With limited progress in the U.N. climate change negotiations, the European Union has been looking at ways to further reduce global CO2 emissions by extending the scope of its cap-and-trade system, most recently through flights entering and leaving EU airspace. The EU Aviation Directive entered into force on January 1st, 2012, requiring all airlines to hold permits covering their CO2 emissions for flights operating in EU airspace. For instance, Singapore Airlines will be required to hold permits for CO2 emissions for its flights from Singapore to Frankfurt, which will include all CO2 emissions over Singapore, third countries, the high seas and EU airspace.
International Criticism of the Aviation Directive
The EU’s decision to include non-EU airlines under its cap-and-trade system has been controversial. U.S. Secretary of State Clinton and U.S. Secretary of Transportation LaHood have stated that they “strongly object on legal and policy grounds” to the application of the Aviation Directive to U.S. airlines and urged the EU to halt, suspend or delay application of the Directive. In 2011, the U.S. House of Representatives passed a bill that would make it illegal for U.S. airlines to comply with the EU Aviation Directive. China has said that the EU scheme violates the United Nations Framework Convention on Climate Change (UNFCCC) principle of common but differentiated responsibility (CBDR) the notion that developed and developing countries should not be expected to make the same efforts in reducing their C02 emissions  — and the International Convention on Civil Aviation (ICAO or the Chicago Convention) has adopted a declaration opposing those parts of the EU Aviation Directive that require non-EU airlines to purchase emissions allowances. 
Legal Challenges to the Aviation Directive
The airline industry has also challenged the legality of the Aviation Directive before the competent courts in the EU. The Air Transport Association of American (ATAA) and various U.S. airlines have sought a ruling from the Court of Justice of the European Union (CJEU) regarding the consistency of the Aviation Directive with EU law, including the application of customary international law and the Chicago Convention to the Aviation Directive. But on December 21, 2011, the CJEU ruled that the Aviation Directive is consistent with international law and the Chicago Convention. 
Competitiveness and Carbon Leakage Issues in the EU and the U.S.
With general public support in the EU for further climate change action, the EU extended its cap-and-trade system to the aviation sector. However, to maintain support for climate change action the EU has to limit the so-called carbon leakage and competitiveness issues that would have arisen if the scheme had been limited only to EU airlines. Carbon leakage arises when a carbon price causes domestic businesses to relocate to countries not pricing carbon or to increased imports of goods from countries not pricing carbon, resulting in no net reduction in global CO2 emissions. Competitiveness issues occur when a carbon price increases the price of domestically produced goods, causing consumers to substitute with cheaper imports from countries not pricing carbon, ultimately harming domestic industry and undermining support for these policies. In summary, designing the EU scheme without including non-EU airlines could have defeated the environmental goal of reducing CO2 emissions while harming the EU aviation industry.
While the U.S. has taken the lead in opposing the application of the EU Aviation Directive to U.S. airlines, in 2009 the U.S. House of Representatives passed the American Clean Energy and Security (ACES) Act – a comprehensive cap-and-trade bill that raised similar competitiveness and carbon leakage concerns.  Like the EU Aviation Directive, this bill responded to these concerns by extending the domestic carbon price to imports. But despite these measures, concern over the economic impacts of a domestic carbon price was a key reason behind the ultimate failure of Congress to pass a cap-and-trade bill.
The International Trade Implications
Applying a carbon price to imports imposes a cost with important implications for international trade. First, applying a domestic carbon price to imports raises questions about the consistency of the Aviation Directive with the EU’s World Trade Organization (WTO) commitments. Although this question could be resolved through WTO litigation, a WTO dispute can take three years to finalize during which time other non-EU countries could impose restrictions on EU imports based on their disagreement with the level of climate change action the EU is taking – creating a form of tit-for-tat trade retaliation, reducing international trade and economic growth. I have written in more depth on the consistency of the EU Aviation Directive with WTO commitments in an article that will appear in the March 2012 edition of the Journal of International Economic Law, and online at their website in January 2012.
