European Union’s Carbon Border Adjustment Policy and Its Ramifications for Trade Dynamics of Developing Countries

Climate change and trade share a complex relationship where trade can exacerbate and mitigate the climate crisis reshaping our world.  As climate change takes centre stage in domestic and international policy priorities, countries worldwide are employing unilateral trade measures to achieve their decarbonisation goals set by the Paris Agreement of the United Nations Framework Convention on Climate Change (UNFCCC). The European Union’s (EU) Carbon Border Adjustment Mechanism (CBAM) is a notable example of such climate policies. However, this policy has sparked growing disagreements among developing countries, including India, which argue that it negatively impacts their trade dynamics by restricting exports to the EU and other regions. Promoting trade openness and transferring technology and know-how is essential instead of unilateral trade policies to ensure a just and inclusive transition to a greener economy. This approach would build the capacity of the developing world to advance towards a greener future alongside other nations.

The rise of unilateral trade measures stems from their opposition to the Common But Differentiated Responsibilities (CBDR) principle followed by international climate regimes. This principle allows for the broad participation of countries in the climate agenda while differentiating responsibilities and climate ambitions among them. This scenario leads to carbon leakage, where companies move production from countries with stringent policies to those with more lenient ones, increasing greenhouse gas emissions. These risks have prompted some countries to consider border carbon adjustment measures. CBAM is a policy tool that adds a price to the carbon embedded in products to encourage consumers to choose less carbon-intensive goods and services by making carbon-intensive products more expensive. CBAM aims to address the imbalances caused by carbon leakage by adding a carbon tax to imported goods equal to the domestic carbon charge. The EU will fully implement CBAM from 2026, with a transitional phase from 2023 to 2025.

However, CBAM has faced widespread criticism from developing countries, including India, as it is seen as detrimental to exports from carbon-intensive sectors such as steel and aluminium. The World Bank’s CBAM Exposure Index indicates that it disproportionately affects low and middle-income economies, leading to a decline in trade compared to higher-income economies. Countries like Zimbabwe, Ukraine, Georgia, Mozambique, and India will see their exports to the EU affected by CBAM, as imposed tariffs could reduce global demand for imported goods, driving down prices. While the EU’s CBAM seeks to achieve its carbon goals, it transfers the adverse effects of its policies to low-income countries, potentially creating trade tensions. Along with the practical difficulties of implementing border adjustments, such as challenges in calculating carbon footprints due to a lack of standardised methods, it also increases compliance and administrative costs, further deteriorating exports from developing countries as costs rise.

While CBAM aims to reduce emissions by taxing carbon-intensive imports, it risks causing significant economic disruptions.  Developing countries like India could substantially lose exports, particularly in the iron, steel and aluminium sectors. It could exacerbate carbon leakage, redirecting trade to countries with less stringent policies, thereby undermining global carbon emission reduction efforts.  For example, India's trade loss in emission-intensive sectors could amount to USD 771 million. These shifts threaten economic stability and decrease the likelihood of achieving carbon reduction targets. Encouraging intra-EU trade at the expense of developing countries could lead to more significant global emissions, as production may move to less regulated regions.

Green protectionism is emerging as environmental measures are increasingly adopted worldwide, with close to 77 separate carbon pricing initiatives in 46 countries. Countries fear that carbon-pricing nations will unfairly restrict their exports. This dilemma raises the critical question of whether unilateral trade policies and border carbon adjustment measures are the proper steps to address the climate challenges of the 21st century, especially when many developing countries lack the technological prowess and know-how to transition to greener industries. Although CBAM might push countries to introduce carbon pricing domestically and spur innovation in less carbon-intensive technologies in the long term, it could increase trade tensions and discourage much-needed low-carbon investment in low-income countries.

As India will be one of the key countries that CBAM will impact significantly, it should consider several policy options. Firstly, negotiating for exemptions or rebates under CBAM for developing countries could provide temporary relief. Secondly, enhancing technological efficiency in production can help transition to less carbon-intensive sectors. Lastly, India should seek to diversify its export markets and strengthen trade relationships with countries outside the EU. Emphasising common but differentiated responsibilities in international climate negotiations will ensure that CBAM does not harm India's economic interests disproportionately.

Instead of unilateral trade policies, which harm the trade interests of developing countries, the solution to climate change could be the transfer of technology and resources to developing countries.  Trade openness facilitates higher economic growth, generating additional financial resources for adaptation strategies such as climate-resilient infrastructure. It also allows broader access to services that help prepare for climate-related shocks, such as weather forecasting, insurance, telecommunications, transportation, logistics, and health services. Trade openness can reduce the carbon intensity of economic output by shifting resources to more productive and cleaner firms, as firms engaged in international trade tend to be more competitive and energy-efficient than purely domestic firms. Climate objectives, rather than the protection of domestic producers, must be the central rationale for developing and implementing trade-related climate policies, and the EU can play a more prominent role in the global reduction of carbon emissions by facilitating trade and investment with the rest of the world.  

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