Does the risk of carbon leakage justify the CBAM?
EU har beslutat att införa en gränsjusteringsmekanism för koldioxid (CBAM) i samband med att klimatmålet höjs från 40 till 55 procents utsläppsminskning till 2030 jämfört med 1990. Förslaget innebär att importen av järn och stål, aluminium, cement, konstgödsel, elektricitet och vätgas beläggs med ”klimattullar” som motsvarar skillnaden i utsläppspriser mellan EU och andra länder.
The EU has decided to introduce a Carbon Border Adjustment Mechanism (CBAM) as part of the fit-for-55 program that raises the target from 40 to 55 percent reductions of greenhouse gases by 2030 compared to 1990 level. Effectively, the proposal means that EU will impose “climate duties” on the imports of iron and steel, aluminium, cement, fertilizer, electricity, and hydrogen. By 2030, all products covered by the emission trading system will be included. The duties will equal the difference in carbon prices between the EU and other countries. The purpose is to offset the incentives to relocate production to countries with lower emission prices, so-called "carbon leakage". The new mechanism will be introduced gradually from October 2023. In a first step, importers will have to submit data on the foreign emissions. The duties will be introduced in 2026 at the same rate as the free allocation of emission rights is phased out within the EU. Other OECD countries are considering similar measures, which primarily will affect developing countries with lower commitments in the Paris Agreement. The issue therefore has a "north-south" dimension that may cause tensions in the global trading system and in the climate negotiations since the rules of this kind of measures are unclear.
Against this background, this report examines the following questions: How big is the problem of carbon leakage in the world? Has the risk of leakage increased and therefore the need for carbon border adjustments? The study is based on an analysis of global greenhouse gas emissions from 1995 to 2018.
The report begins by describing the greenhouse gas emissions between 1995 and 2018 for different countries. The analysis shows that developing countries accounted for the entire increase in emissions during this period, especially China, which increased its share of global emissions from 14.5 percent in 1995 to 27.4 percent in 2018, while the US's share decreased from 19.5 to 12.4 percent and the EU's share from 16.4 to 9.1 percent. Together, China, the USA, and the EU account for half of global emissions. The analysis shows that developing countries generate more greenhouse gases than they consume, and vice versa for developed countries. The pattern reflects the international division of labour, in which developing countries, to simplify slightly, specialize in the extraction of raw materials and primary production and developed countries in business services and high-tech industry, which have different emission coefficients. Emissions per capita are still lower in developing countries.
Next, a decomposition analysis is carried out, in which the growth in global emissions is divided into a scale effect, a technology effect, and a composition effect, in which the last effect is a proxy for “carbon leakage”. The analysis shows that the growth in greenhouse gases between 1995 and 2018 is mainly due to economic growth in the world (the scale effect) and developing countries in particular, which has not been fully offset by a corresponding reduction in emissions per unit of output (the technique effect). The analysis also provides some evidence for carbon leakage, but this is the smaller part of the emission growth. What we observe in the data are that emission-intensive sectors tend to grow faster in countries with relatively high emission coefficients (the composition effect). Whether this is caused by differences in climate policy or other correlated factors, such as increased demand for steel and cement in rapidly growing economies, we cannot determine with our methodology. What speaks against climate policy having played a decisive role is that the shift towards developing countries began before the emission requirements were tightened for industrialized countries when the Kyoto Protocol entered into force in 2005. Rather, the decisive factor seems to be that China joined the World Trade Organization in December 2001 and then gained access to the world market on the same terms as other countries, which was followed by an investment boom in China, including in relatively emission-intensive sectors.
Next, we analyse whether the risk of carbon dioxide leakage has increased and therefore whether there is a need for border carbon adjustments. We investigate the matter by analysing whether emissions per unit of output have diverged or converged in the world. The analysis shows that there are large differences in the emission coefficients and that the EU is generally at the lower end of the distribution. However, over time, the gap has narrowed significantly. This means that the risk of carbon dioxide leakage has decreased in the sense that it matters less than before where production is located, even though emission prices have diverged.
One explanation for the "convergence paradox" is that many countries use policy instruments other than carbon taxes and emission-trading systems to control emissions, such as regulations and the phasing out of coal-fired power plants. Another explanation for the convergence paradox is that the first step in the climate transition is easier than the last steps because there are still many "low-hanging fruits" to pick in the carbon tree. It is therefore natural that lagging countries start to catch up when it becomes harder for the leading countries to achieve further emission reductions, which requires ever higher emission prices, as we now observe in the EU.
In the last part of the study, we bring all things together. We note that carbon leakage is not the largest problem but is also not negligible. Regardless, the competition problem must be managed somehow to allow the EU to move ahead of other countries and take a greater responsibility for the climate. Border carbon adjustments are a "red line" for the EU industry to support the fit-for-55 program and compensation for the decision to phase out the allocation of free emission allowances. When the CBAM is introduced, imports into the EU are likely to decrease due to the increased administrative burden, even if emission prices are not prohibitive. If the carbon border adjustments are seen as a protectionist measure rather than an environmental measure, the case will likely be tried in the World Trade Organization WTO, and if the EU loses, trade sanctions await unless the CBAM is withdrawn or reformed. It is therefore important to anchor the proposal in the WTO and in the UN climate negotiations.
To avoid trade wars over carbon prices and border adjustments, the OECD Secretary-General, Mathias Corman, proposed that an international rulebook should be negotiated. The OECD is willing to take the lead in this process, as it has done in the past when it brokered an international agreement on a 15-percent minimum tax on multinational companies to avoid harmful tax competition.
The climate crisis can only be solved through international cooperation.
Does the risk of carbon leakage justify the CBAM?
Serial number: Report 2023:01
Reference number: 2023/16