The Unresolved Trade Problem of Paris—and How Glasgow Can Help

November 08, 2021
9 min read
Photo credit: MaxxjaNe / Shutterstock.com
World leaders meeting in Glasgow to fight global warming need to save the Paris Agreement from itself.

As the European Union’s new climate change proposals highlight, the “differentiated responsibility” approach in the UN Framework Convention on Climate Change (UNFCCC) can lead to cries for protection against “unfair” competition from exporters in countries that do not adopt equally tough decarbonization measures. But even carefully defined efforts to provide that protection, like the EU’s Carbon Border Adjustment Mechanism (CBAM) proposal, are in turn seen as unfair by affected countries, possibly leading to trade disputes and souring the politics of climate change for all.

Trade law cannot resolve these tensions; leaders in Glasgow should instead ensure that the Paris Agreement recognizes that some protection may be allowed if it is carefully circumscribed. And as a recent GMF roundtable involving government, business, and civil society representatives from the EU, Brazil, Morocco, Turkey, and Ukraine underscored, the EU CBAM proposal may provide important guidance for this, particularly in its focus on factory-specific emissions.

Sweeping EU Climate Measures Proposed

The European Union in March adopted a law committing it and its 27 member countries to become carbon neutral by 2050, and to reduce greenhouse gas emissions by 55 percent (from 1990 levels) by 2030 as part of that effort. Unlike others who (subsequently) claimed similar ambitions, the European Commission in July proposed a sweeping suite of measures to make the EU “Fit for 55,” including a huge increase in taxes on fossil fuels, a major expansion and tightening of the EU’s Emissions Trading System (ETS), phasing out of fossil fuels-based vehicles by 2035, and a shift to non-fossil fuels even in airplanes and ships.

The ETS proposal implies a major cost increase for the EU’s energy-intensive industries, as it forces factories to buy permits for the greenhouse gases they emit, ratchets down the volume of permits, and consequently escalates the price of the permits, from €34/ton at the beginning of the year to €57/ton on November 1. Not surprisingly, companies and workers in the EU’s trade-exposed energy-intensive industries—iron and steel, cement, aluminum, fertilizer, electricity, chemicals, pulp, and paper—are deeply concerned about how this affects their competitiveness against “unfair” imported products from countries that do not have similar measures and have loudly let their politicians know it.

Protecting Competitiveness

Knowing member states would vote down its proposals if they appeared to destroy jobs, the European Commission also recommended a carbon border adjustment mechanism to ensure that imported products pay a similar carbon price. The proposed CBAM is carefully designed to meet international trade law requirements in that it is explicitly presented only as an effort to preclude a “carbon leakage” from a net increase in greenhouse gas emissions should production move from the EU to third countries as a result of the EU’s ambitious measures. Furthermore, it is tied only to industries covered by the ETS and covers only the most exposed industries (iron and steel, cement, fertilizer, aluminum, electricity) where the price of carbon emissions generated during production can be relatively easily related to the product. The mechanism focuses on factory-level emissions, so more modern/efficient plants do not pay, and requires that imports only pay the differential between their domestic carbon costs and the EU values. The EU’s CBAM would be phased in as free allowances for the involved industries are phased out.

Clear Trade Effects

The European Commission’s own impact assessment shows, however, that the proposed CBAM would significantly increase the fees placed on imported products: the implied tariff on imported products in the four affected sectors is 3.6 percent, including 9.8 percent on cement, 7.5 percent on fertilizer, and 4.2 percent on iron and steel—and this is assuming the Commission’s relatively low estimate of the ETS carbon price. The countries most affected would be Russia, Ukraine, Turkey, Morocco, Brazil, and Mozambique (especially for aluminum). Were they to file a complaint in the WTO against the EU measures, they would likely win, largely because the connection to the EU’s Emissions Trading System focuses on production processes, while WTO trade law focuses on products. So, the key question is whether these countries will decide to complain.

Reactions from Affected Countries

The representatives of Brazil, Morocco, Turkey, and Ukraine participating in our roundtable all expressed a genuine desire to address climate change, although NGO representatives argued that their countries should do more. In that connection, all had some empathy for the political difficulties the EU faces as it considers the tough measures the Commission proposed.

Yet they also shared a sense that the EU’s CBAM was unfair, especially as there is no evidence that carbon leakage has happened (the EU argues that past free allowances have avoided this). For critics, CBAM contravenes the UNFCCC/Paris Agreement “differentiated responsibility” approach. Industrialized EU countries have generated far more carbon over the decades and should do more to offset this. The EU’s CBAM thus unjustifiably requires other countries to adopt as stringent an approach (and carbon cost) as Europe has. Similarly, many argue that on a per capita basis, their emissions are significantly lower than the EU’s.1

For critics, CBAM contravenes the UNFCCC/Paris Agreement “differentiated responsibility” approach.

Like the EU, other countries also face domestic political challenges. As a few roundtable participants noted, some politicians in their countries will use this perceived unfairness to undermine any local efforts to fight against climate change, which they portray as a new form of colonial oppression of developing countries.

