Is the EU’s Carbon Border Fair to the Global South?

Issue 13 of Southern Lens on Development by Prof. Jane Mariara 

In a new paper co-produced by the Partnership for Economic Policy in collaboration with Centre for Econometrics and Applied Research (Ibadan, Nigeria), and as part of the Sustainability Performances, Evidence, and Scenarios (SPES) project, researchers assessed whether the CBAM has contributed to improving the climate policy framework of EU and Global South countries. In this edition of my newsletter, we will explore the macroeconomic impacts of the CBAM on countries across the globe with a focus on the Global South and understand the path forward.

What is Carbon Border Adjustment Mechanism or CBAM?

The Carbon Border Adjustment Mechanism (CBAM) is a market-based policy pricing tool introduced by the European Union (EU), which imposes carbon taxes to promote clean energy transition and incentivize green technology adoption in energy-intensive countries and sectors. It is aimed at mitigating the impacts of climate risk and climate change, enabling EU to progress towards its climate neutrality goal for 2050.

Imposed on selected industrial sectors and goods imported into the EU, the idea is simple—if European companies are paying a price for their emissions, so should foreign competitors. The policy is a step in the search for an equitable framework for carbon pricing in the EU that captures both locally produced goods from targeted high-carbon-emission sectors and foreign products imported from the rest of the world.

However, it is important to explore if the tax is likely to have implications on the economic growth and macroeconomic stability of the Global South countries. For instance, it could create global shocks in commodities, exacerbate supply chain disruptions and dampen demand, thereby affecting trade and financial flows between countries. Additionally, there is a risk that it could provoke a trade war between the EU and its trading partners.

To understand the possible concerns further, this research study examined the resilience or otherwise of Global South countries to the carbon tax on imports coming into the EU, given the EU’s importance as a major global trading block.

Is EU’s green ambition a global win?

The simple answer is a no. To arrive at it, the study explored four critical questions to inform policy makers in the EU. These included:

• Do the Global South countries show macroeconomic resilience or exhibit vulnerability in the face of global shocks posed by the CBAM?
• What is the nature of the effects of the CBAM on inflationary pressures in the Global South countries?
• What are the likely impacts on the Global South’s international trade competitiveness (via real exchange rates)?
• Are there dissimilarities in the macroeconomic effects of CBAM between the Global South and Global North countries?

The researchers used a powerful macro-econometric simulation model - the Global Vector Autoregression (GVAR) to study the impacts in 33 countries (14 of these from the Global South), all representing 90% of the global economy. The findings raised serious red flags, especially for those countries least equipped to bear the cost. Not only did the study provide results for the Global South as a unit but also highlighted results for individual Southern countries, and for the different regions (Africa, Asia Pacific, Latin America & the Caribbean region, and the Arab region) within the Global South. It also provided a comparative analysis between advanced economies (excluding EU) and the Global South.

Indirect impacts of the CBAM on economic growth

The CBAM, as mentioned above, is a carbon pricing mechanism aimed at reducing the rate of carbon leakage in the EU by levying carbon costs on products being imported into the EU. However, in effect, the carbon tax can be viewed as a higher production cost imposed on countries of origin in energy-intensive sectors such as manufacturing, petroleum, transportation, and electricity generation, which is likely to lead to output decline because exports decline. According to the study results, the indirect impacts of the CBAM from the global demand side on the real GDP showed a consistent decline across geographies, especially in all regions of the Global South. For instance, Africa’s real output was likely to decline by about 2.1 per cent, the Arab region’s by 1.8 per cent, Asia Pacific’s by 2.2 per cent, the Americas’ by 2.6 per cent, and the Global South as a unit by 2.2 per cent. The Global North as a unit showed a decline by 1.8 per cent. Hence the negative impacts cut across and were expected to be long-term in nature.

From the supply-side, the indirect impacts of carbon tax on imported goods to the EU were less emphatic. The results showed that of the four Global South sub-regions, the supply shock produced significant negative real output effects only in two regions, namely, Africa and the Americas. Overall, the effects were greater in the Global North than in the Global South when the geographic units are compared.

Direct impacts of the CBAM on real exchange rate and inflation

The results of the simulated direct macroeconomic impacts of the CBAM on the Global South countries showed that in addition to the decline in real output, the policy could lead to real exchange rate depreciation in all the regions, including the Global North, except for Saudi Arabia, whose economy would remain insulated and competitive. This would make their goods relatively more expensive and less competitive. For instance, the real worth of goods could be costlier in the regions by 3.23 per cent in Africa, 2.25 per cent in the Asia Pacific, and a substantive 4.09 per cent in Latin America and the Caribbean. This is likely to be a major concern for countries that rely on exports for foreign earnings. Further, the Global North as a unit would experience about 0.73 per cent real exchange rate depreciation as compared to the Global South, which would experience 2.64 per cent real exchange rate depreciation.

On the other hand, inflation impacts in these regions were largely statistically insignificant and the policy could not be considered inflationary.

Policy recommendations for the European Commission

The ability of the CBAM to curb carbon leakage and aid the EU's clean transition process by blocking the transfer of carbon to Europe through importation is not disputed in the study. However, the associated costs on the economies of the EU's trading partners with those in the Global South being particularly prone to shocks as demonstrated in the results is a cause for great concern. The CBAM policy could have far-reaching negative welfare consequences on these countries (i.e. negative real GDP growth) if it was allowed to disrupt macroeconomic conditions. Moreover, the policy also had potential negative impacts on real exchange rate deprecation for EU’s trading partners, especially if trade wars were allowed to fester as a result.

To address these and to mitigate apprehensions, the study suggested that the European Commission widen its exclusion net beyond low-carbon sectors to include less-advanced countries whose emission levels were below a certain predetermined threshold. Further, it suggested that the EU could set aside a large chunk of the revenues accrued from the CBAM to finance climate action programs in countries that are not only poor but are also adversely affected by the policy to enable them realize the goals of the Paris agreement.

In conclusion, this study’s insights offer a wake-up call to EU policymakers: green policies must also be just policies. If CBAM proceeds without thoughtful adjustments, it risks increasing the gap between rich and poor countries, even as it reduces the carbon footprint. As always, I welcome your comments and feedback.

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