Good climate policy: EU CBAM

The EU’s Emissions Trading Scheme is the world’s largest carbon pricing and trading mechanism. This system places a price on carbon and allows companies to trade carbon allowances. This creates a profit incentive for environmentally conscious behaviour. Companies can turn carbon emission reductions into profit by selling excess allowances to companies that can’t easily reduce their emissions.

While the Emissions Trading Scheme has contributed to the gradual decarbonisation of the EU, it has also resulted in carbon leakage. Carbon leakage occurs when a firm moves carbon emission-intensive production from a country with stringent environmental policies, to a country with fewer protections. For example, this can happen when a chemical manufacturer moves their plant from the EU to China, and then imports products back into the EU to avoid carbon prices. Given that the location of carbon emissions is irrelevant to its aggregate effect on the planet, this undermines the potential benefits of a system like the Emissions Trading Scheme. In fact, if carbon leakage is rampant, the scheme serves only to penalise EU-based environmentally conscious companies that do not move their carbon production and therefore face higher costs of production. 

The issue of carbon leakage provides the core rationale for the EU carbon border adjustment mechanism (CBAM). CBAM is designed to ensure that goods imported into the EU face the same carbon production costs, as those produced in the EU. It does so by imposing tariffs on imports in proportion to the amount of carbon associated with their production. This aims to incentivise greener production in non-EU nations by internationalising carbon pricing, thereby fixing the carbon leakage problem. CBAM is scheduled to take full effect on January 1^st, 2026.

However, CBAM is criticised as a protectionist and coercive policy, offensive to a fragile global order of trade multilateralism, likely to disproportionately impact developing nations. This is because the unilateral implementation of CBAM by the EU creates strong incentives for EU trading partners to adopt carbon pricing mechanisms to avoid tariffs. Given that CBAM is simply a mechanism to internationalise carbon pricing, the debate about CBAM therefore comes down to one’s perspective on carbon pricing. 

There are two primary arguments in favour of carbon pricing. The first revolves around the “polluter pays” principle. Carbon emissions impose a cost on society; “a negative externality” to use the language favoured by economists. Therefore, the price paid by the consumer for a carbon-emitting good like petrol does not reflect its full cost on society. There are additional costs that need to be accounted for. Through carbon pricing, the government can attempt to bridge this cost gap by forcing the polluter to cover some of the costs they inflict on society. 

The second argument in favour of carbon pricing is that it makes carbon-emitting goods more expensive relative to their green alternatives. This encourages greener consumption and production methods by making environmentally friendly alternatives more competitive. For example, higher carbon prices raise the cost of a fossil fuel-based vehicle relative to the lifetime cost of an electric vehicle.

However, critics claim that carbon pricing is economically regressive (i.e. it takes proportionately more in income from the poorest in society). Even when carbon pricing is nominally a burden on the producer, this claim holds because the increase in the cost of production will be fed through to the consumer in the form of higher prices. It is true that carbon pricing is regressive, when we focus just on money. However, if we take a more holistic perspective on the costs and benefits associated with carbon pricing, and the timeline of these effects, then carbon pricing becomes a progressive policy. 

The costs associated with climate change will be enormous. According to The Institute for Economics and Peace, 1.2 billion people will be displaced due to climate change over the next 30 years. These adverse impacts of climate change, such as floods and heatwaves, will be felt most acutely in the developing world. Effective carbon pricing will reduce the severity of these impacts. While it is true that it will impose some burdens on many who already have enough to bear, every fraction of a degree that it shaves off increasing global temperatures will benefit countless individuals across the planet. The majority of the costs associated with CBAM will be borne by European Consumers in the form of higher prices of goods. These costs pale in comparison to the benefits of diminishing the extent of climate catastrophe; the majority of which will accrue (rightly) to those in the developing world over the next century. 

If what we care about when we decry a policy as being “regressive” is the inequitable distribution of benefits and costs, then it seems incumbent upon us to consider more than money. When we do so, CBAM can be seen as a harbinger of a new progressive era of climate policy. 

Conor Perry is an economist and policy researcher from Cork City, working and studying in London