At the same time, the prospect of the EU CBAM has pushed countries to accelerate their green transformation, particularly in Turkey and Ukraine. For years, Turkey refused to ratify the Paris Agreement because it was classified as a “developed” Annex I country that would not receive financial assistance under the UNFCCC. This has been overcome as Turkey ratified the Paris Agreement in October—a move some at the roundtable believe was related to the CBAM threat. Similarly, in Ukraine, which exports a significant amount of electricity to the EU, the prospect of CBAM has discouraged investment in coal-fired power plants and further stimulated an opening to foreign investment in its energy sector.

Complaints about Methodology

One of the major complaints of the affected countries centered on the methodology the EU chose for its carbon border adjustment mechanism, claiming that the EU’s proposed approach does not recognize a country’s past decarbonization achievements. Ukraine, in particular, resents this, as its carbon emissions today are 60 percent lower than those in 1990. The EU approach also does not account for relative wealth: a comparatively low price of carbon in countries such as Turkey has a much more dramatic impact on its industry than an equivalent level would have in the EU. Moreover, industries fear that their governments do not necessarily have the means and/or the political willingness to sustain them through the decarbonization process at a similar pace to that of the EU.

Finally, there are doubts about whether and how the EU can determine the equivalence between the EU’s ETS price for carbon and the many regulatory measures it may adopt that effectively increase the price of carbon, even if there is no market price placed on it. This is particularly relevant for the United States, where the Biden administration contemplates many measures that will reduce carbon emissions even without an explicit carbon price. Concerns may be mitigated, however, with an EU approach of allowing each supplying factory to demonstrate it could meet greenhouse gas emission benchmarks.

Who Gets the Money?

The way the EU uses the €1.3–2.1 billion in additional emissions trading revenues generated by the CBAM seems to be one of the most difficult knots to untangle. Right now, these would go into the EU’s general coffers, reducing the amount member states would need to pay into the EU budget. Even within the EU this is criticized, as member states believe the money should go to them (perhaps to subsidize investments to reduce greenhouse gas emissions). Not surprisingly, representatives from the countries that would be paying for CBAM believe the funds should come back to them, as part of the EU’s pledge to support climate change mitigation globally. On the other hand, some developing countries also argue that the EU has already pledged many billions to help them fight climate change, and that it is not right that these funds should effectively come from those countries themselves. Or, an even better approach, some argue, would be not to charge a CBAM, so factories in the south could invest in upgrading. Even if the CBAM revenues are directed to developing countries, questions remain about which countries should receive them to maximize investments in better technology and disincentives against polluting business models.

Toward a Global Tax on Carbon

Taking the truly ambitious steps necessary to combat climate change will require a fine balance. Whatever measure a country adopts, the explicit or implicit price of fossil fuel energy used in production must increase—and increase substantially. Domestic industry will feel disadvantaged if it believes it experiences this alone and will demand protection. Foreign industry will feel unfairly affected. This tension can only delay needed action, to the detriment of all.

The EU should use CBAM in a way that does not alienate its trading partners while also pushing them to be bolder in their green transformation. On a case-by-case basis, European diplomacy should play an important role in this process. But also important is the EU’s focus on factory-specific emissions, as these steer the CBAM away from targeting a country for lack of ambition and point instead to the need for all to use the most efficient production methods.

The EU should use CBAM in a way that does not alienate its trading partners while also pushing them to be bolder in their green transformation.

In any event, the EU should be careful to prevent the narrative around CBAM from becoming one of European countries dumping the costs of their green transformation onto developing ones. This would feed conspiracy theories and promote disinformation against climate action and the EU itself.

To avoid that, financing is key: fulfilling global pledges of climate financing, but also carefully considering how to allocate and spend CBAM revenues. The EU focus on factory-level emissions helps; revenues could be allocated to help upgrade individual factories in Europe and LDCs, as this would clearly help address climate concerns, even though it could also introduce another level of competitiveness concerns.

Of course, how the United States and China act is critical. Many developing countries might accept the EU CBAM in isolation; most worry, however, that the United States and other countries will adopt a similar—and potentially more discriminatory—scheme. And all are concerned China will take advantage of everything. The U.S. and EU should work together to help develop constraints on CBAM, in exchange for developing countries recognizing that these will be politically necessary for the two biggest economies to move at all. The EU­-U.S. deal on steel and aluminum brokered in the context of the last G20 meeting is a promising start, as it envisions a common carbon-based sectoral arrangement on steel and aluminum trade by 2024, and possibly opens the way for CBAM to adapt to equivalent non-price measures. At the same time, all need to convince China that it, too, must play. The evolution of China’s own decarbonization process will make the difference, based on whether it will also introduce a CBAM, or decide to position itself as a leading voice against it.

While CBAM is not the focus of attention in Glasgow, the need for policy instruments like CBAM would be substantially decreased if the world’s largest economies of the G20 were to set their climate targets in a way that builds trust around a similar desire for decarbonization, either through carbon pricing or equivalent measures. These concerns need to be resolved in a UNFCCC context and should not be allowed to turn into a trade dispute.

Thanks to Annika Vollmer, Alberto Tagliapietra, Kadri Tastan, and Tina Scholz for their research assistance.

  • 1Per capita CO2 emissions in 2020 (measured in tons per person): Europe 6.61, Ukraine 4.89, Turkey 4.6, Brazil 2.2, Morocco 1.75. Source: Our Word on Data