The EU’s carbon border adjustment mechanism will have a marginal impact on the bloc’s decarbonisation efforts and a detrimental one on equity, in terms of trade, income and jobs.
By Anirban Ghosh
The monsoons are in full swing. Unlike before, there are some days of very heavy rain and many days of low or no rain. The instances of very heavy downpour are severely testing the resilience of urban infrastructure. A couple of days ago a large pumping station in Mumbai was inundated and water supply to much of the city was disrupted for more than 24 hours. In faraway Germany, unusually heavy bouts of rain have caused extensive flooding. Climate change is here and the pressure to decarbonise and achieve the goals in the Paris Agreement is enormous.
The EU has made ambitious plans to transition to a low-carbon economy. One of the tools it has adopted is carbon pricing. The Emission Trading System, in place for some time now, has already had a positive impact. Indications are that a new, more intense, carbon pricing regime will bring emissions down further in European industries. But the new system is expected to make European goods more expensive. This could increase imports that cost lower, but have higher embedded emissions. It also raises the possibility of European manufacturing moving to jurisdictions where carbon regulations are not stringent, and cost of manufacturing is lower.
Though a paper by the World Bank’s Carbon Pricing Leadership Coalition shows that carbon pricing has marginal impact on competitiveness, the EU is considering an elaborate compensating mechanism called Carbon Border Adjustment Mechanism (CBAM) as a part of its Green Deal. Simply put, the EU will add a carbon tax to the price of goods imported from countries where embedded carbon is higher than what is available within the EU. Estimates indicate that if the CBAM is applied to all the goods covered by the ETS, up to $16 billion of developing country exports to the EU could face an additional charge.
It is expected that CBAM will prevent carbon leakage into the EU. While an UNCTAD paper (bit.ly/3hTZzq6) does show that a combination of a carbon tax within the EU and CBAM will achieve this purpose, it also shows that the incremental impact of CBAM on decarbonisation will be marginal. While a potential EU domestic carbon price of $44 on all emissions reduces its global emissions by 13%—and by 21% in the case of a carbon price of $88—the introduction of the CBAM only adds another 0.8 to 1.3 percentage points. This makes CBAM less of a carbon-reduction tool and more of a tool to level the playing field for trade with the EU. The UNCTAD paper goes on to mention a few other consequences of the CBAM. It shows that CBAM will reduce EU trade with other regions while increasing intra-EU trade. It also mentions that imports from developing countries will go down while exports from EU will increase. The actual impact will vary from country to country depending primarily on one historical accident—the mix of sources used to generate electrical power in a country.
Large developing countries like India will be at a disadvantage because the preponderance of coal as a source of power will not change very quickly even if it has the largest renewable energy programme in the world. CBAM will re-order the attractiveness of nations as a source of import. In the case of steel, China and Russia will face higher taxes compared to Turkey and India who, in turn, will be worse off compared to Thailand and Vietnam.
CBAM is expected to lead to income losses in many countries including Australia, India, Serbia while income effects are positive in countries exempted from CBAM. This correlates with anticipated increase in unemployment in countries whose exports to the European Union are dominated by products that face the CBA such as, Kazakhstan, Serbia and Bosnia and Herzegovina, Saudi Arabia and Ukraine, as well as countries in North Africa and Central Asia.
With CBAM having marginal incremental decarbonisation over an EU carbon tax and negative consequences on equity, in terms of trade, income and employment, there is reason to look at alternative solutions that enable achievement of the primary goal of decarbonisation better.
One possible positive externality of CBAM, if approved for implementation, is the likelihood of accelerated adoption of technologies such as clean hydrogen in countries where emissions are high. It is fair to ask whether a concerted move to enable economic feasibility of clean hydrogen, renewable energy, and battery storage by aggregating demand and leveraging economies of scale could be more impactful from a decarbonisation perspective and have lesser negative externalities than the CBAM.
The author is Chief sustainability officer, Mahindra Group
Views are personal