Europe's "Green Airline War" Provides a Glimpse Into a WTO-less World

The EU's implementation of new regulations imposing a tax on airlines based on their carbon emissions has resulted in a firestorm of litigation and international teeth-gnashing.  The EU's steadfast commitment to assess the tax also has led many to speculate that the system could set off a "trade war" among nations as they impose similar retaliatory fees on EU-based airlines that enter their airspace.  The whole thing is a giant mess that could end up costing airlines and, inevitably, consumers billions of dollars and crippling the already-struggling global airline industry, but it does have one - albeit small - silver lining: it demonstrates just how dangerous the world might be without the WTO.

As you may recall, the demise of the WTO's Doha Round of multilateral trade negotiations has led many people to speculate that the global trade body has become pointless and/or impotent.  I've long disagreed with such commentary, arguing that, while the WTO may have its struggles as a negotiating body, its existing rules and dispute settlement mechanism are vital for maintaining an open trading system and thereby preventing the collapse of the global economy.  I'm certainly not alone in such a defense, and the EU airline fiasco shows just how right we WTO-defenders are.  But before we get to all that back-slapping, first let's check in on the EU "green airline war" as per the good folks at the WSJ:

Europe's anticarbon crusade failed to extend the Kyoto Protocol this month, but the boys in Brussels don't give up easily. Now Europe may kick off a trade war with its new scheme to tax airlines on carbon emissions.

The rule, which goes into effect January 1, will apply to all airlines regardless of nationality and to all flights to or from Europe. Airlines that refuse will be subject to fines of €100 per ton of CO2 that exceeds the EU's limits, and they could be banned from operating in Europe.

The International Air Transport Association estimates the rule will cost €900 million next year and at least €2.8 billion annually by 2020. That's a lot for an industry that expects to turn a combined global profit of €3.5 billion next year. The EU admits the scheme will raise ticket prices and dampen consumer demand, which may be the point: To make carbon-spewing international travel accessible to fewer people.

In September the U.S. joined Brazil, India, China, Russia and 21 other governments in declaring that "the unilaterally imposed [European] measures were inconsistent with international legal regimes." The 1944 Chicago convention on aviation gives every signatory "complete and exclusive sovereignty over airspace above its territory."

Brussels shrugged that off, and last week the European Court of Justice rejected a challenge brought by American and Canadian airlines. The ruling included the logical gem that while all EU nations ratified the 1944 convention, the EU itself did not exist at the time and thus cannot be bound by its provisions.

The European rule does allow exemptions for airlines whose governments are taking "equivalent measures" to penalize carbon emissions, though airline sources say a patchwork of carbon-reporting and taxation schemes would be even more unpalatable than the EU's blanket measure.

Meanwhile, the EU's trading partners are threatening to retaliate. Beijing has floated a cut in Chinese airlines' Airbus orders, and Chinese carriers are launching their own lawsuit. New Delhi is mulling a payback tax, and Moscow hasn't ruled out increasing overflight fees on European carriers.

The U.S. has stated its "strong legal and policy objections" to the move, and this month Secretary of State Hillary Clinton and Transportation Secretary Ray LaHood warned that Washington "will be compelled to take appropriate action" if the EU doesn't back down. The measures could include a tax on European airlines, judging by the request the U.S. made this month to nine European carriers for information on their 2012 carbon allowances and 2010 revenues.

So how, exactly, does this mess shine any light on the WTO's value?  Well, because the airline services regulated by the EU anti-carbon tax are most likely exempt from WTO rules, that's why.  Typically, those rules would require WTO Members (with certain exceptions) to treat each others' services in a non-discriminatory manner, and these non-discrimination disciplines, when applied to goods, are one of the reasons why WTO Members like the EU and United States haven't imposed "carbon tariffs" on each others' imports - something I've discussed a lot here.  The WTO's General Agreement on Trade in Services (GATS), however, contains an "Annex on Air Transport Services" which expressly exempts “measures affecting trade in air transport services, whether scheduled or non-scheduled, and ancillary services” from GATS disciplines.  The Annex states that the GATS will not apply to (i) traffic rights or (ii) services directly related to the exercise of traffic rights, except for aircraft repair and maintenance services, with very limited exceptions.  A “traffic right” is broadly defined in the Annex and basically covers every type of remunerative air transport (passenger, cargo and mail).  Thus, because the EU carbon tax regulates airlines’ exercise of "traffic rights," it's very likely exempt from the GATS.

Moreover, the Directive is also likely exempt from the WTO Agreement on Technical Barriers to Trade (TBT) because services are expressly excluded from that Agreement (Annex I).  So, under WTO rules, it appears that the EU can basically do whatever it wants with respect to taxing and regulating airline services that occur in its airspace.  And when it does, other WTO Members can retaliate in the same or similar fashion.  This explains why (a) no WTO Members have challenged the EU directive at the WTO; (b) why US and other airline carriers were forced to go to the EU courts to challenge the directive (yeah, good luck with all that); (c) why the EU has basically ignored nations' vocal complaints; and (d) why other nations are threatening to impose their own airline taxes to spite the EU (or to maybe qualify for an exemption from the tax).

In short, it's the Wild West out there, and airline consumers (and global trade) will inevitably be the casualties of any shoot-out.

A couple years ago, I stated that, even without Doha, the WTO remained indispensable because "(i) WTO rules establish a baseline of global trade liberalization, (ii) nations pursue "WTO plus" commitments through unilateral liberalization (best route) or bilateral/regional trade agreements with other willing partners (meh route), and (iii) many large trade disputes are adjudicated through the WTO's dispute settlement body."  These disciplines help thus nations avoid tit-for-tat protectionism that can, in the rules' absence, devolve into a real global trade war.

The EU's "green airline war" shows us just how right this is, and just how nasty a WTO-less world could be.

UPDATE:  Right on cue, Chinese airlines are saying that they'll refuse to pay the new EU carbon tax.  Yeah, that should go swimmingly.  Meanwhile, "other Asia Pacific carriers, already battling a weak travel market, are likely to pass on the extra cost to passengers."  Awesome.