By Mia Saito Callahan
What Is happening
Despite the implementation of ever-more ambitious climate initiatives in countries across the world, yearly global emissions have not decreased. This failure is in part due to a loophole exploited by multinational enterprises (MNEs)—corporations based in jurisdictions with stricter climate-related manufacturing restrictions relocate their manufacturing (and therefore their emissions) overseas, rendering many climate policies ineffective.
To reach emissions targets, this loophole must be closed so that climate policies truly incentivize sustainability. While the solution may seem as simple as improving international trade policy or changing how national emissions are defined, the most viable solution is a new method of climate accounting known as E-Liability. This data-based solution will be essential for understanding climate change in the context of our increasingly complex supply chains, as well as for creating better-informed environmental policy.
The Offshore Loophole
Under the Paris Agreement, 195 countries have agreed to work to reach international climate targets. These targets, most notably to keep the increase in global average temperatures to below two degrees-celsius compared to pre-industrial levels, are to be reached by lowering a country's carbon emissions, which are calculated as the emissions produced within a nation’s borders.
This method of calculating emissions may seem intuitive and insignificant at first glance. However, this method of assigning national responsibility for emissions reduction oversimplifies complex and intertwined economic processes.
Because a country is only responsible for emissions within its borders, large corporations have a strong incentive to send their manufacturing operations overseas, usually to less-developed countries with less-stringent climate policies. With decreased restrictions, corporations are able to employ much cheaper and faster manufacturing processes, which often come at the cost of higher emissions and pollution.
The goods manufactured overseas are often then sent back to the investing country, along with most of the profits from the cheaper methods.
The Outcome: Degradation and Death for No Returns
The offshore loophole has become common practice in recent years. Between 2005 and 2016, emissions in developing nations have spiked, while emissions in developed nations like the United States and the UK have largely plateaued.
The growth of offshoring practices has of course come at a cost. Developing nations have suffered in recent years from an increase in air pollution, climate disasters, and related deaths. In India, 106,000 deaths yearly are associated with the production of exported goods, including deaths from air pollution and from the results of climate change. There are 238,000 annual deaths from the same cause in China, as well as 129,000 in the rest of Asia.
Obviously, air pollution and climate disasters pay no mind to national borders. Pollution generated in countries like India and China spreads across the rest of Asia before dissipating over the Pacific Ocean .
The location of offshored manufacturing naturally determines the destination for related pollution, and therefore related deaths. In offshoring production, developed nations not only continue to worsen a global issue, but also systematically push the consequences to other countries while keeping most of the profits.
Why Don’t Developing Nations Increase Climate Restrictions?
The solution to the offshore loophole may seem simple: why don’t developing nations increase climate restrictions to match those abroad?
Emissions restrictions are inherently costly—they call for newer and more complex manufacturing processes in exchange for long-term sustainability. As a result, these policies can slow economic growth.
Developing nations face many challenges outside of the fight against climate change. These countries often suffer from lower institutional and financial capacities and face disproportionate risks from climate change, such as storms, droughts, or air pollution . These costs are increased by the pollution and deaths created from the offshoring loophole, creating a cycle of low levels of climate regulation, high levels of offshoring, and finally high levels of climate damage.
The result is that countries who suffer most from the effects of climate change are the least-equipped to counter them, a fact worsened by extensive use of the offshore loophole in manufacturing.
Investment Based Climate Accounting: A Simple Fix?
If the problem is how nations define and assign responsibility for emissions, it would logically follow that governments should change the way emissions are defined.
An article in Nature Climate Change discussing investment-based climate accounting proposes just that. Rather than looking at emissions originating within a country’s borders, the article proposes that greenhouse gas (GHG) emissions are better understood through foreign direct investment (FDI). Following this, when a firm offshores manufacturing to another country, the country investing in the manufacturing is still held responsible for the emissions produced.
In theory, this accounting method rewards foreign investment in sectors that are more environmentally friendly, or that utilize sustainable manufacturing processes. It also encourages developing countries to adopt more environmentally conscious practices, while reducing emissions and pollution from offshoring.
Unfortunately, this method of accounting is unrealistic and doesn’t completely address the offshoring issue. Developed countries have been extremely careful to avoid increasing their emissions burden. These countries pushed for the Paris Agreement—the largest existing climate treaty in the world—to not include language that holds any country in particular liable for the impacts of climate change.
Even as countries have called for climate aid or reparations, their requests have gone largely unanswered. In 2021, Barbadian Prime Minister Mia Mottley asked the EU and the United States to pay for the damages caused to her country by a climate change-related hurricane. She argued that these nations’ emissions are largely responsible for climate change, and that they are therefore liable for the damages to her country.
While developed nations had pledged $100 billion dollars annually for “climate finance” in 2015, this goal has not been fully achieved. Furthermore, the fund is meager compared to the damages, covering less than half of the estimated costs of climate destruction in 2020 alone. The United States has clarified that it does not support an additional fund for climate disasters, despite acknowledging the urgency to address the issue.
