The EU’s Carbon Tariff Doesn’t Work for the Rest of the World

The EU’s Carbon Tariff Doesn’t Work for the Rest of the World

The EU would do well to adjust its Carbon Border Adjustment Mechanism, which has riled developed and developing countries alike, lest it risk exacerbating geopolitical tensions and reducing its diplomatic standing.

Last month, the world descended on Dubai for COP28, the latest annual UN climate conference. The summit featured the first-ever trade day in hopes that trade measures could contribute positively to climate progress, but they portended more strife than consensus when they arose. Throughout negotiations, the European Union (EU) Carbon Border Adjustment Mechanism (CBAM)—currently in a transitional phase—that will effectively apply Europe’s domestic carbon price to imports across a wide swathe of industries and countries captured attention. Brazil, China, India, and South Africa, proposed adding “unilateral trade-related climate measures” to the negotiating agenda of COP28, calling them protectionism disguised as climate policy and coercive actions that jeopardize international trust. Essentially, the most significant emerging economies pushed the EU to defend its policy on the global climate stage.

This push failed, but it is far from over and will likely resurface at subsequent multilateral meetings on the road to COP30, which Brazil will host in two years, coinciding with the CBAM exiting the transitional phase. Between now and then, the EU would do well to adjust its CBAM, which has riled developed and developing countries alike, lest it risk exacerbating geopolitical tensions and reducing its diplomatic standing. 

To be fair, the EU CBAM rests on sound economic principles, even if the geopolitics may be against Europe. Economic theory champions carbon prices as the most cost-efficient approach to reducing emissions. Indeed, the emissions trading system substantially contributed to declining emissions in Europe. The CBAM is an extension of that logic. It allows the EU to strengthen domestic policy by imposing carbon-based tariffs on steel, aluminum, and other industrial imports not regulated by comparable carbon prices in their countries of origin. The CBAM, in other words, will take an internal carbon price abroad, where it will collide with geopolitical realities in three ways. 

First, even though the EU claims that its CBAM complies with international trade rules, that does not make it unassailable. The CBAM reflects the bloc’s domestic price, notionally requiring all countries that engage in substantial trade with the EU of covered goods like steel to adopt Europe’s preferred policies. The CBAM design dictates importers pay the same carbon price as EU producers, creating an economically defensible level-playing field. Nonetheless, it is still a price that is determined within the EU and would require real-time adjustment from other countries to match the European market.

The EU is known for deftly achieving protectionism within the constraints of the World Trade Organization (WTO) with nontariff barriers designed to benefit domestic producers leveraging phytosanitary standards, rules of origin, or other cleverly designed regulations. Standard-setting already has substantial ramifications on energy transition. Countries battle over hydrogen rules and nuclear energy according to their domestic political preferences. Carbon tariffs will be no different, in part, because the world lacks an established accounting methodology and an agreed-upon forum to discuss standards and forge compromises. Part of the argument against including unilateral trade measures on the COP28 agenda was that other venues like the World Trade Organization (WTO) would be more appropriate. Such a suggestion ignores the reality that the WTO lacks the infrastructure and climate track record to guide such negotiations. This impasse likely assures that concerns remain unaddressed and that the EU is less likely to establish a global standard and more likely to kick off a tense conversation with a carbon tariff that other countries deem unilateral. 

Second, the CBAM will encounter substantial verification challenges. The EU intends to avoid resource shuffling when countries export clean products or derivatives while consuming dirty versions domestically, but it has no clear plans to deliver. Similarly, the EU would ostensibly rely on data from companies from the exporting country, which can be hard to corroborate. The CBAM will require companies in scores of countries to enhance their capacity to measure embedded carbon, a logistical feat with which developed economies struggle. The EU can provide technical capacity to help countries comply, but it would be logistically difficult and likely impossible to meet the resources needed. CBAM policy is also precarious if it assumes the ability to get reliable data on embedded emissions from products originating in China after decades of unsuccessful efforts to compel their Chinese counterparts to share such data. Brussels may sidestep this issue in favor of ensuring that CBAM gets off the ground, but that scenario would raise tension between the EU and the United States and undercut CBAM’s effectiveness.

