Introduction
Despite the acknowledged international agreement to curb global emissions, a gap persists
between setting nationally
determined climate change mitigation targets and establishing cooperative, practical
implementation measures [1]. This
inertia arises from the significant economic burden and potential risks to international
trade that early adopters, or
"first movers," would disproportionately incur.
Global trade and climate change are fundamentally interconnected. While international trade facilitates economic growth and can promote technology transfer, which is important for emissions reduction. Its current structure also risks shifting pollution to less-regulated regions that don’t have stringent climate policies and innovation. This latter effect, known as carbon leakage, is the phenomenon where carbon-intensive production relocates to regions with laxer environmental controls. It exposes a critical gap in global climate governance, demonstrating the need to develop trade-related mechanisms to ensure that emissions are accurately priced and accounted for globally [1], [2], [3].
The European Union (EU), in its ambitious "Fit for 55" legislative package, aims to reduce net greenhouse gas emissions by at least 55% by 2030 relative to 1990 levels, and ultimately achieve carbon neutrality by 2050. A cornerstone of this package is the Emissions Trading System (ETS). Operating as a cap-and-trade mechanism, the ETS requires industrial facilities across designated sectors in EU states to acquire and surrender carbon allowances, which are tradable permits that authorize the emission of one metric ton of carbon dioxide equivalent. The system is a sophisticated approach to emissions reduction because it creates a market-based incentive: firms receive a limited number of free allowances but must procure any additional required permits either through auction or by trading with companies that have successfully reduced their own emissions.
However, ETS’s efficacy is challenged by the risk of carbon leakage. Consequently, this is projected to lead to the decline of industrial activity within the EU as companies would seek cost-effective production elsewhere. In this scenario, the policy risks becoming counterproductive, leading either to the contraction of the EU industrial base or, worse, to the increased import of carbon-intensive products [4]. The risk is expected to escalate as the price of carbon increases, underscoring the necessity of a coordinated response to leakage [5]
In response to the risk of carbon leakage and to ensure the competitiveness of its local industries, the EU initiated the application of the Carbon Border Adjustment Mechanism (CBAM) on October 1, 2023. The CBAM establishes a system to equalize the carbon cost between domestic and imported products by ensuring that a carbon price has been paid for the embedded emissions of certain imported goods [6]. Implementation includes a transitional phase from 2023 through 2025, during which importers are to report for the first time by January 31, 2024. The mechanism will fully enter its definitive operational phase in January 2026.
Since the European Commission proposed the CBAM, there have been many reactions from academicians, industries, and governments in several parts of the world. Some scholars have argued that it is a way to impose a new form of tariff, since the EU has a robust green energy technology. Some others have viewed it as a protectionist policy. Other scholars have analyzed the trade impact on certain developing countries [7], [8], [9], with the BASIC countries (Brazil, China, India, and South Africa), as well as Russia, arguing that this goes against the World Trade Organization’s law and the principle of Common but Differentiated Responsibilities (CBDR). Some others have analyzed the impact of the system on the multilateral trade system. This article aims to synthesize all differing opinions about the CBAM and present them as they relate to both the environment and trade. We also show what a “fit for all” Carbon Border Adjustment system would look like, as presented by several scholars.
Legal and Regulatory Perspectives
In this section, the legal foundation of the Carbon Border Adjustment Mechanism (CBAM) is
principally scrutinized
against the core tenets of international law and climate frameworks, including the UNFCCC’s
CBDR, the Paris Agreement,
and World Trade Organization (WTO) law.
While many analyses suggest the CBAM could incentivize the decarbonization of Emission-Intensive, Trade-Exposed (EITE) industries globally, its implementation is challenged by concerns bordering on fairness, particularly toward developing nations.
However, the international legal framework provides context for such unilateral action. Article 3.5 of the United Nations Framework Convention on Climate Change (UNFCCC) states that "measures taken to combat climate change, including unilateral ones, should not constitute a means of arbitrary or unjustifiable discrimination or a disguised restriction on international trade." This clause confirms that the UNFCCC does not prohibit measures such as the CBAM outright, provided they meet clear non-discrimination and transparency standards.