With such uphill battles to even receive partial aid for climate disasters, it would be near impossible to convince the US or other developed nations to switch to an alternative method of climate accounting specifically to increase their emissions responsibilities. While developed nations are more capable of reducing emissions and implementing climate policies, it is difficult to hold any particular group responsible for climate change, especially when taking responsibility would likely mean paying most or all of the climate bill.
Additionally, many scientific papers and climate treaties are written with emissions defined as what is produced within a nation’s borders—completely changing this would create confusion around climate targets and complicate ongoing studies.
While investment-based climate accounting would be more accurate in presenting the emissions burdens for each country, it doesn’t fully address the issue of disincentivizing the offshoring of emissions. Even with more accurate emissions accounting, it is difficult to regulate production methods outside of a nation’s borders. Therefore, in order to identify and effectively lower emissions from offshoring, further data collection and policy implementation would be needed to properly close the loophole.
This criticism does not imply that the concept is meritless by any standard. Investment-based climate accounting recognizes the complexities of emissions embedded in the supply chain, and the need to pressure those countries with enough wealth to offshore manufacturing to clean up their own mess. It also provides a foundation for creating innovative methods of tracking emissions that normally slip through the cracks.
Emissions Liability Accounting: A Surprising Solution
Rather than completely changing the definition of national emissions, the E-Liability (emissions liability) accounting system offers a solution through increased data collection.
The E-Liability system requires corporations to keep track of all emissions produced throughout the production and transportation of goods. Starting with the production of fuels such as coal, firms would calculate total emissions involved in production per unit or weight of the goods produced. From there, emissions transfer as E-Liability from firm to firm when goods are purchased.
Countries could use the total emissions created in producing a good to set more informed taxes and lessen incentives to send emissions to other countries. Instead, the intended incentive of climate policy is upheld: to encourage sustainable production methods.
The E-Liability system aids in enforcing global sustainability, rather than just changing the party responsible for certain emissions. It also more clearly illustrates the complex web that composes the international supply chain. Rather than singling out certain countries or industries as unsustainable, E-liability would create a concrete and more complete image of the real cost behind any given good.
On top of these benefits, this method of climate accounting would also aid in collecting crucial data for understanding climate change and global emissions. This data would be essential in informing subsequent environmental policy and in supporting developing nations in their fight to receive aid for climate disasters.
The data-focused approach used by the E-Liability accounting method is much more difficult for developed nations to ignore. In rejecting the E-Liability method, nations wouldn’t be refusing to pay for the entire meal, they’d be refusing to even look at the itemized bill.
E-Liability Accounting: Addressing Possible Doubts
While it may seem as difficult to implement the E-Liability accounting system as investment-based accounting, the two differ for multiple reasons. Firstly, there is a stronger incentive for firms to willingly adopt the E-Liability system. While the investment-based system only impacts firms that are intentionally offshoring manufacturing to avoid climate restrictions, the e-liability system impacts all firms. Domestic firms that already sell products using eco-friendly labels or marketing strategies could further support their claims by willingly adopting this system. The data-based method strongly counters claims of “virtue signaling” by providing proof of firms’ claims.
If consumers agree with this system, it may give firms that adopt it a competitive edge. This would prompt gradual adoption of the E-Liability system and promote the standardization of the practice nationally.
While it may be difficult to get international cooperation on implementing E-Liability, this would not prevent E-liability accounting from assisting in regulating emissions abroad. Taxes could be implemented not only on goods with high environmental liability but also on those for which the due diligence of calculating liability was neglected in the first place. This both incentivizes the implementation of e-liability accounting abroad as well as careful and sustainable investment in manufacturing by multinational corporations.
Tracking emissions from the many inputs and factors of production is another area of concern when evaluating this strategy. Fortunately, the methods required for tracking emissions in most aspects of manufacturing already exist. Environmental engineers are capable of estimating the emissions of “a company’s primary-source activities'' , or emissions from the direct operations of a corporation. They can also estimate the emissions created from transporting a certain quantity of a product (often measured in weight), which helps to fill in many gaps.
The other half of this issue—the cost of implementing such an involved accounting system—is not unique to E-liability. Environmental regulations and policies are inherently costly, and producing sustainably requires implementation of more expensive production methods. Conversely, the standardization of these practices incentivizes developing new, cheaper methods of sustainable production, which is essential for combating climate change.
Why It Is Not Enough
It is clear that the lack of climate regulations on multinational corporations is having serious adverse impacts, especially on those who are least able to combat them. Adopting a method of climate accounting is essential for reducing emissions, incentivizing sustainable development, and understanding the challenges the world faces.
The implementation of climate policy works in tandem with a culture that takes into consideration the collective consequences of one’s actions. Without the belief that individual choices contribute to global environmental degradation and the deaths caused by climate change, climate policy will continue to face significant challenges in achieving meaningful results. On an individual, corporate, and national level, those that are responsible for emissions must finally learn how to pay the bill.
Mia Saito Callahan is a writer for the Economics & Business team and is currently a second-year at the University of Washington Department of Economics.