Carbon Border Adjustment Mechanism: Protectionist tax or climate protection tool?
To counter allegations of protectionism and enable the EU’s new Carbon Border Adjustment Mechanism to become an effective climate tool requires policies that utilise CBAM revenues to help finance the climate transition in developing countries.
The EU ETS and emission allowances are not a very popular topic in the Czech Republic, nor in several other EU member states. However, it is a key instrument of European climate policy. The new CBAM legislation, essentially a carbon tariff, is also supposed to become its vital component.
How is the CBAM related to EU climate policy? And most importantly, can the two instruments increase global climate ambitions and help in the fight against climate change?
The EU ETS as an inspiration
The European Union has some of the strictest environmental protection standards and perceives itself as a leading voice in expanding climate ambitions around the world. The European Union’s Emissions Trading System (EU ETS) is a key tool in the area of emissions reductions, and the EU supports the efforts of other countries to establish their own carbon markets.
The EU ETS was the first and, until recently, the largest emissions trading system in the world and inspired other countries to implement similar schemes. Since the establishment of the EU ETS, carbon markets have emerged in New Zealand, the USA, Japan and Canada. China launched a national carbon market in 2021, which surpassed the EU’s in the volume of emissions covered. The launch was preceded by six years of cooperation between China and the EU, during which the European Commission supported the establishment of seven pilot systems in larger cities in China.
Over time, carbon markets have grown around the world, partly due to the perceived economic efficiency of the instrument, which helps explain the system’s popularity over a carbon tax. Thanks to this trend, in 2022, about 17% of the world’s emissions were covered by some sort of market-based scheme.
Carbon tariff to the fore
The EU ETS affects only local producers and this means that companies from countries outside the EU whose products flow to the single market every year do not pay anything for the emissions released in the production process, unless they are covered by a local carbon pricing scheme. This also applies to emission-intensive products such as steel, iron and aluminium. As part of the European Commission’s ‘Fit for 55’ reform package, EU member states agreed to introduce the Carbon Border Adjustment Mechanism, or CBAM, to impose a carbon price on imported emissions.
How will this carbon tariff work in practice?
CBAM will cover countries that export cement, iron, steel, aluminium, fertilisers, hydrogen and electricity to the EU. Manufacturers who want to export such products to the single European market will have to purchase emission certificates corresponding to the price of a European carbon allowance. The system will enter into force on 1 October 2023 but it will not be fully operational until 2026. During the transition, importers will only have to report greenhouse gas emissions, with no financial obligations.
Motivating partners or protectionism?
Of course, the new instrument has not been welcomed by all the affected countries. According to many of the EU’s trading partners, including the United States and India, CBAM is a protectionist tool of the EU. China has even questioned its compatibility with the World Trade Organisation rules in the past. But the EU argues that the CBAM is supposed to stimulate climate measures in countries that export their goods to the EU and will motivate other states to decarbonise both at the political and economic levels. Partner countries will be incentivised to implement local carbon trading systems because if their producers prove they have paid a certain carbon price in the national framework, they will be exempt from the carbon tax to that extent.
At the same time, the private sector will receive clear incentives to decarbonise their production and operational processes, as companies will have to obtain certificates according to the amount of emissions they emit during production. The effect of the new legislation was felt even before the Russian invasion in Ukraine, which mainly exports iron, steel and electricity to the EU. According to an analysis by the Potsdam Institute IASS, CBAM and climate ambitions came to the fore in the political discussion at the moment when they intersected with the economic interests of large business groups. It is likely that the EU will aim to exempt Ukraine from the carbon tariff as part of post-war reconstruction. However, the final impact of the legislation on global emissions will be determined by how companies and governments react to it.
Electrifying questions
Initially, the CBAM will cover not only emission-intensive products but also electricity, which flows into the EU every year from neighbouring countries, such as the Western Balkans. In 2019, this region exported 6.3 TWh of electricity to the EU. Because the countries of the Western Balkans, with few exceptions, rely on coal for electricity generation, their electricity is on average about four times more emission-intensive than that produced in the EU.
The same 6.3 TWh was responsible for about a fifth of emissions from all electricity imported into the EU. And since its production is not subject to any carbon taxation, local electricity producers are motivated to export to the EU, which does not benefit either the global climate or local air quality. And this is precisely the kind of problem that CBAM should solve. “I believe CBAM will be effective against carbon leakage, especially when it comes to imports. Decisions concerning the location of production do not only depend on carbon pricing anyway, and I think CBAM will create a level playing field. […] In my opinion, CBAM will not hinder the import of carbon intensive goods but it will slightly decrease it. But not before the 2030s,” says Anne Gläser, a Senior Policy Advisor for carbon pricing at Germanwatch.
CBAM: a tool of inequality?
Almost half of all product imports that CBAM will cover come from just five countries – Russia, China, the United Kingdom, Norway and Turkey. However, none of them are among those most affected by the new tariff. Many of the emerging economies are dependent on raw material exports. One example for all is Mozambique, which exports aluminium worth 7% of its GDP to the EU.
The EU states did not agree on using CBAM revenue to support climate measures in partner countries. For the carbon tariff to be considered a climate instrument, the EU must ensure that countries such as Mozambique have sufficient resources and capacity to meet the requirements of European legislation, such as monitoring and verification of emissions.
If the financial burden of implementing climate policies was left to the developing world, CBAM would exacerbate global income inequality and contribute to the unequal distribution of wealth. According to research from Boston University, CBAM could result in annual gains of up to $141 billion in the Global North, while countries of the Global South would lose a total of $106 billion. And this is because CBAM can lead to a decline in exports from the countries of the Global South in favour of richer states.
It is, therefore, crucial that EU member states recycle a large part of the CBAM revenues back to the most affected countries. “Countries such as India and Ukraine refer to revenue recycling as a decisive factor for possible acceptance of the CBAM,” writes Anne Gläser. Revenue recycling will not only underline the compatibility of the instrument with WTO rules, but will also promote the international acceptance of the instrument by other states. In her research, Gläser further proposes for the EU to establish an investment fund or another financial instrument that would be separate from the existing climate finance structures. Such an instrument would be financed from the sale of CBAM certificates.
Climate protection, not economic protectionism
It is clear that both CBAM and the EU ETS can play an important role in the promotion of global climate policies in the future. Since the establishment of the EU ETS, similar schemes have spread around the world and currently cover about a fifth of global emissions.
CBAM can help further develop emissions trading systems. But it must be seen as a tool that will move us closer to our climate goals, and not as a tool of protectionist politics. In order to ensure the transparency of the instrument and overall international support, a wider range of participants – national governments, EU trading partners, as well as representatives of civil society must be involved. In order to develop functioning local carbon markets, the EU must offer technical assistance to states that are considering their introduction.
Moreover, EU countries should agree on the use of CBAM revenues for climate finance and financial support for meeting the technical requirements of the EU carbon tariff in third countries. Only in this way can CBAM be taken as a transparent instrument whose real aim is the global support of climate policies.
