A practical carbon border adjustment mechanism
The European Commission has proposed a carbon border adjustment mechanism (CBAM) as part of a package of measures to help meet its ambitious emission reduction goals
The mechanism aims to make sure that the imported goods face the same cost of carbon emissions as domestically-produced goods do, in order to prevent carbon leakage
The scheme is limited in the products it covers, which means that it is not a comprehensive equalisation of carbon costs, but it does avoid the complexity that a wider scheme might create
The phasing out of free Emissions Trading System allowances should mean that CBAM will likely be World Trade Organisation compliant
As part of a package of energy and climate laws aimed at reaching the EU’s 2030 goal of cutting emissions by 55%, the European Commission (EC) has proposed a carbon border adjustment mechanism (CBAM). The basic aim of the
mechanism is to make sure that the imported goods face the same cost of carbon emissions as domestically-produced goods do, in order to prevent ‘carbon leakage’. This note sets out the rationale behind the proposal, the details of how it
would work, as well as some of the drawbacks and limitations of the scheme.
Preventing carbon leakage
The EC’s case for proposing CBAM is that the EU has more ambitious policies to tackle climate change than many of its international trading partners. Specifically, the price applied to green house gas emissions in Europe is higher than
elsewhere, which raises the risk of carbon leakage. Carbon leakage occurs when in response to (higher) charges on emissions in the EU, businesses transfer production to other countries or imports from these countries replace products
(which are responsible for lower emissions) produced domestically.
The concern is that carbon leakage would offset the impact of the EU’s climate policies on global emissions by increasing emissions in other countries. CBAM is aimed at
addressing this issue, but also creating incentives outside the EU to step up their efforts to reduce their carbon emissions. The EU has had an Emissions Trading System (ETS) in place since 2005 to limit emissions. Yet the evidence of significant
carbon leakage up until now has not been very convincing (see a Bruegel study from last year here for an overview of some of the evidence). However, this might be because of existing carbon leakage protection mechanisms.
In particular, ETS sectors that are most vulnerable to carbon leakage are granted free emission allowances as well as state subsidies to compensate for higher electricity costs. While addressing the risk of leakage, the Commission notes that the system of free
allowances also dampens the incentive to invest in greener production at home and abroad.
Meanwhile, the EC reasonably makes the case that the divergence in climate policies, and hence the risk of carbon leakage, will likely increase going forward, given the EU’s accelerated efforts. Emission reduction targets have been made more ambitious, while the free allocation of allowances will decline over time (see our note ‘Stricter ETS to accelerate emission cuts’ – here)