The world economy is in tatters. On the one hand, a tiny black swan in the form of a virus is wreaking social and economic havoc and triggering a correction of financial exuberance that, to some extent, was long overdue. On the other hand, a political climate of trade wars (whether Trump’s policies or Brexit discussions) poses a real threat to the globalised economy that has served the world so well in recent decades.
In both areas, there are reasons for growing concern, but also for increased hope. On the COVID front, the forceful actions of governments and central banks will ease tensions and help reduce the pandemic’s long-term consequences. Second, the last-minute shift from trade wars to trade agreements shows that politicians understand that a poor agreement is always better than a good war. These elements may not represent an existential threat to the world economy as we know it.
However, there is another threat on the horizon that we may be underestimating: trade wars arising not from populism, but from the much-needed and long-overdue fight against climate change.
What do we know so far? We know there is broad public support in Europe, a mixed picture in the US, and much lower awareness elsewhere. We know that large corporations, especially in finance, are increasingly treating ESG issues as strategic. The outcome of the recent climate change conference in Madrid (Chile COP 25) is cause for hope: while governments were unable or unwilling to reach an agreement, civil society as a whole showed a level of compromise not seen before. Particularly striking is the embrace by financial firms—whether global banks or asset managers—of ESG values, and in particular of the fight against climate change, even in jurisdictions where governments are moving away from global consensus.
What are the chances of a global political agreement on climate change? Very slim, I am afraid. The most likely outcome may well be a patchy solution, with different levels of ambition and a staggered adoption by countries of more stringent policies as social demand and technological change take hold. In this context, Europe will lead the race towards a sustainable economy, with the US not far behind, and emerging economies such as China and India most likely lagging behind.
This landscape will transform the rules on which trade has been based. Since complying with ESG principles entails costs, producers of goods and services in leading jurisdictions in the fight against climate change will become less competitive, while those based in countries lagging behind will become formidable competitors. However, that situation will be unacceptable.
The only way to restore fair competition will be to use carbon taxes in the form of tariffs imposed on imported goods, commensurate with the differing carbon footprint of their sector and country of origin. This is not a new idea: it has been proposed by leading authorities (see, for instance, Adair Turner’s recent article on the subject). However, it is difficult to envisage how this could happen smoothly.
On the contrary, countries will surely disagree on the carbon footprint of the goods and services being traded, with importing jurisdictions overestimating it and exporters underestimating it. Clearly, the EU and the UK (post-Brexit), which are emerging as global leaders in the fight against climate change, will have an agreement within reach. But what about trade between the EU and China, India or Indonesia? Even Japan and the EU may struggle to strike a balance on fair carbon tariffs. I would not bet on agreements being reached and global trade continuing.
If we were to include services, the complexity of any agreement would escalate. Consider tourism, a carbon-intensive sector even though the carbon footprint is generated by foreigners. How would the EU adjust for this in climate-related trade agreements?
The end result may well be a world of isolated economic blocs with diverging ESG ambitions. Welcome to the brave new world of green trade wars fought around the fight against climate change—just in case you thought the coronavirus was not enough.
José María Roldán, Chairman and CEO of the Spanish Banking Association
