Cooperation and conflict: The geopolitical push and pull of climate change

Aligning Canada’s climate policy with its industrial policy, as both China and the U.S. are now actively doing, is a necessary step towards net zero.

Canada, the United States, and China are collectively responsible for over 40 per cent of current global greenhouse gas emissions, and, even in the midst of growing geopolitical tensions and diminished cooperation, all three countries are committed to achieving net zero emissions by mid-century. China in particular has emerged as a driving force of the global clean energy transition, and the U.S., following the passage of the Inflation Reduction Act, is moving decisively to catch up. Canada has been slow to align industrial policy with climate policy, but is now more in that direction following the approach of the U.S.

It was with this significant historic transition in mind that I travelled to D.C. recently to present at the Fifth China-U.S.-Canada Trilateral Roundtable Dialogue. What follows is the basic case I laid out to them to view technical cooperation on climate policy, and on border carbon adjustments in particular, as one key area that can drive progress on climate, even in areas where economic interests diverge.

Much has changed in the geopolitical arena since the Paris Agreement, which committed the world to dramatically reduce global greenhouse gas emissions by mid-century, was concluded in the spirit of international cooperation.

Seven years later, it’s a different world. Trade wars complicate cooperation, as do power struggles over spheres of influence. And the South China Sea is an accident waiting to happen as fighter jets buzz within meters of each other at Mach speed.

The shifting geopolitics has upended climate policy, especially within the UN Framework Convention on Climate Change where progress is slow and the spirit of cooperation has waned. Instead, aggressive trade promotion and protection now define the space.

Against this backdrop of deteriorating bilateral and multilateral relations, it’s useful to look at the trilateral relationship between China, Canada, and the United States from a frame of diverging and converging interests. What you’ll find is that even where national interests diverge, significant progress is possible—and technical cooperation on the core elements of border carbon adjustments can help drive that progress.

The overarching convergent interest these three countries share is to collectively reduce global emissions and avoid significant economic drag and social instability. The main divergent interest is centred on each country’s imperative to maintain domestic competitiveness and aggressively promote low-carbon trade, investment, and production. Within this context, there is a significant short-term opportunity to improve the trilateral relationship while advancing both convergent and divergent interests by engaging on technical cooperation to start to calm the protectionist waters and accelerate the clean energy transition. Let’s unpack what we mean by convergent and divergent interests, then turn to exactly what technical cooperation on a border carbon adjustment mechanism could look like.

First, every nation in the world shares a convergent interest to minimize global emissions. A tonne of carbon emitted anywhere on the planet results in significant climate damages everywhere. These damages are happening now and will compound in the future. They already represent a drag on economic prosperity now, and that drag is getting worse, which then compounds existing economic and social vulnerabilities, adding to instability.

To understand the significance of this climate change-driven economic drag, the Canadian Climate Institute conducted a major macroeconomic analysis called Damage Control: Reducing the costs of climate impacts in Canada. The study downscaled global emission scenarios to a fine geographic resolution predicting changes in precipitation, temperature, and extreme events. We then conducted a series of detailed studies linking climate change to more than 30 impact areas involving business, infrastructure, and human health. Finally, we modelled the economic consequences to the end of the century using a macroeconomic model including international trade and investment flows.

We found that economic damages are already widely distributed across the economy, working their way through supply chains, causing business disruptions and trade losses, knocking out productive capital, and absorbing increasing business investments to fix what an increasingly volatile climate keeps breaking. Businesses and households are heavily impacted, with labour productivity losses and increasing health damages accelerating to mid-century.

Our analysis suggests that climate damages in Canada equal about half of all economic growth today. This is not to say that today’s economy is growing half as fast, but small changes in economic activity add up. Out to mid-century, we see significant damages that do in fact halve the annual GDP growth. This economic drag puts significant strain on government balances with lower tax receipts and higher expenditures to respond to extreme events, prematurely replace infrastructure, and cover the cost of rising health care demand in a warming world. Businesses increasingly need to reallocate scarce capital to address damages and higher costs, impacting profits and trade. Similarly, households get squeezed, and it is the lowest income households that get hit hardest—stealing 8 per cent of net income from the poorest households by mid-century, and worsening.