Further complicating the fairness argument is the CBDR principle explicitly stated in Article 3.1 of the UNFCCC:
“The Parties should protect the climate system for the benefit of present and future generations of humankind, on the basis of equity and in accordance with their common but differentiated responsibilities and respective capabilities. Accordingly, the developed country Parties should take the lead in combating climate change and the adverse effects thereof.”
This principle puts the spotlight on industrialized nations to lead in climate change mitigation efforts [11]. This is a result of their historic contributions to emissions. Although the Paris Agreement no longer reserves the exclusive right to emissions mitigation for developed countries, it now binds all members to prepare, communicate, and maintain nationally determined contributions (NDCs) that they intend to achieve, coupled with domestic measures to achieve those objectives. But this is achieved based on normative expectations in light of different national circumstances.
The imposition of equivalent carbon costs would raise profound economic and equity concerns. As Lowe [12] argues, it is unreasonable for poorer countries to shoulder the same burden as richer countries, noting that this may widen the gap between the rich and poor nations, especially as poorer countries may have less access to low-carbon financing and technology [13]. While the EU has acknowledged the issue, trust remains uncertain amongst its trade partners. A major cause is the lack of transparency about the use of revenues made from the sale of certificates, which could be better utilized by channeling them towards helping developing countries with decarbonization efforts.
Furthermore, the EU’s commitment towards the Global South is viewed as insufficient. The mechanism offers a gentle statement that the EU ‘stands ready to work with low and middle-income countries towards the decarbonization of their manufacturing industries [and] should support less developed countries with the necessary technical assistance to facilitate their adaptation to the new obligations’. Critics argue this is in contravention of Article 9 of the Paris Agreement, which requires developed countries to provide financial support to assist mitigation efforts by developing countries [11].
This brings us to the next cause of criticism: WTO compatibility. This section analyses the CBAM against the fundamental principles of the General Agreement on Tariffs and Trade (GATT). The relevant GATT articles relevant to this analysis include: Article 1: General Most-Favored-Nation (MFN) Treatment; Article II: Schedules of Concessions; Article III: National Treatment on Internal Taxation and Regulation; Article XI: General Elimination of Quantitative Restrictions; and Article XX: General Exceptions.
GATT Article 1 is a cornerstone of WTO laws [14], mandating that a member state, and in this case, EU states, refrain from discriminatory acts in trade. It requires that any benefit or privilege granted to a product originating from one country must be extended to the “like product” originating in all other WTO countries. However, the CBAM introduces a complex challenge to this principle. While the CBAM itself applies universally to all non-EU imports, its financial impact will be assessed differently based on each exporting country's domestic environmental regulations and technology levels [15].
GATT Paragraph 2 of Article II provides the legal exception that allows border measures related to domestic taxation, stating that: “Nothing in this Article shall prevent any contracting party from imposing at any time on the importation of any product: (a) a charge equivalent to an internal tax imposed consistently with the provisions of paragraph 2 of Article III in respect of the like domestic product or in respect of an article from which the imported product has been manufactured or produced in whole or in part”
This, therefore, permits the introduction of CBAM if the charge collected on imports is strictly equivalent to the internal carbon price that EU producers must pay under the ETS.
GATT Article III governs Article 2. It imposes that: (1) “the contracting parties recognize that internal taxes and other internal charges, and laws, regulations and requirements…should not be applied to imported or domestic products to afford protection to domestic production”, and (2) “The products of the territory of any contracting party imported into the territory of any other contracting party shall not be subject, directly or indirectly, to internal taxes or other internal charges of any kind in excess of those applied, directly or indirectly, to like domestic products”. While the CBAM aims for equality, critics highlight that its current design potentially violates the non-discriminatory principles of Article III [16]. If EU producers benefit from certain free allowances while importers must pay the full equivalent carbon price, the measure affords de facto protection to domestic production, directly contradicting the mandate of GATT Article III:1.
GATT Article XI, paragraph 1 strictly prohibits the use of Quantitative Restrictions (QRs)- such as quotas, import/export licenses, or prohibitions on trade:
“No prohibitions or restrictions other than duties, taxes or other charges, whether made effective through quotas, import or export licences or other measures, shall be instituted or maintained by any contracting party on the importation of any product of the territory of any other contracting party or on the exportation or sale for export of any product destined for the territory of any other contracting party.”
