports into the EU and US.
As with BCAs, this agreement would require the EU and US to agree on the design of key policies. They would need a common methodology to measure the carbon-intensity of steel and aluminum products as well as a definition of low-carbon and carbon-intensive production processes.
Critical to the climate club discussion is the fact that other interested countries could join the arrangement. Any country that harmonizes its policies with those above and “meets criteria for restoring market orientation and reducing trade in high-carbon steel and aluminum products” could also form part of the agreement. This arrangement could satisfy Nordhaus’ conditions for a climate club, with “members” having the benefit of easier access to one another’s markets (of which the immense EU and US markets, importantly, form part) than “non-members,” who face restrictions. Such a deal could also be the basis for further amicable collaboration on and supranational harmonization of climate policies between members, calling into mind how the post-WWII European Coal and Steel Community grew into what we know today as the European Union.
Whether the steel and aluminum deal develops a framework that could turn into an international climate club depends on the agreement’s forthcoming specifics and, as always is the case with the US, how the political tides turn.
German G7 Presidency
Perhaps the most promising avenue towards a climate club comes from Germany, which currently holds the rotating presidency of the G7 and has come forward as one of the most ardent supporters of a club. Chancellor Olaf Scholz came out strong during the 2021 federal elections in support of establishing such an agreement, for which he also ardently advocated as Finance Minister. The new government’s coalition agreement specifies creating a club that would focus on climate neutrality, a significant expansion of renewable energy and accompanying infrastructure as well as the production of hydrogen. In its G7 Presidency Programme, Germany advocates for a “cooperative global climate club that is open to all countries, expanding international partnerships beyond the G7, especially with G20 partners.” Germany has also made clear that, though the language of a “club” may sound exclusive, its objective is to include countries in all stages of development and with climate policies of varying levels of ambition, with measures that would support countries in implementing stronger climate protection plans.
If the G7 were to come up with a framework for a climate club, especially one that would offer incentives for less-developed countries to join, the Group’s immense political and economic power could redirect high-emitting countries onto a fast track for ambitious climate policies and establish a structure in which members can hold one another accountable to their commitments.
However, in spite of the surge to international prominence of the climate club idea due to its priority on the G7 agenda, little is still known about how the envisioned club would work. Many are looking towards the 2022 G7 Summit and hoping the Group provides clarity on its plan to establish the world's first international climate club and announces who will join, how it will be structured and when it will be established.