The EU is introducing a carbon border adjustment mechanism (CBAM), in effect a border tax that will draw revenues from other countries, including developing ones. The CBAM’s impact on African countries is larger, as a share of GDP, than on all other regions. David Luke writes that the climate finance discussion needs to consider unintended impacts on Africa, home to 33 of the world’s 46 least developed countries.
David Luke will be chairing the event Financing Climate Change? Inspiration for change from African thinkers, Wednesday 14 June, 1.00pm to 2.00pm
The Paris Agreement established a framework for the transition to a net-zero world underpinned by principles such as common and differentiated responsibility, respective capacities, and a just transition. These principles are embedded in Article 9 of the Paris Agreement, which is concerned with climate finance. Developed countries with historic responsibility for higher levels of carbon emissions are required under this provision to provide financial resources to assist developing countries with much less of a carbon footprint to help the latter meet their obligations with respect to both mitigation and adaptation. At each iteration of the UNFCCC Conference of the Parties (COP), climate finance, its measurement, adequacy and allocation is a matter of contention between developed and developing countries.
With the spotlight on how to enlarge the pot of climate finance and its apportionment, less attention has been paid to an emerging trend: policies to decarbonise trade as part of efforts to achieve climate neutrality — and their broad implications including financial ones. The European Union is most advanced in rolling out these policies, but the US, UK, Japan, Canada, China, India and others are also engaged in related initiatives. For the G7 countries, policy coordination is being achieved through a carbon club established in 2022.
The EU approach to decarbonising trade is part of the European Green Deal which aims at achieving climate neutrality by 2050. It establishes a carbon border adjustment mechanism (CBAM), in effect a border tax, to ensure that the carbon price embedded in imports is equivalent to the carbon price within the EU as determined by the EU Emissions Trading System. This will draw revenues into the EU as a major trading bloc, including payments from developing countries. The scheme will cover products from high carbon-intensity sectors such as iron and steel, cement, aluminium, fertiliser, hydrogen and electricity. Under certain conditions, the CBAM will also include indirect emissions, certain precursors and some downstream products such as screws and bolts and similar articles made of iron and steel. The CBAM is expected to be introduced on 1 October 2023, with a three-year transition period during which only emissions reporting obligations will apply, without financial payments.
After the transition period, the CBAM will be gradually phased in from 2026 to 2034. During the transition period, free allowances under the EU emissions trading scheme (ETS) for sectors covered by the CBAM will be gradually phased out. To level the playing field and bolster its position in case of legal challenges at the World Trade Organization (WTO), the CBAM will be phased in at the same speed that free allowances under the ETS are phased out. A review is envisioned before the end of the transition period to assess whether to extend the product scope, such as to include organic chemicals and polymers and further downstream products.
No carve-outs for the poorest countries
As the EU CBAM policy evolved, an exemption for the least developed countries (LDCs) and vulnerable economies was considered but decided against. Concrete commitments to LDCs affected by the CBAM are yet to be made. Rather, the CBAM requires the EU to commit CBAM revenues to its Innovation Fund, which seeks to “support innovative techniques, processes and technologies, including the scaling up of such techniques, processes and technologies, with a view to their broad roll-out across the EU” (Council of the European Union, 8 February 2023, p.87). This contradicts an earlier EU proposal to finance LDC efforts towards the decarbonisation of their manufacturing industries at the level of revenues generated by the sale of CBAM certificates. According to one estimate, assuming a carbon price at 100€/t CO2, the combination of a domestic carbon price and an EU CBAM would yield between €293 billion (with export rebates) and €387 billion (without export rebates) per year for the EU budget (Beaufils, T; Ward, H; Jakob, M; and Wenz, L; 2023). Only a small part of this will come from low-income countries due to lower trade volumes with the EU, as the exports from most low-income countries to the EU are poorly diversified and often with high carbon intensity. However, the CBAM will generate an income inflow from these countries. This contradicts the Paris Agreement Article 9 principles.
Poor countries’ trade with the EU will also take a hit
A joint study of the African Climate Foundation and the LSE Firoz Lalji Institute for Africa found that the CBAM will have the effect of reducing trade flows to the EU.
Across two different modelling approaches, the CBAM was found to have a moderate impact on the economies of African countries but in a low-income country context, the effect in terms of revenue loss will be a significant hit. In one model, the CBAM is forecast to reduce the GDP of no single African country by more than 0.18%. In the other, the effect is larger, with the CBAM forecast to reduce the GDP of the continent by 0.91% (equivalent to a fall of $25 billion at 2021 levels of GDP). In the modelling, a number of African LDCs would be among those most impacted by the application of the CBAM, notably the Gambia, Mauritania and Mozambique. Africa is home to 33 of the world’s 46 LDCs, identified as highly economically vulnerable and confronting severe structural impediments to sustainable development.
In comparative terms, the impact on African countries is larger, as a share of their GDP, than on all other regions because the EU is a particularly important export market for African countries. The EU accounts for 26% of Africa’s exports of fertiliser, 16% of iron and steel, 12% of aluminium and 12% of cement. Africa’s exports of several important commodities to the EU are relatively more carbon intensive than those of Africa’s competitors. The CBAM could cause a fall in exports from Africa to the EU of aluminium by up to 13.9%, iron and steel by 8.2%, fertiliser by 3.9% and cement by 3.1%. However, a reasonable share of those commodity exports would shift over time to other destination markets, especially China and India.
The European Commission envisages CBAM product coverage expansion in the future. If this happens, the impact on African economies could be more substantial. The ACF/LSE study considered a hypothetical model in which the CBAM is applied to all imports. It forecast the CBAM to reduce total exports to the EU from African countries by 5.72% and to reduce Africa’s GDP by 1.12% (equivalent to $31 billion at 2021 levels of Africa’s GDP). Eleven African LDCs are forecast to experience a moderate to large negative impact to their GDP by more than 1.5% and up to 8.4%.
In another scenario, in which other developed countries follow the EU and equivalent regimes to the CBAM are imposed in the US, Japan, Canada and UK, alongside the EU, the weight of these regimes would fall less proportionately on African countries than on other economies in the world, such as China and India. This is mainly due to the relatively smaller share of those countries in Africa’s total exports. The EU market, and by implication the CBAM, by contrast is especially important to African countries.
Conclusion – need for the climate finance spotlight to be pointed at policies to decarbonise trade
It will be clear from the foregoing that among the implications of policies to decarbonise trade is not only a perverse revenue flow from poor to rich countries but also a financial hit to the economies of poor countries. The climate finance discussion needs to be broadened to take account of this. At the same time, we must acknowledge that the implications of the CBAM-type polices depend on the determined carbon embedded in production in each country. The lack of carbon markets and established systems for monitoring and measuring carbon content in production on the African continent (outside of South Africa) could see producers in many African countries assessed at higher default rates of emissions intensity and forced into paying higher CBAM tariffs. As policies to decarbonise trade gain ground, African countries should consider developing their own carbon monitoring systems, and potentially regional carbon markets, to better prepare for a climate neutral future. In the meantime, policies to decarbonise trade that entail financial transfers from poor to rich countries require closer scrutiny as they contradict the Paris principles.