The future for global trade in a changing climate

What to know about the implications of the EU’s Carbon Border Adjustment Mechanism on international trade.

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Silvia Weko

Former Visiting Fellow, Environment and Society Centre

Countries are increasingly linking climate and trade with measures like the US Inflation Reduction Act and EU Carbon Border Adjustment Mechanism (CBAM) although other countries have critiqued these measures including at COP27. However, the EU maintains that the CBAM will only minimally impact trade while simultaneously leveraging further climate action. As the design of CBAM is being negotiated, with the trial period beginning in early 2023, what should we know about CBAM?

What is it?

The EU Green Deal raises concerns that higher carbon prices and industry standards could make emissions-intensive and trade-exposed industries like cement, aluminium, iron and steel less competitive in international markets. This could result in ‘carbon leakage’ where dirtier production abroad replaces EU industry and global emissions increase.

Until now the EU’s solution to carbon leakage was to give these industries free allowances under the Emissions Trading System (ETS). The steel sector alone makes up 5 per cent of the EU’s emissions and was issued around 2.3 billion in emissions allowances for free from 2008-19.

The CBAM is a new approach to carbon leakage, aiming to create a ‘level playing field’ by charging a fee on carbon at the border, which would go to the EU budget. It is roughly equivalent to the ETS applying to goods entering the EU unless the producer has already paid for carbon at the location of production. The policy is under negotiation between the European Commission, European Parliament and European Council and the pilot phase of emissions tracking without enforcing fees should begin in early 2023.

What has been the international response so far?

Within the EU, exposed industries claim that avoiding severe carbon leakage requires a CBAM with export rebates plus continued free allocations. Outside the EU, producers may be impacted differently depending on their carbon intensity and existing capacities and infrastructure for emissions reporting.

Most debates centre on key trade partners like the US and China without considering that the EU is the most important export market for many smaller countries – some of which also export high-emissions goods. For example, 65 per cent of Bosnia and Herzegovina’s trade is with the EU even though it only made up 0.3 per cent of the EU’s trade in 2021.

Some trade partners like Turkey and Bosnia and Herzegovina have signalled that they will speed up decarbonization efforts because of CBAM. Others, especially China, frame the measure as unfair to Global South countries with lower historical emissions or as a protectionist measure that distorts markets although trade in goods covered by CBAM is only around 2 per cent of China’s exports to the EU. The US, too, sees CBAM as a step too far and therefore only to be used as a ‘measure of last resort’. Going into COP27, the European Parliament emphasized that CBAM revenues should partly be used to support LDCs thereby signalling the importance of framing CBAM as a climate leadership measure that takes the needs of vulnerable countries into account.

What was the reaction at COP27?

Criticism of the CBAM at COP27 as being unfair to developing countries was repeated especially by emerging economies. India and China, together with other BRICS countries and Like Minded-Group of Developing Countries (LMDC), used the response measures forum to oppose carbon border measures while the G77 argued for work on cross-border trade impacts including around CBAM and the US Inflation Reduction Act. This was rejected by developed countries but is expected to be addressed at the next COP.

BASIC countries – Brazil, South Africa, India and China – then critiqued CBAM directly in a statement on 15 November 2022 stating that: ‘Unilateral measures and discriminatory practices, such as carbon border taxes, that could result in market distortion and aggravate the trust deficit amongst parties, must be avoided.’ They further called for developing countries to mount a united solidarity response to what they see as an unfair shifting of responsibilities.

For some European actors, these critiques of CBAM are to be expected, but are largely symbolic with little concrete opposition because the true impact of the CBAM on most countries is low.

At the same time, EU representatives have argued that the CBAM already has positive impacts and are therefore convincing countries around the world ‘to think more intensively about carbon pricing.’ This is clearest for countries in the EU neighbourhood, such as Turkey, which has announced more ambitious targets including an Emissions Trading System perhaps because of CBAM.

What happens next?

These diverging narratives at COP27 seem to reveal a mismatch around the effects of CBAM. On the one hand, CBAM has been framed since its inception as necessary to avoid carbon leakage and ensure a level playing field. On the other hand, it is being framed as having minimal impacts on most trading partners and would therefore be uncontroversial in the international sphere. If the CBAM will not greatly influence trade – which is itself debated – this begs the question of what the point is of CBAM.

One possible answer is it can serve as a signal which can push international ambition alongside other EU actions. If this is the case, its value will partly rest on the EU’s international legitimacy on climate change action. Compared to other issues like climate finance and loss and damage, for which developed countries were criticized for not living up to their pledges, CBAM was relatively minor at this COP but it is nevertheless tied into an ongoing conversation about North-South imbalances which is not likely to go away anytime soon.

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It is important to keep an eye on the international political discussions as the pilot phase begins. The challenge will be for the EU to keep its CBAM ambitious enough so that it can decarbonize with minimal carbon leakage while maintaining US cooperation and strengthening ambition in the BRICS countries. Yet to be determined is whether other countries will be convinced and what the implications will be for international trade and climate cooperation.

This article is part of the Chatham House Global Trade Policy Forum which promotes research and policy recommendations on the future of global trade.