The EU designed the CBAM as a financial charge to fall outside the scope of Article XI. However, critics argue that if the cost imposed by the CBAM is prohibitively high for certain low-income countries' producers, the charge could be argued to be a ban. Similarly, if the mandatory requirements are so burdensome that they prevent some foreign producers from assessing the EU market, it could be seen as a hidden restriction or barrier [15].
The EU Commission has to defend the CBAM in the WTO under Article XX. Article xx(b) makes exceptions for measures that are necessary to protect human, animal, or plant life or health. Article XX(g) makes exceptions for measures relating to the conservation of exhaustible natural resources if such measures are made effective in conjunction with restrictions on domestic production or consumption.
Successfully invoking either exception would require the CBAM to pass the Article XX Chapeau test, proving that the mechanism is not applied in a manner that constitutes arbitrary or unjustifiable discrimination between countries or a disguised restriction on international trade.
In summary, the legal issues surrounding CBAM have created an environment where trade friction and retaliatory measures are distinct possibilities. Recognizing that policy decisions, even those driven by climate necessity, can trigger geopolitical and economic responses, the next section will consider the potential impacts of this policy on international trade.
Economic Impacts of CBAM
The implementation of CBAM is expected to trigger significant shifts in global production,
trade flows, and economic
activity. This review considers the mechanism’s projected impacts on GDP, trade flows,
greenhouse gas (GHG) emissions,
and possible retaliation from global trade partners.
The CBAM’s impact on the EU’s own GDP is projected to be minimal (0.2% decrease by 2030) [17]. However, the real economic risk lies in geopolitical tension and trade friction. To maintain balanced trade relationships and limit trade retaliation, it is essential to have a revenue recycling scheme. This scheme would be important, particularly for fossil fuel exporters who risk being affected greatly if this were not to happen. It would also save the interests of major trade partners and limit the likelihood of retaliation. However, it might limit the effect of the carbon price, unless the recycled revenues are targeted towards low-carbon alternatives [18].
The mechanism would exert uneven pressure on trade partners, depending on their industrial structure and trade relationship with the EU. According to a study, countries such as Mozambique, Cameroon, Morocco, and Tajikistan may face a decline in export volumes exceeding 2% [19]. It was also analyzed that the mechanism will specifically challenge industries heavily reliant on iron and steel, aluminum, fertilizer, and cement, as these materials mark the EU’s highest imports [19], [20]. China faces the overall highest risk. As the EU’s largest trading partner, its unique industrial and energy mix exposes a significant portion of its exports to the CBAM’s cost adjustments.
Economic activities in the global south will be largely affected, particularly the steel, fertilizer, and aluminum sectors [21]. The burden is amplified by pre-existing structural issues. Developing economies often suffer from rigid labour markets and high dependence on a few carbon-intensive sectors, which makes the transition extremely costly [17]. For firms in regional blocs like ASEAN, the risk of higher carbon-adjusted costs is compounded by outdated machinery and poor access to renewable energy inputs. Without integrated carbon governance frameworks at the regional or national level, these firms will struggle to compete on cost.
Adoptable Policies to Mitigate CBAM’s Impact
Scholars have proposed various policy adjustments to mitigate the economic and legal
challenges posed by the
implementation of the CBAM. One widely proposed solution is a review of the CBAM’s provision
to respect the technical
and economic capabilities of each partner country [22]. Specifically, some scholars advocate
for the introduction of
tiered carbon charges. This approach is based on the argument that a uniform carbon price
creates an excessive burden on
importers from developing economies [22], [23]. Although critics argue this would likely
constitute a clear violation of
the WTO’s MFN policy, and conflicts with established global trade norms.
A more trade-complaint policy strategy involves exporting countries establishing their own domestic carbon pricing mechanisms. By doing this, these nations can levy the carbon cost at the source rather than paying it to the EU at the border. However, implementing such systems remains difficult for countries lacking the institutional capacity for rigorous carbon accounting and reporting. Furthermore, even if retained domestically, the imposition of a carbon price, whether paid to the EU or local government, still represents a new cost that might be challenging to local industries, if not backed with support.
Recognizing the limitations of purely technical solutions, Byiers and Medinilla [24] suggested the need for diplomatic engagement that advocates the need for reflection on unique economic realities, while making provisions to decarbonize.
References
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