Does EU’s CBA Violate International Trade Agreements?

Emissions trading system (ETS), also known as emissions trading scheme, is a market mechanism that allows bodies such as countries, companies or manufacturing plants which emit greenhouse gases into the atmosphere, to buy and sell these emissions, as permits or allowances, amongst themselves. At the end of each year, they must have enough allowances to cover the greenhouse gas (GHG) emissions from their annual production. This system provides a price on carbon emissions, a previously not monetized byproduct of production.

A study conducted in 2023 concluded that there was a 10% reduction in carbon emissions between 2005 and 2012 after the implementation of ETS in EU, having no adverse impact on the producers’ profits. Consequently, since 2013 the EU ETS has generated more than EUR 152 billion in revenue. It has also resulted in the decrease of air pollutants like sulfur dioxide, nitrogen oxide, and others which leads to health benefits for the residents of the impacted areas.

The major disadvantage of this system is that it results in carbon leakage, which is defined in economic literature as a displacement of carbon emissions from a region with stringent climate policies toward a region with less stringent climate policies. 

If the additional cost is high enough to put them at a competitive disadvantage compared to foreign producers, EU producers may choose to relocate outside the EU to avoid paying this additional cost. This would decrease production within the EU and increase production outside the EU, which would prove to be detrimental to the EU’s efforts to mitigate carbon emissions as any reduction in emissions would be compensated by an external increase, consequently harming their economy and local industries.

To combat the loss of production and the increase in carbon emissions through carbon leakage, carbon border adjustment (CBA) was introduced where CBA imposes a carbon price on foreign goods imported to the EU. It would create an incentive for these producers to invest in carbon-abating technologies and processes, resulting in an overall reduction in emissions.

Although the CBA seems to be a perfect solution for carbon leakage, there are various obstacles standing in its way. It goes against the principle of most favored nation and the national treatment clause of World Trade Organization (WTO) where; the most-favored-nation clause forbids countries from implementing trade policies that discriminate between different WTO member nations; and the national-treatment clause forbids countries from implementing trade policies that favor their domestic producers over foreign producers.

UNFCCC’s principle of common but differentiated responsibility also stands in the way of CBA. The principle states that while all countries are commonly responsible for addressing climate change and environmental destruction, each country’s contribution to this cause should be proportional to its capacity to act and to its share of responsibility in historical global emissions. This means that developed countries are expected to contribute more than developing countries, the latter being responsible for a small share of historical global emissions and having more limited means of action.

Thus, we can conclude that policymakers should aim to decrease the impact of the energy channel by developing universal policies between regulated and unregulated countries regarding fossil fuel and carbon pricing. They should also try to promote green technology diffusion to unregulated countries and reinvesting CBA funds into an international technology fund.

Carbon leakage at least partially undermines the effectiveness of national carbon pricing policies. However, developing countries benefit economically from such policies due to the increase in economic activity. Thus, policymakers should also take development considerations into account when designing policies through which global carbon emission reduction can be achieved in the near future along with the economic development of countries.

Aradhita Srivastava

MES, School of Arts and Sciences

Aradhita Srivastava is a first year Master of Environmental Studies student with a concentration in environmental policy . Her area of research interests include environmental policy, environmental economics and management