General exceptions

GATT Article XX exempts measures from being considered WTO violations based on various domestic policy goals, including the protection of public morals. If all else fails, to make CBAM WTO-compliant, the EU may rely on this provision and argue that the CBAM regulations qualify for general exceptions (on the grounds of preservation of exhaustive resources or human health) per GATT Article XX. However, to qualify for Article XX, the EU must show that the CBAM is the only option that would allow it to protect health concerns and that it is the least trade-restrictive measure reasonably available. Most importantly, Article XX states that the CBAM regulation cannot be a disguised restriction on international trade. To rely on this provision, WTO rules require the EU to prove a “close and genuine” relationship between the border adjustment on imports and conservation goals. The fact that revenue generated from the CBAM will go to the EU budget may attract scrutiny. There have been suggestions to use the revenue generated to assist developing countries in meeting these countries’ clean energy goals.

Impact on trade flows and economy

Impact on Europe

European trade flows – both imports and exports – will be affected by CBAM provisions. For exports, the subsequent elimination of free allowances will have a bearing on the export competitiveness of European downstream sectors. For imports, the extent of the impact will really depend on how carbon-intensive the EU’s trade partners are and whether they have meaningful measures in place to drive decarbonization in their industries, and how quickly they are able to do so.

European consumers will face higher prices as imports become more expensive. As the allocation of free allowances to domestic sectors is gradually reduced, the phasing-in of CBAM will drive up costs for EU producers.

Reporting obligations related to CBAM will also push up costs, to be eventually borne by consumers. Some of the immediate and direct impacts that EU companies may feel include higher import prices of goods from industries covered under the CBAM (e.g., steel) and increased prices of secondary goods that include components of such goods (e.g., vehicle manufacturers buying parts from another EU manufacturer that contain imported higher-priced steel or aluminum).

Impact on trading partners

The CBAM could have a significant impact on the competitiveness of countries that export these goods to the EU, particularly emerging and developing economies. The extent to which a country is affected by the CBAM depends on the EU ETS price, the severity of the CBAM’s impact, and on exporting countries’ exposure, i.e., the volume of their affected exports to the EU. However, exposure alone does not say much about possible economic risks. A more significant risk measure is vulnerability. Vulnerability measures economic dependency, export diversification, and export concentration, besides exposure alone.

Some developing countries export large quantities of these goods to the EU. Zimbabwe, for example, is a major exporter of iron and steel to the EU, and Ukraine sells large quantities of fertilizer to the bloc.¹ In absolute terms, Russia, China, Turkey, and Ukraine are the main EU trade partners in CBAM products, and hence the most exposed countries. In relative terms, the degree of exposure of economies that export CBAM products to Europe varies substantially, with many developing economies having more than 2% of their exports and 1% of their production impacted by this measure.² Promoting the substitution of highly polluting technologies with green technologies, while arguably easier in economically advanced Europe, is not as feasible in developing and emerging economies. Many jobs and fiscal revenues are at risk if the CBAM is implemented without considering the specific contexts of the EU’s trading partners.

Expectedly, CBAM has triggered a backlash from several of the EU’s trading partners including the United States, China, India, Brazil, and South Africa. It is viewed in China as a new tariff barrier. “If Europe imposes taxes based on the [carbon] price differences on relevant products from China, it may have a very large impact on China’s related industries and enterprises,” Zhou Chengjun, director of the Financial Research Institute of the People’s Bank of China, said at an academic forum in Beijing in July³. Others have also expressed concerns that the new rules will further complicate trade and raise export costs for non-EU manufacturers.

The EU’s trading partners might choose to retaliate and impose barriers on EU imports in response. Some like China and India could further challenge this policy at the WTO. China has already asked the EU to justify its incoming carbon border tax at the WTO. India plans to file a complaint to the WTO over the EU's proposal to levy imports of high-carbon goods like steel, iron ore, and cement from India, top government and industry sources say⁴. India has set up its own carbon trading system and brought in a series of measures and norms to push high-emission industries towards decarbonization to “mitigate the impact” of the CBAM⁵.