Europe’s Carbon Tax: Combating Climate Change or Erecting New Trade Barriers?

European Green Deal and the Fit for 55 Initiative

As the limit for carbon production far exceeds the capability of its absorption, the devastating effects of climate change have become ubiquitous. A series of measures are being undertaken across the globe to assuage this concern. To that end, the European Commission has formulated its Green Deal and unveiled a bold set of policy initiatives to fight climate change and protect the environment.


The new European Commission, appointed in 2019, has professed environmental protection as its immediate priority. The New Green Deal has proposed measures to decrease the greenhouse gas emissions of countries in the European Union (EU) by 55% over the next decade—compared with the current target of 40%. This would aid, facilitate and serve as a precursor to its larger goal of making Europe the world’s first climate-neutral continent by 2050.


The Green New Deal is a part of Europe’s ’Fit for 55’ package which alludes to its aim of decreasing emissions by 55%. It is of a coherent and balanced framework that will introduce new initiatives to align EU’s policies and capabilities with its climate objectives. While the blueprint for achieving these goals is laudable, it includes a provision that will have considerable implications for EU’s trade partners.

Carbon Border Adjustment Mechanism (CBAM)

The industrial sector is carbon-intensive. To encourage domestic companies to work in an increasingly climate-friendly manner, the EU has sought to impose a carbon price on the greenhouse gas emissions or the carbon content of fossil fuels involved in the production process. While this may help Europe go a long way to reach its goal, it could also lead to a ‘carbon leakage’ – wherein companies would shift their carbon-intensive production activities from regions with tough emission reduction policies to places with laxer policies and less stringent rules.


Thus, instead of combating the source of climate change, this would only redirect the production of carbon-intensive goods to other regions. That is to say, it would lead to trade deviation. Further, it could prospectively lead to the loss of the competitive edge of the European industries. The raised manufacturing costs for the same product - due to the added carbon pricing - would lead them to be outpriced in their world market thus affecting their labour, trade and economy.


To respond to the domestic political concerns and to decarbonize the industrial sector, while also keeping them competitive at a global level, the European Union has proposed a Carbon Border Tax which is to be levied from 2026 in a phased manner. It directs non-EU companies exporting to Europe to pay the same price for their carbon footprint as native European companies. That is to say, the Carbon Border Tax on imported goods is meant to run parallel to carbon pricing in domestic industries and local production in the host country. It seeks to put a price on carbon pollution as a means of bringing down emissions and driving investment into cleaner options. By treating all goods alike, it aims to restore competitiveness and create a level playing field for domestic and international production.


Points of Contention

While the rest of Europe’s measures towards combating climate change are being encouraged and emboldened by the global community, its border tax on imported goods is one met with resistance and backlash. It could create serious short- and long-term challenges, and be a new source of disruption to a global trading system that is not short of problems of its own.


This attempt at homogenisation of goods from domestic and international spheres of production overlooks the resource divide between the Global North and the Global South. By pegging all goods to the same standards, it disproportionately impacts the developing countries that are export-dependent for sustaining their economies and do not have the wherewithal to transition to cleaner forms of energy. That is to say, it fails to account for each country's response to climate change based on their level of economic development.


This unilateral proposal by the EU goes against the UN principle of Common but Differentiated Responsibilities and Respective Capabilities (CBDR–RC). The CBDR-RC acknowledges that richer countries shoulder the responsibility of providing financial and technological assistance to developing and vulnerable countries to fight climate change. In other words, developing nations should not face the same mitigation burden as richer countries. Many have retaliated against the border tax on account of its ‘discriminatory’ nature and disjuncture with the bottom-up approach of nationally determined contributions – which by extension undermines the principles of the Paris Agreement.


By weaving climate policy into trade policy, Europe’s carbon tax challenges the tenets of the international free trade system. What is seen as the EU’s revenue-generating scheme for post-pandemic recovery, violates the World Trade Organization’s measures designed to prevent importing countries from discriminating against particular exporting countries. As a result of these factors, many countries have vociferously expressed their disapproval.


Prospects for a Trade War

Introducing the carbon border tax will further disincentivize global trade, undermine mutual trust and accelerate the protectionist surge amongst nations. This could have an enormous impact on economic growth, the way we conceptualize international trade and cross-border investment schemes.


Russia, Turkey, Britain, Ukraine and India are emerging markets that export carbon-heavy goods like cement, iron, steel and aluminium to the European Union. These countries would potentially be the most affected as they may have to make drastic and costly changes to comply with Europe’s proposal. However, many of them may not have the funds to facilitate such a transition, thus leaving them in an uncomfortable position.


Countries with carbon-intensive industries and other large trading partners of the EU could introduce countermeasures and respond with retaliatory tariffs of their own, thus leading to the deterioration of trade relations. By using the climate policy to erect new barriers, the possibility of a trade war isn’t too far fetched. Further, if Europe is the only one to implement a carbon tax, companies could sell their products to other countries which do not have a carbon border tax leading to trade deviation. This presents a potential for re-shaping international trade relations and foreign affairs at large.


An Optimistic View

While the risks and burdens that come with carbon border adjustments by far outweigh the opportunities, observers credit it with having helped change attitudes towards climate action in other countries. Academicians, economists and policymakers are of the view that this issue will be short-lived and the impact would fade over time. The initial adjustment period is most crucial and requires close oversight to facilitate a smooth transition with an insulating mechanism to ensure that its repercussions are not felt too strongly on global trade. They believe that the trade-off between short-term economic growth at the cost of long-term climate security appears to be rather myopic. Everyone needs to join their forces to create the necessary change starting with Europe’s Carbon Tax incentivizing a domestic and global shift.


Conclusion

The EU's latest form of economic imperialism has drawn a lot of criticism. Alternative approaches have been proposed to encourage global decarbonization and preserve the competitiveness of the EU industry during the transition to a zero-carbon economy. In this light, the EU must find a way to reduce their carbon emissions while ensuring that they create a level playing field in a WTO-compatible manner to secure international cooperation. To alleviate some concerns, possible ways for revenue recycling and establishing investment funds or setting up bilateral climate partnerships should be considered by the policymakers in the European Union.


For the carbon border tax to be accepted by the global community, the EU and other countries in the Global North must prioritize the provision of resources in terms of capital and infrastructure to the countries in the Global South. By having those mechanisms at their disposal, these countries would be able to make a smooth transition to cleaner forms of energy, thus enabling them to provide alternatives to carbon-intensive production. This will not only aid the implementation of a carbon tax at international borders but also motivate countries to produce low-carbon intensive goods, thus helping the collective fight against climate change. The EU must account for the basic fairness principles, impact on the poor countries and mobilize diplomatic efforts to make this initiative successful, prevent trade sanctions, and collectively work towards climate policies.


A close observation of the EU’s Carbon Border Adjustment Mechanism that is in practice from 2026, would give the world an opportunity to witness its ramifications on the production of carbon-intensive goods, the trading patterns that emerge and the agreements that are negotiated. It assesses the open-ended question of whether border adjustments are the best way to encourage global cooperation on climate change or if other approaches might work better. By understanding what works, and what does not, other countries could adopt certain elements and replicate this initiative to meet their climate policy goals.

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About the Author

Khushi Baldota is a final year student at the Jindal School of International Affairs. Her interests include security studies, public policy and political economy. She can be reached at: khushiibaldota@gmail.com