The moral conundrum of carbon border taxes
Will a carbon trade war help or hinder the energy transition?
On paper, a carbon border tax is the perfect mechanism for coercing trade partners to reduce their emissions and, potentially, deliver a global deal on carbon pricing – the Holy Grail of COP26. In reality, world leaders are unlikely to agree on rules for a global carbon market, meaning border taxes will be introduced unilaterally. These will punish exporting countries that do not decarbonise their energy-intensive products if development finance promised to help them transition fails to materialise.
Climate change is primarily the consequence of Western industrialisation. Poorer nations played only a minor role in contributing to atmospheric CO2 inventories, yet will experience among the worst effects and are least prepared to deal with them.
Europe and North America account for the lion’s share of coal, oil and gas burned to date since the industrial revolution. As they grew wealthier, Western nations offshored large chunks of their domestic manufacturing base to developing countries with lower labour costs and environmental standards.
This proved to be a quick and effective means to outsource the West’s emissions problem and cultivate a narrative of shared climate responsibility. At the same time, Western finance poured into overseas fossil fuel infrastructure to keep factories producing cheap goods for Western consumers.
Now, the European Commission and US government are negotiating a pact to impose border taxes on steel and aluminium imports according to their carbon footprint. This would force overseas producers to either decarbonise their operations or pay carbon prices equivalent to those set in Western economies.
The EU is already ploughing ahead with its own carbon border adjustment mechanism (CBAM), which will levy a tariff equivalent to the going rate for EU carbon allowances on imports of cement, iron and steel, aluminium, fertilisers and electricity.
Smelters in Sweden recently produced the first batch of zero-emissions ‘green’ steel, proving that hard-to-abate sectors can in theory decarbonise. But money matters, and pilot projects such as this one receive generous government support. Rival producers in other parts of the world can’t readily replicate this success.
When CBAM is phased in from 2026, it is conceivable that ex-EU suppliers of affected goods will have to compete on price terms adjusted for emissions that they cannot avoid.
The idea is that CBAM incentivises fuel switching outside the EU, so EU Commissioners ostensibly wish for CBAM revenues to be zero. But they must know that switching will take time. Some have even hinted that carbon taxes will fill EU coffers.
CBAM therefore creates a perverse incentive for EU countries not to help their trade partners decarbonise energy-intensive industries. The less climate aid the EU sends overseas, the more those countries must pay in carbon taxes to trade with Europe.
This outturn would accentuate the transfer of wealth from poorer to richer nations, and fall under the umbrella term of ‘carbon colonialism’: economic subjugation disguised as climate progress.
All stick, no carrot
The government of India has vocally opposed carbon border taxes, saying these go against principles of differing climate capabilities and responsibilities, as enshrined in the 1992 UNFCC treaty.
To underscore this narrative at COP26, India published an online Climate Equity Monitor to highlight the developed world’s ‘carbon debt’ and the ‘carbon credit’ owed to the Global South.
The threat of unilateral carbon pricing is designed to hang over tortuous COP26 discussions on a global market for carbon: ‘get with the programme, you’ll have to pay anyway’, seems to be the message to climate laggards.
This strategy has been partially successful with two of the EU’s biggest (and most provocative) trade partners. Russia is reportedly considering its own carbon tax, while Turkey cited CBAM as a factor influencing its decision to finally sign the Paris climate accord.
These reactions from Moscow and Ankara — relatively well developed ‘red’ economies in the above map — illustrate the geopolitical power of CBAM. It must be wielded carefully in ‘blue’ countries. Threats alone cannot force those without the means to reform to change their ways. The ‘stick’ must be accompanied by a ‘carrot’ of assistance to modernise industries in the poorest countries.
This has been distinctly lacking. The Green Climate Fund, established in 2009 to send $100 billion in climate finance to developing economies, might finally achieve this sum within the next two years. But there’s a lack of clarity over where GCF cash will go, how it is audited, how ‘green’ the investments really are and who ultimately benefits.
Moreover, climate finance sums pledged so far at COP26 are barely a fraction of the estimated $1 trillion required every year to help poor countries clean up their domestic industries. It is not at all clear where that amount of money will come from.
The China question
In the US, meanwhile, there is no pretence about the main purpose of any future American version of CBAM: countering China. The White House said in a communique that it secured the removal of EU steel tariffs in return for “toughe[r] enforcement mechanisms to prevent leakage of Chinese steel and aluminum into the U.S. market”.
In the hawkish world of US foreign policy discourse, fighting climate change has become synonymous with fighting China. A carbon trade war presents a new frontier in that endeavour.
The irony is that China is the leading manufacturer of technologies, materials and equipment that the energy transition requires. China dominates the market for lithium-ion electric vehicle batteries, rare earth processing capacity and polysilicon for solar PV modules. Chinese wind turbine suppliers are also major players in overseas wind markets.
It makes sense for a US President who campaigned on a ‘climate jobs for Americans’ ticket to seek to repatriate energy technology manufacturing capacity. But that is a multi-decade process, and the world needs to mobilise capital and manufacturing at a war-like scale from today. Is there a credible version of the energy transition in which China does not play a pivotal role?
The US and China signed a joint declaration on climate cooperation at COP26. But experts say this is limited in scope and unlikely to spill over into other areas of international cooperation.
E3G senior policy advisor Johanna Lehne told Energy Flux:
“This will definitely hold true for trade where cooperation has been particular difficult, especially in light of recent moves by the EU and the US to harness trade policy to green supply chains, with potential implications for Chinese producers. While climate has been a key motivator in both cases, commentators have also noted an implicit motivation to counter what are seen as unfair Chinese trade practices in industrial sectors. As climate and trade policy increasingly collide, it will become harder to see cooperation in one area not start to be affected by conflict in the other.”
Driving up costs
There may be good reasons for NATO countries to use climate policies to oppose Chinese industrial hegemony. But doing so comes with trade-offs.
The energy transition will be complex and expensive enough without a ‘carbon trade war’ hindering the free flow of goods, services and capital required to rewire the global economy around clean fuels.
Border taxes might seem like a clever way of spurring laggards into action, but they could just as easily trigger a wave of reciprocal protectionism that undermines progress on emissions reductions.
There are also open questions around compatibility with World Trade Organization rules, and whether exemptions will be made for the least developed countries (which could see affected goods shipped through exempt countries to circumvent levies).
Fundamentally, are Western consumers prepared to pay significantly more for everyday goods that have a lower emissions footprint? This question must be answered regardless of where in the world energy-intensive manufacturing takes place. If carbon border taxes add to the bill, there could be blowback.
Seb Kennedy | Energy Flux | 11th November 2021