Opinion Why EU’s carbon levy helps rich countries get richer

The carbon adjustment mechanism falls short of WTO provisions, is against climate justice

This mechanism also seeks to penalise ‘free-riders’. A free-rider is one who is not contributing, although has the means to do so, riding on the contribution of others. The country that fits this definition is the US with its ‘sometimes in, sometimes out’ response to climate action.

Partha Sen

June 22, 2023 08:14 PM IST First published on: Jun 22, 2023 at 06:52 AM IST

Historically, the primary responsibility for climate change been with the advanced economies, and their process of industrialisation. The contribution of the poorer countries (the Global South) was negligible. The Kyoto Protocol recognised the “common but differentiated responsibilities” in the fight against climate change. Its successor, the Paris Agreement, asked countries to set voluntary emission targets but required the richer countries to make financial transfers to the developing economies for the latter to cope (that is to reduce emissions and adapt to the negative effects of climate change) with the problem. It set a floor of $100 billion per year for these transfers. This was supposed to be over and above 0.7 per cent of their national income which was the overseas development aid.

In the definition of climate finance, commercial loans should not be counted. Countries of the Global South were already under the cosh, servicing their external debt, exacerbated by the pandemic. To pile climate change borrowing on top of it is unconscionable. In 2020, $83 billion was paid into the climate finance fund to be transferred to the countries of the Global South, of which less than $25 billion was in the form of grants. The industrialised countries have not walked the talk.

President Emmanuel Macron of France has convened a summit for a “New Global Financing Pact” in Paris on June 22 and 23. This seeks to provide finance for tackling climate change (and poverty alleviation) in the Global South. I am not holding my breath about its outcome, given the recent history of empty promises on the flow of funds to the Global South.

Recently, the European Union (EU) has put forward a proposal, called the Carbon Border Adjustment Mechanism (CBAM). The US, Canada and Japan are planning similar measures. This involves imposing tariffs on imports from other countries that are seen to be using carbon-intensive methods of production. It is argued that the stringent environmental regulation in the EU makes the production of polluting industries move to countries with relatively lax regulation. These sectors will contract in countries where carbon is priced higher, causing a “carbon leakage”. A tariff on the import of these goods by the EU would restore competitive parity to the domestically produced goods that are subject to a higher price of carbon.

The CBAM is expected to achieve three objectives. First, reduce EU’s emissions; second, for the EU not to lose competitiveness in carbon-intensive goods; and third, to make the targeted countries reduce the carbon intensity of their exports.

This mechanism, starting in 2026, will cover products such as cement, steel, aluminium, oil refinery, paper, glass, chemicals and electricity generation. The countries most affected will be Russia, Ukraine, Turkey, India and China (the UK, though outside the EU, has regulations similar to the EU’s). Only three of the 12 exporters to the EU, have a mechanism for “pricing carbon”.

But, we need some details before this is implemented. First, which countries will be exempt? These are likely to be those that possibly have a national emissions cap or a sectoral cap or are the poorest countries. Second, which emissions are included in the levying of the import tax? Are indirect emissions embodied in inputs like machines to be considered or only direct emissions? Finally, which products are to be included? Possibly, a narrow coverage with high trade and carbon exposure (such as the list proposed above).

It is obvious that there is some arbitrariness involved in the coverages of a CBAM. Moreover, it is not always easy to infer the process of production by looking at the final good. For instance, it may be possible for steel, but not for aluminium.

What does the international law say about this? GATT and its current avatar, the WTO have promoted free trade to prevent the world from slipping back into the anarchy of the inter-war period. The CBAM is a unilateral move, against the spirit of multilateralism. The problems of measurement mean that it could be used for protectionism. It targets production processes (not the product itself) that the WTO does not approve of.

The WTO’s approach is very legalistic and leaves little room for economic arguments. Environmental disputes at the WTO have hitherto been tackled on a case-by-case basis. Its dispute settlement system currently is comatose as it does not have the minimum number of judges.

One can easily find many examples where this tax would conflict with WTO rules. To use the existing rules, a consensus or, at least a majority among members is required. A reform of the WTO is unlikely, but bypassing it would lead to retaliations and trade wars.

Let us now turn to the place of this tax in the global economy, and its fairness or otherwise, to the Global South. The analytical framework for tackling climate change is based on putting a price on carbon emissions. Since the burning of carbon anywhere in the world affects climate change exactly in the same way, we need a global price for carbon to redress this global “externality”. This would work well if there was a world government. In its absence, who gets to keep the tax revenue is important — for example, if the oil producers are allowed to keep it, the consequences resemble an OPEC-like oil price increase, where the revenue from the oil price increase goes to the producers. In the case of the CBA, it is the tariff-imposing EU that will keep the revenue — it will be used to retire its outstanding debt.

This mechanism also seeks to penalise “free riders”. A free-rider is one who is not contributing, although has the means to do so, riding on the contribution of others. The country that fits this definition is the US with its “sometimes in, sometimes out” response to climate action. The developing countries did not create the problem, and have limited means to pay for a “clean up”.

Finally, even if CBAM ¸overcomes the hurdles of measurement and its incompatibility with WTO, it is targeting the emissions embodied in a limited number of traded goods. Its effect on climate change is likely to be small. While the proposal has been touted as a solution to trade and climate issues at one go, there are some difficulties, such as the problem of measurement. It also flies in the face of equity considerations. It’s designed to help rich countries avoid paying for creating the climate problem.

The writer is former Director and Professor of Economics, Delhi School of Economics