Third, even a carbon border adjustment designed with principles of fairness and sound accounting methodology will run against the crushing maw of geopolitics in which trade policies like sanctions, tariffs, and import-export controls are seen as acceptable means for national security. Developing countries view it as an extension of a domestic environmental standard imposed on global trade, akin to any other tariff with a large economic impact. The viewpoint is understandable as they seek increasing climate finance to tackle and adapt to a climate crisis, to which they historically contributed much less. Pragmatically, no developing country will adopt a carbon price equivalent to Europe’s, which for much of 2023 was almost ninety euros per ton

These issues do not exhaustively preview CBAM’s geopolitical knock-on effects, which could be manifold and unpredictable. Take Moldova as an example. Chisinau is planning its own carbon tax to align with the EU’s CBAM legislation, but that effort has generated tension with its Russian-backed breakaway region of Transnistria, where the majority of the country’s heavy industry is located. The CBAM would “most likely lead to unemployment and reduced wages” in Moldova, with effects concentrated in Transnistria. This region, housing 1,500 Russian troops, is plagued by corruption and does not recognize the Moldovan government's authority. 

It is unclear how Moldova would implement complex policies such as carbon measurement, reporting, and verification, even as 60 percent of Transnistria’s exports, mainly iron and steel, go to the EU. This issue presages a wider geopolitical dynamic that may arise from CBAM that the EU did not intend. 

Still, these risks must not discourage climate action. The EU should be lauded for advancing CBAM amid Russia’s invasion of Ukraine. Many countries are reluctantly accelerating their carbon pricing legislation to move the energy transition forward. In the United States, where there is no political support for a national carbon price, the possibility of a bipartisan agreement around carbon tariffs is promising, given the polarized political climate. However, policymakers should prepare for the range of possible risks and shape a trajectory closer to a virtuous circle. 

Such a policy toolkit could contain three elements. First, during its CBAM’s transitional period, the EU should clearly establish the requirements for “performance equivalence,” by which products could be exempt from CBAM coverage. For example, products with less embedded emissions could be exempt, creating a clear decarbonization incentive. The EU should not seek to impose its preferred approach when regulations and incentives can achieve the same endsand developing countries lack the resources to engage in large-scale industrial decarbonization. 

Second, the EU could mandate that all the revenues raised via the CBAM are redirected to developing countries to help decarbonize the same hard-to-abate industries that are being tariffed. Such a measure would help the CBAM avoid regressive impacts on less affluent countries and provide global benefit since most emissions and emissions growth now take place in the developing world. EU lawmakers have hinted at similar proposals but have no such plans in place.

Third, the G7 climate club, which nominally exists but has stagnated, should take up the issue. It can provide a platform for countries to collaborate on establishing accounting methodologies and arrive at a tariff collectively, which may require carveouts for developing countries that could serve as a ladder to full participation and include support for monitoring, reporting, and decarbonization in trade-exposed, emissions-intensive sectors. Such a club should establish broader rules of the road to prevent excessive protectionism and trade fragmentation that would slow the transition. The Inflation Reduction Act has also stoked tensions at the intersection of climate and trade. A multilateral agreement on subsidies and border carbon adjustments could encourage ambitious domestic policies while limiting geopolitical downsides. 

Fourth, WTO reform is a necessary long-term solution. To be sure, the institution was built before the climate crisis became a pressing issue, and its rule may constrain action more than enable it. Still, updating it may provide the long-term stability that the energy transition needs. The authors of this essay and some of their colleagues have previously suggested that WTO stakeholders could clearly define exceptions to trade rules that define the appropriate use of carbon tariffs, among other trade tools, including green subsidies. 

The Paris Agreement succeeded because of its bottom-up approach that allows each country to determine its own pathway. When inevitably pressed on its CBAM approach again, the EU would do well to reflect that hard-earned lesson. 

Sagatom Saha is an adjunct research scholar at the Center on Global Energy Policy at Columbia University, where he helps lead climate and trade initiatives. He previously served in the Office of the Special Presidential Envoy John Kerry and at the International Trade Administration in the U.S. Department of Commerce.