The U.S. and other countries have not yet, however, expressed their opposition to the Aviation Directive in terms of its consistency with WTO law. Instead, and as outlined above, these countries have focused on the EU Aviation Directive as being a breach of state sovereignty and the Chicago Convention. A WTO finding that the extension of the Aviation Directive to non-EU airlines is WTO inconsistent would make similar approaches to addressing the competitiveness and carbon leakage issues, like the ACES Act, increasingly vulnerable to WTO litigation.
Secondly, the extent to which competiveness and carbon leakage concerns arise also depends on climate change action being pursued by other countries. Ultimately what matters is the difference in costs incurred by industry in the country pricing carbon compared with other countries.
One measure of the action countries are taking to address climate change is to compare their international commitments under the Kyoto Protocol. Under the Kyoto Protocol’s first commitment period (2008-2012), only developed countries (excluding the U.S.) agreed to binding caps on their CO2 emissions. Developed countries agreed to do more than developing countries to reduce their CO2 emissions because they are better able to absorb the costs of reducing their CO2 emissions and they accepted responsibility for most of the historical build-up of global CO2 emissions.
For some developing countries, the allocation of responsibility under the Kyoto Protocol has become synonymous with the notion of CBDR. There is, however, no consensus over what CBDR means in terms of actions that developing countries should take to reduce their CO2 emissions. The U.S. and EU position is that while developed countries should have heightened responsibilities, developing countries should also participate in addressing climate change. On the other hand, China interprets the notion of CBDR as meaning that developing countries should not be obliged to participate in non-differentiated emission reduction methods like the EU’s emissions trading system.
One of the consequences of viewing the Kyoto Protocol as fixing a permanent divide between the responsibilities of developed and developing countries for reducing CO2 emissions is that it completely ignores the role that large developing countries like China - which is now the world’s largest CO2 emitter – but also India and Brazil, will have to play in order to keep global temperature increases below 2 degrees Celsius above pre-industrial levels. Simple arithmetic shows that without significant reductions in CO2 emissions from large developing countries, even if the developed world reduced their CO2 emissions by 80 percent by 2050, the world would still overshoot this 2 degree goal. The tension between the expectations that developed countries should take more ambitious climate change action and the need for significant climate change action by the largest developing countries has underlined many of the difficulties in the U.N. climate change negotiations.
At the U.N. climate change meeting in Durban in December 2011, the EU and a few other countries  agreed to a second commitment period under Kyoto Protocol and all countries agreed to negotiate by 2015 an outcome with legal force that will be applicable to all parties. The combination of no reference in the Durban outcome to CBDR and the agreement by all countries to undertake a legal commitment is a step towards overcoming the developed/developing country divide enshrined in the Kyoto Protocol a main obstacle to making meaning multilateral action so difficult.
However, an agreement with legal force does not mean equal CO2 mitigation by all countries. And as long as developed countries do more to reduce their CO2 emissions than developing countries, pricing carbon will lead to competitiveness and carbon leakage concerns. In this sense, the competitiveness and carbon leakage issues described above are an unavoidable by-product of the U.N. climate change negotiations and in particular the principle of CBDR.
In practice, the extent to which these competitiveness and carbon leakage issues arise will depend on the action that developed and developing countries take. While developing countries have been holding fast to their definition of CBDR in the U.N. climate change negotiations, domestically they are increasingly prepared to undertake serious efforts to reduce their CO2 emissions. For instance, China has adopted a CO2 emission intensity target of 40-45 percent by 2020 (compared to 2005 levels); a renewable energy target of 15 percent by 2020; and has allocated funding for renewable energy, mass transit, and electric vehicles. Similarly India is developing renewable energy, improving energy efficiency, and investing in its forestry and agriculture sectors and Brazil has pledged to reduce its emissions by reducing deforestation and increasing the use of bio-fuels and renewable energy.
Moreover, it is clear that not all developed countries are undertaking the same efforts to reduce their GHG emissions. For instance, only the EU is regulating CO2 emissions from aviation. Additionally, the extension of the EU Aviation Directive to non-EU airlines aims to address the competitiveness and carbon leakage issues that arise from the lack of regulation of CO2 emissions from aviation in developed as well as developing countries.
