Climate policy packages, like the “Fit for 55” package that the European Union (EU) has introduced as part of the European Green Deal, are become more extensive and ambitious as countries start to step up their climate goals. This strategy outlines the necessary steps, including stepping up the carbon pricing strategy, to reduce greenhouse gas emissions by 55% by 2030 and achieve net neutrality by 2050. The US has chosen a different approach to decarbonizing its economy because it recognizes that climate change is a global issue that calls for a concerted response from states. The US is subsidizing its homegrown clean energy sector rather than placing a price on carbon. Which method is superior has been the subject of discussions.
Leakage of carbon and its effects
Carbon pollution is charged a price, or carbon pricing. As a result, those that pollute are responsible for paying the corresponding external expenses. To escape these expenses, high-polluting companies may relocate their operations to a region with a laxer climate policy when faced with rising carbon pricing. Carbon leakage occurs when businesses relocate their activities outside of the EU and take their carbon emissions with them. The EU’s groundbreaking Carbon Border Adjustment Mechanism (CBAM) proposes a fair price on imported carbon-intensive goods in order to stop carbon leakage.
What is the CBAM?
The EU’s new carbon border tax is known as CBAM. For each tonne of carbon dioxide released during production, EU importers will need to buy CBAM certifications. It will initially apply to imports of high-carbon items like cement, iron, steel, electricity, aluminum, and fertilizers. Plans are also in motion to make it longer. The EU Emissions Trading System (ETS), which is slated for revision as part of the Fit for 55 packages, will be in line with the price of carbon. Emitters purchase emissions allowances to achieve emission targets under the cap-and-trade system that governs the ETS. Either companies cut their emissions or they buy permits on the carbon market.
CBAM’s role in carbon leakage prevention
High-polluting industries previously received unrestricted allowances under the EU ETS to stop carbon leakage. Reduced allocations and a phasing-out of the cap are two things that the EU ETS plans to do. CBAM will be helpful in this situation. The EU ETS’s phase-out of free allocations will coincide with the CBAM’s transitional period. Imports from the EU will be subject to carbon tariffs and require importers to buy and surrender CBAM certificates that are equal to the carbon price under the ETS. By making domestic products that are subject to carbon pricing more competitive with imports from the EU that might not be, this levels the playing field for the home industry.
Sparking fears of protectionism
Non-EU nations have resisted CBAM, accusing the EU of protectionism and doing so under the pretext of taking climate action. Brazil, China, South Africa, and India all expressed “grave concern” about how the EU is treating imports from other EU countries unfairly by levying them. CBAM will increase the administrative burden on individuals who are exposed to it and drive up the cost of goods in the EU.
African nations are among those subject to the new limitations. For instance, 13.3% of fertilizer imports come from Morocco. Hence, CBAM will reduce the nation’s export revenue. Consideration should be given to how CBAM will affect African economies and their capacity to industrialize, particularly given how the industrialization of other states has exacerbated the effects of climate change for the most vulnerable nations that have not had the same chance to fully industrialize. In response, the EU has proposed that the profits from CBAM be used to provide climate funding for developing nations.
A global carbon pricing strategy
The bigger picture needs to be kept in mind rather than just the prospective trade ramifications. This EU-based policy has the potential to boost climate policy in non-EU nations, which could have good effects that go beyond the EU. In order for the EU to achieve its climate goals, free allocations must gradually be phased out. Now, CBAM should encourage other nations to create their own carbon border mechanisms or enhance their carbon pricing measures rather than allowing other countries to profit from having laxer climate policies through carbon leakage. Assistance for nations affected by CBAM is essential, but there should be more debate about collaboration on carbon pricing in an open discourse about changing climate policies and their effects on trade.