Clara Geddes and Kreg Lonneberg

December 9, 2021

Arriving as it did just 10 days after the close of COP26, last month’s Speech from the Throne included a major climate change thrust. The speech reiterated Prime Minister Justin Trudeau’s longstanding assertion that “growing the economy and protecting the environment go hand in hand.” It’s hard to take this statement at face value, though, if the government is committed to protecting the environment by raising the carbon price but cannot mitigate carbon leakage—where production moves offshore to countries with less robust environmental policies.

Trudeau and Environment Minister Steven Guilbeault clearly know this, having both made the case for global carbon pricing at COP26. But Canada alone cannot push this through. Global carbon pricing will require buy-in from the international community, and it may be a tough sell. So Guilbeault proposed a backup plan. Should a global carbon pricing regime not materialize, Canada will move forward with implementing a border carbon adjustment (BCA), an idea the government floated in Budget 2021. This comes hot on the heels of the European Commission adopting a proposal for a BCA earlier this year.

Global carbon pricing and BCAs sit at the rare nexus of being both good for the environment and business competitiveness. Both policies build on the success of domestic carbon pricing schemes, exerting the same pressures, but on a global scale. The underlying principle is that raising the price of carbon incentivizes firms to lower their emissions.

The basic structure of both policies is, in theory, quite simple.

A global carbon pricing scheme, a policy that’s gained momentum within the International Monetary Fund (IMF), would set an international price floor on CO2 emissions. As the name suggests, a global carbon pricing scheme only works if every country agrees to adopt the price floor. Under a BCA, on the other hand, one country would unilaterally impose a fee on imports to ensure that foreign firms pay the same price for carbon as domestic firms.

Both achieve similar ends for Canada.

They would level the playing field for domestic firms currently paying higher carbon prices than foreign competitors who export their goods and services here. This decreases the risk of carbon leakage by making both domestic and foreign firms internalize the cost of emissions, reducing the incentive to purchase goods and services from heavy-emitting producers abroad.

While either would exert decarbonization pressure on firms in jurisdictions that currently have lenient climate policies, both would not necessarily have the same impact on global emissions.

Global carbon pricing would of course apply to all goods and services in every jurisdiction, rather than just those exported to countries with a BCA. This is crucial because all countries need to dramatically reduce emissions to slow global climate change.

And there is no guarantee that foreign firms will decarbonize as a response to a BCA; market interventions often come with unintended consequences. For instance, recent scholarship suggests that when California tried to implement one for their electricity sector, they were subject to resource reshuffling, whereby producers in other states reallocated their carbon-intensive electricity elsewhere instead of actually reducing their overall emissions.

It is worth noting, though, that the government plans to raise our carbon price to $170 per tonne by 2030, which is far higher than the IMF’s proposed global carbon price of $75 per tonne for developed countries in the same year. Thus, domestic firms would still pay far more than their global counterparts. This brings us back full circle to the issue of carbon leakage.

Regarding their implementation, each presents unique obstacles.

Implementing a BCA system that accurately quantifies the emissions attached to imports will be no small feat. This is especially true if we want to expand our system to cover industries with more complicated supply chains, such as manufacturing. For comparison, the current EU model only applies to sectors such as cement and electricity, whose inputs are easier to report.

Moreover, any BCA will inevitably face a World Trade Organization (WTO) challenge. Given that the EU will soon implement their own system, Canada should wait and see how it fares in WTO dispute settlement bodies. However, the EU system is not a perfect analogue, given Canada’s complicated output-based pricing-system (OBPS), which imposes different standards on different industries in regulating industrial emissions.

Whatever the problems with BCAs, they at least put Canada in the driver’s seat. The same is not true for global carbon pricing. Canada will have little say in whether a minimum price is established. And though feasible, implementation would require significant international coordination, and we should expect pushback from high-emitting developing economies such as India, as well as from China.

At the end of the day, the choice between global carbon pricing and border carbon adjustments is not Canada’s alone. As of now, both are possible but ambitious. The onus is on our government to respond quickly and effectively when it becomes clear which we can adopt. The stakes are too high not to be prepared either way.

Clara Geddes is an economic analyst and Kreg Lonneberg is a policy analyst at the Institute of Fiscal Studies and Democracy (IFSD).