With the current world struggling out of the pandemic, the urgency of climate action has taken precedence. The recently released Intergovernmental Panel on Climate Change (IPCC) report expounds that the world is in a state of emergency with respect to limiting global temperature rise to 1.5 degree celsius. Ambitious emission cuts are way more important now than it has ever been to save our planet from the imminent climate catastrophe. One globally widespread accepted method of reducing emissions takes the form of carbon pricing, with a newer iteration now being discussed, namely the carbon border tax adjustment mechanism or as the European Union (EU) calls it, the CBAM. The proposed CBAM structure is however already garnering some amount of criticism. With this, the ever- pertinent questions of climate justice and the efficiency of carbon taxes come back into the picture, particularly from the developing country perspective.
CBAM found its way in the climate agenda under the EU’s Fit for 55 plan, wherein European Commission adopted a package of proposals to make EU’s policies fit for reducing net greenhouse gas emissions by at least 55% by 2030, to achieve the ambitious climate-neutral continent target by 2050. CBAM in turn is essentially a means for EU to prevent ‘carbon leakage’. As the EU runs stringent climate policies with an emission trading system (ETS) in place already, there is a high risk of carbon emitting companies to move production abroad. This in turn not only raises the probability of domestic products being replaced by more carbon intensive imports in the EU, but also ultimately neutralises the whole agenda of working against climate change for the global well-being.
However, international forums and academia have been abuzz with concerns regarding the compliance of CBAM with World trade Organisation (WTO) rules and its very nature being against the globally accepted no preferential clauses of trade. While the BRICS nations have expressed concerns regarding the rise of trade barriers as a result of the CBAM measure, large emerging economies have also described the proposal as discriminatory and against the principles of equity and common but differentiated responsibilities and respective capabilities. In the past, developing countries have been expressing their reservations with the global carbon pricing system. The concerns have been focused on the inclusion of inevitable emissions like those arising out of electricity generation for consumption in poor households as on par with other categories of emissions, providing less breathing room for developing countries to pursue their economic growth. Further, energy intensive economies that are exposed to international competition are also troubled by the issue of competitive disadvantages in international markets, which in turn could result in domestic job losses, raising concern on the magnitude of welfare losses for the economy. On the same line, the CBAM proposal of the EU has been garnering negative feedback from the developing and emerging economies.
The main focus point of contention has however remained the impact of CBAM on trade equations and competitiveness. There is a growing fear that introduction of CBAM might trigger a trade war. The tax mechanism would put high carbon intensive process products at a strong disadvantage by raising their prices and thus shrinking demand in the EU in comparison to more carbon efficient domestic products. This loss of a huge market has the EU’s exporting partners in worry. EU forms a vital trading partner for a majority of countries. For instance, India is the third largest trade partner of EU. EU accounted for 11.1% of India’s total global trade in 2020, and is the second largest destination for Indian exports. Similarly, China produces half of the world’s steel and thus would see EU as a significant market. Furthermore, there is Russia which forms the fifth largest trading partner of EU and is also the fourth largest emitter of greenhouse gases. The trade equation of all these countries and many others would be significantly impacted by CBAM, perhaps then even leading to the introduction of countervailing measures.
Carbon Tax: Friend or Foe?
While there has been a lot of debate regarding the possible negative effects of a carbon tax, there are also positive possibilities for the developing set of countries. In fact, implicit carbon taxes have been adopted by developing countries like India in the form of several schemes and mechanisms. The main concern of developing countries is for carbon taxes to be inclusive and supporting of economic development. Research studies have in fact revealed that carbon pricing can outweigh the economic efficiency costs of pricing with domestic environmental benefits (read further on this in ICRIER’s previous COP26 blog).
EU plans to roll out CBAM gradually, in phases with the initial implementation being restricted to five high risk sectors of iron and steel, cement, fertiliser, aluminium, and electricity generation. An emission reporting mechanism will apply from 2023, with the financial adjustment coming into the picture only in 2026. Even with respect to the loss of exports, research has indicated otherwise. While developed countries are expected to not suffer export declines, the loss for developing countries is only marginal. Again, the impact will be higher for carbon intensive productions. In fact, a BCG analysis found countries like Turkey and India to gain attractiveness due to existing low carbon production processes and countries like China and Russia to lose out due to high carbon intensity.
The Way Forward
The introduction of CBAM is a sign that climate policy is expanding and will entwine with other policy areas, like with trade policy in the current situation. However, this does not imply taking a complete protectionist stance. For a solution towards climate crisis, the stance and focus will have to change. CBAM needs to be looked upon as a measure that is encouraging carbon efficient means of production and not as a favouring agent of certain countries. The initial period of implementation can be used to learn more about the measure and its implementation mechanism, instead of opposition. Developed countries with existing low carbon technologies can impart the knowledge to the developing and emerging countries through clean technology partnerships to provide similar benefits as well as the exposure to industries. This will provide the twin objective of preparation of the domestic sectors as well as imparting the required knowledge and skill set for a smoother transition. Further, countries can play on their strengths and invest in ‘greener’ areas that are their natural strong points to promote a sustainable low carbon economy. In addition, there needs to be greater incentivisation for the adoption of low carbon alternatives. This would form the part of better planning for future strategy, with strict pollution norms, provision of technological aid as well as government schemes and assurance of financial support to the industries till the end of the initial nascent stage.
While the EU wants to retain its competitiveness and at the same time contribute to the global good by promoting climate action, it is obvious that it will not find support in all. It however remains to be seen whether the CBAM turns out to be as protectionist a measure as it is made appear to be right now. Nevertheless, as the world looks at moving towards recovering from Covid-19 pandemic, it is also the time to pay keen attention to climate change and acknowledge climate responsibility to take some firm and bold decisions.
Views expressed are the author’s own and don’t necessarily reflect those of ICRIER.