This suggests that while we can expect countries to claim pricing carbon raises competitiveness and carbon leakage concerns which requires extending domestic carbon prices to imports, government’s still need to carefully assess the real extent of these concerns in light of the range of climate change actions being taken around the world. Indeed, a key issue will be how countries navigate between the competing goals of taking action to reduce their GHG emissions and addressing the associated competitiveness and carbon leakage issues, while maintaining an open and non-discriminatory trading system consistent with the WTO.
The EU Aviation Directive in the light of WTO law
The key reference point for addressing these climate change and trade issues will be the WTO rules and jurisprudence. It is important to be aware that the WTO does not prevent WTO Members from conditioning access to their markets based on the action (or lack of action) other countries take to reduce their CO2 emissions. Members are therefore able to condition access to their markets on the climate change policies of exporting countries. The key WTO disciplines are that these measures do not discriminate between like imported and domestic goods and services, or provide more favorable treatment to domestic goods and services compared to like imports.
At times, however, WTO Members may find it necessary to discriminate against imported goods and services in order to achieve their climate change goals. For instance, an exemption under the EU Aviation Directive for airlines from countries that regulate CO2 emissions from aviation could be inconsistent with the WTO’s most-favored nation commitment – to not accord more favorable treatment to imports from one particular WTO member. However, as part of the EU’s efforts to address climate change, this could be justified in terms of the WTO policy exceptions for measures related to the conservation of exhaustible natural resources or that are necessary to protect human or animal or plant life or health. In this case, it will be necessary for the EU to demonstrate that the Aviation Directive is not applied in a way that leads to arbitrary and unjustifiable discrimination or a disguised restriction on international trade. This would mean that the EU should provide similar opportunities for countries to demonstrate that they are regulating CO2 emissions from aviation in ways that has an equivalent environmental impact. This would prevent the EU from requiring other countries adopt their same regulatory scheme, and instead would require the EU to focus on the effect of these other efforts in reducing CO2 emissions from the aviation sector.
This is but one example of how WTO rules effectively mediate between the competing claims of ambitious climate change action and maintaining an open non-discriminatory trading system. WTO rules are best understood as not reducing the scope for countries to undertake ambitious action to reduce CO2 emissions, but as placing important limits on the ability of countries to use climate change as a pretext for unduly restricting trade. This should be a goal that climate change advocates can support. Indeed, addressing climate change while ensuring that liberalized trade remains an engine for growth is simply a restatement of the goal of sustainable development, something that is explicitly recognized in the preamble to the WTO and in Article 2 of the Kyoto Protocol.
 Directive 2008/101/EC of the European Parliament and of the Council of 19 November 2008 amending Directive 2003/87/EC so as to include aviation activities in the scheme for greenhouse gas emission allowance trading within the Community, 2009 O.J. (L 8/3) (hereinafter Aviation Directive).
 Letter dated 16 December 2011 from US Secretary of State Hilary Clinton and US Secretary of Transportation Raymond.
 H.R. 2594 European Union Emissions Trading Scheme Prohibition Act of 2011 ’An Act to prohibit operators of civil aircraft of the United States from participating in the European Union’s emissions trading scheme, and for other purposes’ October 24, 2011.
 See Statement by the China Air Transport Association (CATA) on the EU ETS on March 10, 2011.
 The declaration passed by the 26 nations in New Delhi and the resolution passed by ICAO is available at http://www.ainalerts.com/ainalerts/alertimages/ICAO.pdf.
 Air Transport Association of America and others v. Secretary of State for Energy and Climate Change, Judgment of the Court of Justice of the European Union, Case C-366/10, 21 December 2011 (‘ATAA v. Secretary of State for Energy and Climate Change’).
 HR 2454, American Clean Energy and Security Act of 2009.
 EC Working document “Impact Assessment of the inclusion of aviation activities in the scheme of greenhouse gas emission allowance trading within the community, December 2006; See also Statement by Todd Stern to the House Committee on Foreign Affairs, May 25 2011
 The Economics of Climate Change Mitigation: Policies and Options for Global Action beyond 2012, OECD 2009.
 Belarus, Croatia, Iceland, Kazakhstan, Lichtenstein, Monaco, Norway, Switzerland, Ukraine.
 Aviation Directive preamble 17.