EU-CBAM: EU's carbon tax needs global coordination to address concerns

Developing countries face a disproportionate impact from climate change, despite being historically least responsible for it. They are equally subjected to climate measures initiated by developed countries, with transborder developmental consequences. The Carbon Border Adjustment Mechanism (CBAM) is one such measure that compromises the developmental pursuits of most developing nations. Incorporating poor countries’ developmental aspirations becomes even more critical in the backdrop of minimal atmospheric space left to accommodate carbon emissions for meeting the Paris Agreement target of limiting temperature increase within 2 or 1.5 degrees Celsius above pre-industrial levels. In order to meet the Sustainable Development Goals (SDGs) set by the United Nations by 2030, equity-based development at all levels is of critical importance.

 

The economies of least developed countries (LDCs) are fragile, with little diversification and shallow export baskets. Many LDCs export a substantial share of their goods to the EU, with these exports often concentrated in product areas covered by the CBAM, which constitute a significant portion of their gross domestic product (GDP). For example, nearly 60 per cent of Mozambique’s and 29 per cent of Zambia’s total exports to the EU consist of CBAM-covered commodities. In 2023, Mozambique’s CBAM-covered exports accounted for approximately 6 per cent of its GDP, with over 50 per cent of its total aluminium exports destined for the EU. India also exports a significant share of CBAM-covered goods to the EU, comprising about 11 per cent of its total exports to the region.

 

The stated objective of the CBAM is to arrest carbon leakages the EU is experiencing ever since it started its cap-and-trade programme in 2005. However, from an equity perspective, the CBAM in its current format is not the best method to deal with the carbon leakage problem. The fundamental principle of Common but Differentiated Responsibility and Respective Capacities (CBDR-RC), which forms the bedrock of all international environmental negotiations, does not align with such unilateral application of measures. Moreover, it goes against the spirit of the “Enabling Clause” and Part IV of the General Agreement on Tariff and Trade (GATT) titled “Trade and Development,” which include provisions for granting exemptions to LDCs and providing special and differential treatment to developing countries.

 

The CBAM in the present form would have a distributional impact. Firstly, many developing countries would lose their competitiveness in products of their genuine competitive advantage; secondly, the resources would flow from the poor countries to developed ones (EU) because of the mandate to buy certificates by importers in the EU from year 2026; thirdly, several developing countries would lose revenue because they lack capacities to put together an indigenous market mechanism and use such revenues for green transition.

 

On the positive side, a study conducted on the Turkish economy concludes that if some proactive measures on energy-efficiency are taken, the carbon border tax can increase private and social welfare by improving economic gains and environmental and health conditions (Acar et al. 2021).

 

Many developing countries lack the capacity and capability to design and implement effective carbon pricing and trading schemes, and correctly measure, report, and verify carbon emissions — the hallmark of effective trading schemes. The developed countries can help these economies in doing so. It makes enormous sense to exempt LDCs from the CBAM and apply special and differential treatment for some other developing countries, under the World Trade Organization’s “enabling clause”.

 

The EU can provide different transition periods to different sets of countries on the basis of their developmental status. There is a good case for like-minded developing countries, including LDCs, to take a coordinated position on the subject and open negotiations with the EU to bring down the extreme impact of the regulation on their economies.

 

It is noteworthy that only a limited number of products are covered in the first tranche of the regulation, with more to be included over time. Similar regulations are being considered in other developed countries. Therefore, the Global South must unite to address their cumulative impact.

 

On the firm level, the CBAM should not be applied to small-scale enterprises up to a certain level of production value. Hand-holding of small and medium scale enterprises by governments is necessary to meet the CBAM requirements. The revenue earned by the EU through CBAM should also be used to mitigate climate change impacts, primarily in poor and developing countries.

 

In some countries, including India, the internal tax on fossil fuels is already very high. Fossil fuels’ taxes should be included in the calculation of carbon price in the country of origin. Alternatively, the government could adopt a revenue-neutral strategy to address the CBAM challenge by balancing fossil fuel taxes with the potential carbon price. This approach can help in retaining the international competitiveness of the affected products. India needs to include petroleum products under the goods and services tax. India is expected to start its cap-and-trade carbon emission scheme from 2026, the year when CBAM would become chargeable. The collected revenue could be shared objectively with the states to offset any losses.

 

Industry associations have a proactive role to play in educating businesses, particularly small enterprises, about the CBAM. While it is unlikely that the EU will concede to any changes in the applicability of the regulation in the ongoing FTA negotiations, India must insist on securing support for awareness-building, technology sharing, standard setting, verification systems, and capacity development. The climate change is no more an esoteric concept. There is unlikely to be any dilution in emerging international regulations. It would require strategic domestic policymaking and coordinated efforts on the part of the Global South to ensure that their developmental concerns are mainstreamed in global policies.

 

The authors are, respectively, distinguished fellow and consultant with Research and Information System for Developing Countries. The views are personal