Canada’s sensitivity to a changing climate is not unique. These Canadian results are broadly applicable globally and likely underestimate the disruption to come.

Our convergent interest therefore is to collectively reduce emissions in order to ensure economic prosperity and support social stability. As we all know, compounding vulnerabilities can tip the scales towards instability, and working together to reduce and limit these current and worsening damages is in every nation’s best interest.

On the divergent side, the main issue is competitiveness. There are two main motivations here for each country: protecting its large emitters, and incentivizing investment to expand trade in low-carbon goods.

First, countries will continue to protect their large emitters by enacting protectionist policy. We see this in Canada in a big way, where within the federation, each province has its own large emitter program applying very different average costs, or balance sheet impacts. Simply put, governments give special breaks to their particular interest groups. This also shows up as protectionist measures to address misaligned carbon costs, such as we see in Europe with the Carbon Border Adjustment Mechanism, which will level the playing field for European producers who now pay a price on carbon.

Second, incentivizing business investment now dominates carbon policy. The U.S. Inflation Reduction Act and the international response to it have shown us that governments will aggressively subsidize industry to position itself for the global net zero transition. The Inflation Reduction Act triggered Canada to follow suit, offering investment tax credits for large industrial emitters. And of course, industrial policy in China has been tightly linked with climate policy for well over a decade. Securing supply chains necessary to manufacture and sell clean energy technologies, notably in critical minerals, is driving increased competition between nations. Canada just rolled out a Critical Minerals Strategy allocating billions of dollars to streamline regulatory processes, provide incentives for development and processing, and invest in infrastructure.

Of course, these subsidies are also designed to drive down learning curves, increasing innovation and lowering the cost of the transition—all while aggressively going after international market share.

The trade in transition-accelerating goods and services has absolutely taken off, with trade data from Canada indicating that a basket of low-carbon and energy efficient equipment has historically outperformed the wider index of manufacturing exports by a ratio of three to one. In some of these sectors, annual growth rates of 80 to 90 per cent are being seen over multiple years. This is a global trend not unique to Canada.

Rekindling the spirit of the Paris Agreement will not be easy, given a lack of strategic assurances across so many dimensions in the geopolitical space right now. I think this is certainly true in the Canada-U.S.-China relationship.

Calming the protectionist waters will not be easy. A short-term cooperative agenda focused on the technical aspects of border carbon adjustments could help. Here are a few places where the three countries can start to work together, as outlined in our report Border Carbon Adjustments: The case for a cooperative, principles-based approach:

  1. Engage with other countries to develop a shared understanding of equivalence on policies and costs applied to border carbon adjustments. This would entail assessing equivalency between systems, including developing a legal, fair, and practical approach to assessing the relative policy stringency between traded commodities. Central to this is knowing the relative emissions intensities of different commodities and the scope of emissions, sectors, and product classifications covered.
  2. Develop co-operative governance approaches to allow for multilateral consultation on the design of border carbon adjustments. The principles of good governance should dictate the design and operation of the border carbon adjustment system. This requires an open and transparent development process to border carbon adjustment development that includes consultation with affected countries.
  3. Understand the carbon policies that a border carbon adjustment credits for equivalent policy.

There are encouraging signs that technical cooperation is possible on climate policy, despite the geopolitical tensions. The U.S. and China are in routine contact at the highest levels, signaling a convergent interest to reduce the disruptive impacts of climate change. Given the importance of Canada’s trading relationship with China and the U.S., Canada needs to be at that table to chart a course through the protectionist waters. Canada also needs to fully lean into the strong geopolitical winds pushing the promotion of low carbon technologies for export.

Continuing to align Canada’s climate policy with its industrial policy, as both China and the U.S. are now actively doing, is a necessary step.