Imagine the following scenario. The European Union (EU) robustly tightens its Emission Trading System (ETS) and the EU carbon price rises dramatically. Investors who are ‘long carbon’ become wealthy. EU carbon emissions plunge as EU energy-intensive carbon emitters, such as cement makers, are forced to adapt to higher operating costs. Imports of cement from China, the United States, the United Kingdom (not in EU anymore!), and other countries increase substantially as they suddenly became more competitive with EU cement makers. The Chinese, American, and British companies are not necessarily dumping or illegally subsidizing their cement exports, they merely aren’t impacted by the EU ETS. Soon, EU cement makers go bankrupt and all cement consumed in the EU is foreign. Globally, carbon emissions increase despite the plunge in EU carbon emissions (although EU carbon consumption emissions rise spectacularly while EU carbon production emissions drop).
The EU is terrified about the above scenario. Not only do their cement companies go bust but the main objective (lowering global carbon emissions and ameliorating the climate crisis) fails.
Accordingly, the EU is pledging that its European Green New Deal will include what it calls a Carbon Border Adjustment Mechanism (CBAM). A CBAM, which has not been implemented anywhere (unless one counts California) has many names. Others include, but are not limited to, a “carbon tariff,” “border tax adjustment,” “border carbon adjustment,” and “carbon border tax.” Some call it a “carbon tax,” which can be confusing and is technically incorrect, as a carbon tax is a domestic tax and is a different mechanism compared to a carbon tariff.
The new EU President mentioned a carbon border tax in her campaign manifesto. More recently, at the World Economic Forum’s annual Davos plutocrat pow-wow in January 2020, she again raised it and said this:
“But there is no point in only reducing greenhouse gas emissions at home, if we increase the import of CO2 from abroad. It is not only a climate issue; it is also an issue of fairness. It is a matter of fairness towards our businesses and our workers. We will protect them from unfair competition. One way for doing so is the Carbon Border Adjustment Mechanism.”
Adoption of an EU carbon tariff admittedly faces obstacles. Many experts have weighed in on what an EU carbon tariff might look like. Of particular worry is whether it would be WTO compliant. As a new article published in the Global Trade and Customs Journal states:
“The new EU leadership has set ambitious goals for reducing global CO2 emissions through, among others, the implementation of a border carbon adjustment (BCA). The adoption of a BCA by the EU will be controversial, internally and externally, and likely to be challenged before the WTO. It is therefore key to ensure that this mechanism is structured carefully, so as to ensure its consistency with WTO rules. This article focuses specifically on the WTO provisions that would affect the design of a BCA. Although many aspects remain speculative, as existing case law provides little clarity on how WTO rules might be interpreted regarding BCAs, some general prescriptions for a WTO-compatible EU BCA can be identified. In the eventuality that the BCA would be found to be inconsistent with the EU’s substantive obligations under the GATT, exceptions are provided by the WTO which could justify any potential conflict with GATT provisions.”
A second obstacle is administration, especially how the carbon content of imports would be measured and taxed. Indeed, the EU would be dealing with limited information on the carbon emitted by goods produced abroad. There are many ideas on how to address this however, such as using the “predominant method of production” or “best available technology.”
The EU is grappling with these challenges and plans to draft a paper for publication in late 2020 or 2021. Undoubtedly, EU analysts will sift through the voluminous record of academic papers and government reports to craft their technical design. Ultimately, however, the design does not need to be perfect. Many would agree that AD/CVD calculations are also not perfect – most government international trade analysts, however, do their best to get close. The hardest part will be the politics: recruiting other countries into a Victor Club to secure strength in numbers against non-abating countries (whether they are climate deniers or not), and not getting wobbly (as the EU did with its proposal for carbon pricing on foreign airlines using EU airports.
The views expressed in this blog are those of the author and not of any institution he is or was affiliated with.