How Trudeau could use his new friendship with Germany to help fix Canada’s carbon-pricing system

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When Chancellor Olaf Scholz visited Canada last week, the focus was rightly almost entirely on Germany’s urgent energy needs and how the host country could help meet them.

But there is also another area of mutual interest, central to the shift toward a low-emissions global economy and how we compete in it, that Ottawa and Berlin should be discussing going forward even if there was little time for it during this visit.

During Germany’s G7 presidency this year, Mr. Scholz has been trying to advance the notion of a so-called Climate Club. It would be some form of alliance between countries with stringent measures to reduce industrial emissions, ideally through carbon pricing, and would potentially impose penalties on other countries that lack such policies.

The point would largely be to prevent carbon leakage, in which countries’ emissions-reducing efforts are undermined by heavily polluting industries shifting to less environmentally responsible competitors.

Although the Climate Club concept found its way into the closing statement at the G7 summit in June, it’s since lost some steam. Everyone has more pressing priorities at the moment, and it’s hard to forge consensus on anything meaningful along these lines.

But Prime Minister Justin Trudeau, who himself launched an effort at last year’s COP26 climate summit to convince more countries to adopt carbon pricing, has strong incentive to work with Mr. Scholz to try to keep the idea alive. In fact, it may be necessary to avoid the collapse of one of the key pillars of Mr. Trudeau’s climate and clean-economy strategy.

Canada’s system for pricing greenhouse-gas emissions from large industrial emitters such as heavy manufacturers and resource producers – which in theory should have greater impact than the parallel, consumer-facing carbon price with which most Canadians are more familiar – is currently severely compromised, less because of domestic government fault than international circumstance.

With many of Canada’s trade partners lacking strong industrial carbon-pricing systems of their own, companies paying high rates here could face competitive disadvantage. So Ottawa, and provinces meeting its carbon-pricing requirements with their own systems, are shielding sectors by largely exempting them. While the industrial price is set at the same rate as the consumer one ($50 per tonne, with scheduled increases to $170 by 2030), sectors are charged on only a small share of emissions – ranging from 5 to 20 per cent depending on perceived trade exposure.

As a result, companies aren’t sufficiently incentivized enough to transform operations in ways that could boost their long-term international competitiveness while spurring clean-technology growth. And Ottawa has to layer on more and more layers of regulation – such as new caps on oil-and-gas emissions it’s developing – plus subsidy programs to have any hope of making good on the national commitment to reduce total emissions 40 per cent by 2030.

The most obvious way to fix that, while still addressing trade exposure, would be to fully apply the carbon price to domestic industrial emissions, and impose tariffs on high-carbon imports from places that lack comparable systems (while perhaps also giving carbon-price rebates on some exports).

That approach, known as a carbon border adjustment mechanism, or CBAM, is one that the European Union is in the midst of implementing for energy-intensive industries to back up its carbon pricing system. And Ottawa has expressed interest in doing the same.

The catch is that Canada is in an almost uniquely bad position to implement carbon tariffs because it so overwhelmingly trades with the United States – a country that does not have carbon pricing at the national level, and that could retaliate in ways that would be devastating here. It’s possible that Ottawa could figure out a way to work with Washington to determine where other climate policies introduced south of the border could be treated as carbon-pricing equivalents, but it would get complicated and potentially contentious.

This is where the Climate Club idea could be of particular interest here. Rather than leave Canada to fend for itself in trying to work out a carbon-pricing solution with its much bigger neighbour, it would exert more pressure on the U.S. and other countries to price emissions, and help figure out what happens when they don’t.

It’s not realistic to expect a sweeping one-size-fits-all solution. As originally proposed by Nobel-winning economist William Nordhaus, a Climate Club would have involved all member nations setting a carbon tax at a certain level, and imposing tariffs on all imports from non-members. Neither Germany nor any other country wants to go that far; aside from the obvious potential for trade wars, it would raise major concerns about fairness, especially around penalizing developing countries.

There are various ways, though, that it could take shape more modestly yet still consequentially.

One of those would be to start with an international pricing system for just one or two sectors. Steel is often raised as an example, because it’s an industry where even Washington could want to narrowly price emissions and impose a CBAM – largely because of possible competitive advantage against China, where steel production is perceived to be relatively dirty. Whatever the motivation, it could establish a template.

Another would be to help set international ground rules for where and how tariffs could be fairly applied. For instance, carbon-pricing alliances could be easier if there were common and transparent global standards for measuring how much carbon is embedded in products and thus needs to be taxed.

But even that sort of incremental progress isn’t going to happen on its own. It’s going to require sustained effort by leaders with vested interests in making carbon pricing work, or else the Climate Club will at best wind up as a series of platitudes about countries working together on industrial decarbonization – which is basically as far as the G7 text went.

Mr. Scholz has advocated for the concept since before he was Chancellor. But especially after Germany hands over the G7 presidency to Japan in 2023, he’s going to need other champions alongside him.

Mr. Trudeau, looking to both build international carbon-pricing momentum and prove a new Canada-Germany partnership in clean-economy transition, should be the most eager ally out there.

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