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The Supply Chain Impact of the EU’s Controversial New Carbon ‘Tax’

Updated: Mar 31, 2023

The EU’s Carbon Border Adjustment Mechanism (CBAM) which is due to come into force in 2023 has split world opinion. Many see it as a necessary way to meet the region’s climate goals, whilst others, particularly in Emerging Markets, see it as inequitable, protectionist measure punishing those countries least responsible for global warming. Either way, it is another headwind for the development of global supply chains.

Preventing ‘carbon leaking’

In many people’s minds, the development of global supply chains predicated on low cost labour and cheap transport has led to the unnecessary movement of goods around the world, causing high levels of carbon emissions.

Examples are often used to show how intermediate products within Global Value Chains cross multiple international borders before final assembly and subsequent shipping thousands of miles to the end user market in Europe or North America. One element of this argument relates to the lower environmental standards often employed in the markets to which production has been off-shored, placing manufacturers which choose to stay in the West at a disadvantage.

The European Union has recently passed legislation to address this perceived unfairness, the Carbon Border Adjustment Mechanism (CBAM). This new tax on imports (part of its ‘Fit for 55’ package – the target to reduce carbon emissions by 55% relative to 1990 levels) has been developed to address concerns in the EU that manufacturers in the region are being put at a disadvantage by stringent environmental regulations which companies in the rest of the world do not have to follow. This, according to politicians, has encouraged off-shoring, the loss of jobs and resulted in so-called ‘carbon leakage’ i.e. carbon reduction efforts in the EU have been off-set by an increase in carbon intensive production in other parts of the world.

The CBAM will result in a levy being charged on imports of the most carbon-intensive goods which will, in the view of the EU, create a level playing-field for EU manufacturers and reduce the pressure on companies to off-shore production to lower cost markets. Commencing in October 2023, importers of certain goods (iron and steel, cement, fertilisers, aluminium, electricity and hydrogen) will need to comply with reporting obligations. Following this, ‘free allowances’ will be phased out in conjunction with the implementation of the EU emissions trading scheme (ETS) although a time scale has not yet been established.

The EU’s effort to ‘level the playing field’ through the implementation of a carbon border adjustment levy has provoked widespread criticism from its trade partners, especially the USA as well as a host of countries in the developing world. However, it has also prompted many countries to engage positively with the concept, developing their own versions of Emissions Trading Schemes which would allow exports to be exempted from the EU’s mechanism. A key driver is that this will mean tax revenues stay at home rather than being transferred to the European Union.

Protectionism of any sort has a negative impact on the global flows of goods and this will be most definitely the case with CBAM, the USA’s version, the Clean Competition Act (CCA) and other such schemes. Their entire reasoning is based on discouraging manufacturers from unbundling, out-sourcing and off-shoring parts of their production to cheaper locations which don’t meet the stringent environmental restrictions being placed upon them. Whilst the impetus for CBAM may well have been to reduce carbon leakage, it is inevitable that in many parts of the world it seems a convenient political tool to stem the exodus of Europe’s heavy industry to markets with cheaper sources of energy.

On top of this, many emerging markets regard the carbon border adjustment as a levy on the poorest countries despite the fact they are least responsible for global warming. In order to counter these criticisms, it may be politic for the EU to look at using monies raised by the mechanism to help emerging markets offset the impact of climate change.

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