Can the EU legally impose carbon border “adjustments”?

At the end of 2019 the European Commission launched its European Green Deal which included plans to introduce a carbon border adjustment mechanism (CBAM) on some high emissions intense imports.

It was a significant step on two fronts. The mechanism was designed to provide greater protection for European heavy industries who would struggle to remain competitive with lower costs imports faced with the expanded scope of the EU carbon price.

The EU externalisation of its internal carbon price also signalled a warning to other economies who exported into Europe’s affluent market of half a billion people. High emissions economies like China, Japan and Korea realised they would need to think about managing their emissions or risk reduced access to lucrative European markets for their cars, appliances and other goods. In 2020 they responded by all committing to net zero emissions targets later this century.

So the policy “threat” of carbon border tariffs seems to be both taken seriously. The mechanism is scheduled to be legislated in the second quarter of 2021.

The legislation of a European CBAM is likely to test some of the rules of the World Trade Organisation (WTO), and whether such mechanisms can be made consistent with existing trade rules.

Concerns about the looming CBAM were raised at a recent WTO Market Access Committee meeting late last year, with some countries suggesting it would be inconsistent with current WTO rules. Particular concern was raised at the prospect that the revenue raised from a CBAM had been earmarked to help fund the economic recovery of Europe out of the current COVID-recession.

Debate is likely to intensify once legislation has been drafted and the impacts assessed by other countries.

Trade negotiators have been warned of tensions between global trade agreements and national environmental policies for decades. Former General Agreement on Trade and Tariffs (GATT) chief Arthur Dunkel warned of the practical difficulties of upholding the fundamental tenet of trade agreements – the absence of discrimination between domestic goods and imported goods. That any environmental measure does not go beyond its specific objective and act to reduce competition in global markets. Which is the thing that many observers fear the European CBAM is designed to do.

It was hoped the development of a multilateral climate policy deal through the United National Framework on Climate Change Convention (UNFCCC) would solve this, but it remains well short. The Paris Agreement allows for voluntary domestic target setting and has little enforcement capability.

The idea of CBAM is popular and was flagged by incoming President Biden during the 2020 election campaign, although this was a thinly veiled swipe at legitimising barriers to cheap Chinese imports.

There are practical problems emerging, even for otherwise legitimate attempts the manage carbon price differentials between economies. Tariffs are effective when applied to specific physical goods, but struggle when used to differentiate between the same product (like steel) made differently.

Trade experts expect the CBAM is likely to be raised as a WTO dispute to test the legal voracity of the mechanism, with China likely to lead the charge but many others watching intently.