‘The EU is showing real courage’

03.09.2021

The EU is at the frontline of the fight against climate change. To protect the environment European countries have begun to increase the prices on carbon. This can damage the economics very seriously, because it means that most products will also cost more because they depend on the prices of transport, electricity production, etc. It is also important for the EU to show unity and to clarify new tariffs with the WTO. IPG-Journal tries to describe the possible threats of the process

In order to protect the climate, carbon prices are rising sharply in the EU. This is good for the environment, but increases the price of many products. To protect domestic industry from climate-damaging and cheaper imports, the EU is planning a carbon border adjustment mechanism (CBAM) on certain goods. What does this mean practically?

The EU sees the CBAM as a component of its climate policies and of the EU ETS. The main purpose of the CBAM is to prevent carbon leakage — the phenomenon that industry for example leaves the EU and starts producing in countries with less stringent climate policies, then exports those products back to the EU — by creating a level playing field for EU producers.

The CBAM is supposed to replace the free EU ETS allowances currently granted to EU producers assessed to be at high risk of carbon leakage. The CBAM will be implemented in 2026, following a transition period of three years characterised by data collection only.

The initial proposal from the European Commission applies to imports of electricity, cement, aluminum, fertiliser, as well as iron and steel products. The levy is to be paid by EU importers of non-EU products. Countries with equivalent carbon pricing could be exempted from the CBAM in the future. The price of the CBAM certificates will reflect the EU ETS prices corrected for any free allowances EU producers still receive.

Tariffs are commonly seen as a protectionist weapon in trade disputes. Can the EU expect its trading partners to show understanding for its CO2 border adjustment or are they expected to impose tariffs on EU imports in turn?

This is the big question. There is the risk that outside nations retaliate and introduce trade barriers, with escalating trade wars and protectionism. However, the risk of protectionism has to be balanced against the risks of climate change, and one argument for the CBAM is that climate change is more devastating.

Retaliatory measures imposed in response to the CBAM could be seen as illegal in case the CBAM is decided to be legitimate in the WTO. I hope that a situation in which other countries also impose carbon pricing and BCAs — as Canada is considering to do — and then collaborate with the EU — meaning that there is no need for a CBAM between the EU and Canada for example — is more realistic.

The World Trade Organisation (WTO) is watching very closely when it comes to the introduction of new tariffs. Are the EU’s plans at all compatible with WTO rules? Or how would the CBAM have to be designed in order not to violate WTO rules?

The legality of the CBAM indeed is not fully clarified; although most legal scholars argue that the CBAM could be designed and applied in a way compatible with the rules of the WTO. WTO rules allow countries to impose compensating charges on similar imported products in order to equalise the tax burden on domestic production. So, direct environmental taxes levied on imported fuel could align with WTO rules as long as the charges are not in excess of those facing domestic products.

However, border charges on products manufactured through GHG intensive processes and production methods (PPMs) might be WTO-inconsistent if they are viewed as discriminatory. Past WTO disputes suggest there is flexibility though around policies to protect human, animal or plant life, health and to conserve finite natural resources — as enshrined in Article XX of the GATT —, but that any climate policies that discriminate against third countries or show preference for domestic products will fall foul of WTO rules.

The concept of ‘like’ — similar in terms of nature, end-use, and consumer tastes for example — products is critical here as it is a part of the foundation of the trade system. Under WTO jurisprudence, a distinction made between products on the basis of the amount of carbon that is used in making them is not justified. No legal determination in WTO dispute settlement has been made yet that says that two products can be considered not ‘like’ based on the amount of carbon used in making them.

First, it would be important to demonstrate that the CBAM is motivated by environmental (climate) reasons and not in pursuit of economic motivations. Second, the EU cannot distribute free allowances anymore to domestic industries that make products for which importers have to buy EU ETS allowances.

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