The EU’s upcoming Carbon Border Adjustment Mechanism (CBAM) is set to reshape global trade and climate efforts, aiming to reduce the carbon content of imports and combat climate change. With a carbon tax of $44 per tonne, the CBAM targets high-carbon imports like steel and aluminum, but developing economies, including India and China, could face disproportionate financial strain.
Discover how this policy is expected to raise developed countries’ incomes by US$ 2.5 billion while potentially costing developing nations US$ 5.9 billion. Further, the article discusses how it is expected to alter the global market and the strategies emerging economies can employ to navigate these challenges.
The European Union’s (EU) Carbon Border Adjustment Mechanism (CBAM) will come into force in 2026. This mechanism is focused to reduce the carbon content of goods in the EU in order to intensify efforts to combat climate change. CBAM will be implemented in a phase wise manner. In its initial phase, the EU will levy carbon tariffs on imports to equalize costs with domestic production and mitigate carbon leakage in industries with high carbon intensity products such as iron and steel, cement, fertilizers, aluminium, electricity, and hydrogen.
The carbon tariff will be eventually extended to all imported products, in a later phase. Even though the effectiveness of CBAM in mitigating climate change is a debatable issue, what is certain through a number of studies is that the carbon tariff is going to affect the developing economies disproportionately. Since these economies have limited access to cleaner technology, a carbon tax of US$ 44 per tonne could increase developed countries’ incomes by US$ 2.5 billion whereas developing countries could experience a loss of US$ 5.9 billion, as highlighted by UNCTAD. In this context, the current article assesses the cost of CBAM on developing countries by evaluating EU’s imports and historical emission patterns thereby suggesting a few strategies to mitigate it.
The examination of imports categorized by industry and product, focusing on items identified under the CBAM regulation by the twenty-seven EU member states, indicates that steel and aluminium constitute approximately 85% of total imports (refer to Figure 1A). On average, total imports covered by the CBAM within the EU have risen by about 44%, from US$ 79 billion in the period of 2013-17 to USD 117 billion in the period of 2018-22 (refer to Figure 1B). It suggests that over the years, EU has scaled back its manufacturing of products subject to the CBAM and meeting its domestic demand through increased imports.
Figure 1 (A): Industry Wise Imports by EU under CBAM (Share in 2018-22)
Figure 1(B) EU CBAM Imports: Advance vs Emerging Economies
Upon mapping the import of products under CBAM category by EU from non-EU members in the last decade, it became apparent that a majority of it originated from the emerging countries. It is more so within the steel and aluminium category, which comprises the largest share among all products. In steel and aluminium, the largest shares were attributed to China, Russia, Turkey, and India. The only exception was in the electricity and hydrogen category, where the share of advanced economies was found to be higher.
Figure 2: Share of Advance & Emerging Economies in EU’s Imports under CBAM
A historical analysis of carbon emissions by industries in advanced and emerging economies reveals notable disparities. Until the 1980s, advanced economies accounted for a significantly higher share of global carbon emissions, measured in million tonnes of carbon dioxide per year, compared to emerging economies (refer to Figure 3A & 3B). However, a pivotal shift occurred post-1990s, marked by a substantial increase in emissions from emerging economies. This surge can be attributed to a confluence of factors, including the shift of polluting industries to the developing economies, rapid industrialization, economic growth, urbanization, relaxed environmental regulations, and the increasing integration of emerging economies into global value chains (GVCs), alongside a reliance on carbon-intensive energy sources.
The increasing gap in emission levels between advanced and emerging economies presents substantial hurdles, especially for developing nations. Global value chains, primarily steered by developed nations, have perpetuated a situation where cleaner production is mainly concentrated in advanced economies, while the more environmentally taxing aspects are outsourced to developing counterparts. Take the steel production sector, for example: emerging economies such as India and China heavily rely on blast furnace (BF) routes, resulting in roughly 2 tonnes of CO2 emissions per tonne of steel produced.
Conversely, advanced economies like the EU prefer Electric Arc Furnace (EAF) routes, which boast a lower carbon intensity of around 0.35 tonnes per tonne of steel. However, the introduction of the Carbon Border Adjustment Mechanism (CBAM) faces challenges, as it overlooks the historical emissions of advanced economies and their commitments under the Paris Agreement, which allow for determining emission reduction targets within specified parameters.
Figure 3: Emission Levels of Advanced & Emerging Economies
Advocates of CBAM suggest that integrating an emission trading system (ETS) and ensuring its effective implementation, especially in regions where it’s already established, could mitigate the impact of CBAM. Nevertheless, a significant hurdle emerges from the stark contrast in carbon prices between regions, highlighted by the EU’s carbon price of approximately US$ 100 per tonne compared to China’s US$ 8 per tonne. Consequently, the EU’s CBAM is poised to encounter scrutiny and potential challenges at the World Trade Organization (WTO).
The EU justifies and designates the CBAM as WTO-compliant, non-discriminatory tariff, and a precautionary measure. Developing countries on the other hand intend to challenge the measure at the WTO, arguing that:
(1) It potentially breaches WTO provisions on non-discrimination and
(2) It violates Nationally Determined Contributions (NDCs) under the Paris Agreement.
Finding a resolution at the WTO appears futile, as any remedies provided by the WTO are prospective. Moreover, the adoption of WTO dispute panel reports could be hindered by appealing to the Appellate Body. However, given the absence of the Appellate Body, pursuing this route seems pointless.
After examining the sector-wise imports of the EU, historical emission trends, and the various challenges associated with the EU’s Carbon Border Adjustment Mechanism (CBAM), it is evident that emerging economies are likely to bear a disproportionate burden. However, to alleviate the impact of CBAM, global policy analysts emphasize several potential solutions. Policymakers advocate for the adoption of a balanced strategy that grants emerging economies sufficient time to transition to decarbonization, guided by the principle of Common but Differentiated Responsibilities and Respective Capabilities (CBDR–RC) outlined in the United Nations Framework Convention on Climate Change (UNFCCC).
Additionally, leveraging the revenue generated by CBAM to promote the development and adoption of sustainable technologies in emerging economies is crucial. This comprehensive approach necessitates collaborative efforts from governments to support emissions reduction initiatives and facilitate the shift toward sustainable practices. By embracing these multifaceted solutions, emerging economies can effectively address the challenges posed by carbon tariffs while advancing toward a more environmentally conscious and resilient future.
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