In the fight against climate change, market mechanisms aimed to incentivize polluting firms to switch to less carbon-intensive methods of production, such as the carbon tax, have received high levels of support from experts. Essentially, a carbon tax places a dollar amount of tax per tonne of carbon emitted and is designed to reduce the pollution that firms and individuals alike have historically done without any repercussions or redress. Currently, a carbon tax has been instated in some form in 40 countries across the world, including Canada and much of the EU. Enacting the carbon tax into law, however, has often encountered political opposition, as is evidenced by the United States. A key argument criticss of the tax make is that it would harm domestic industries, making them less competitive against polluting firms in countries with no price on carbon.
This is where the idea of carbon tariffs, or carbon border adjustment mechanisms, comes in. A carbon tariff would place a tax on emission-heavy imports from a country with no carbon tax, thus offsetting the lack of a carbon tax in the exporting country. Ideally, this would signal to exporting firms that if they wish to have continued market access at a more economical price, it is in their interest to cut back on the amount of emissions required to produce their goods. The EU has put forward such a proposal as part of their ‘Green Deal’ on certain industries such as steel and cement, set to come into effect this year. Other countries including the United States and Canada have also floated the idea.
If implemented, these tariffs would also come with a series of trade-offs. On the one hand, on top of cutting global emissions, they could potentially address the free-rider problem in global environmental policy. This occurs when a country with few climate regulations takes advantage of the benefits brought by one that has reduced its emissions without doing any of the necessary work themselves. On the other hand, these tariffs could spark sentiments of trade protectionism at a time when the global economy is in need of recovery from the COVID-19 pandemic. Furthermore, their enactment could harm developing countries who rely on the export of raw materials as crucial sectors of their economy. For those considering pursuing a carbon tariff, a wide set of political and economic factors will have to be considered, and even then there is no guarantee of their success.
One main reason behind the recent proposals for carbon tariffs is to prevent what is known as ‘carbon leakage.’ Carbon leakage occurs when a country or region has imposed a price on carbon, and as a result, industry then relocates elsewhere only to import back to that region without having to pay the imposed tax. This is thought to have occurred in the EU with their emissions trading scheme and carbon tax. A carbon tariff would prevent this from happening and would help appease critics who, with some justification, worry that a domestic price on carbon makes industry uncompetitive. To avoid a shock on producers and the economy, the tariffs would have to begin at a lower price and gradually increase over time, as Canada intends to do. This would give ample time for both suppliers and consumers to shift to greener alternatives.
To prove effective, carbon tariffs would have to be implemented by many countries in coordination. If done single-handedly by a small or medium-sized economy such as Canada, many firms could seek to export elsewhere if the tariffs were too high a price for their goods. A single country might also be unable to withstand any retaliatory measures by a country impacted by the tariffs. Conversely, an EU-wide tariff could prove effective as it is one of the largest consumer markets on earth, and trade with heavy polluting countries such as China has only been increasing in recent years.
If applied on an even larger scale, which could include the EU, United States, and Canada, a serious signal would then be sent to manufacturers and other industries to scale back emissions. Cumulatively avoiding these markets would prove difficult for large exporters, as together these markets account for over 33% of world GDP. Not only would this coordinated move be a powerful one economically, but it would be a strong one politically, too. It would show a serious effort to limit emissions and give those countries greater influence at international summits that negotiate on climate change.
There is little doubt that these tariffs would come with drawbacks and repercussions, some of which can only be speculated upon as till now they have not been used widely. The first is that they would anger trading partners. No exporter welcomes tariffs of any kind, as they boost the cost of selling their products abroad. Thus, if they were to come into effect, accusations of protectionism of domestic industries would likely begin immediately. This is an argument critics of carbon tariffs make; that the tariffs could be weaponized against foreign countries while exempting domestic industries for political gain, in turn shrinking global trade.
Global trade has already been shaken recently by the trade war initiated by former President Donald Trump against China, followed by the COVID-19 pandemic. Heavy-polluting countries that rely on exports, like China, may view this as yet another targeted trade measure. China’s indignation at these tariffs, if put forward by the United States, would be somewhat justified as the U.S. does not currently have an accompanying carbon tax which would delegitimize their entire premise and allow China to retaliate under global trading rules. Even the EU’s current carbon pricing scheme is not equally enforced throughout the bloc, exemplified by granting many concessions, which would likely also raise controversy with nations that rely on exporting there.
Carbon tariffs would also risk burdening developing countries that export to richer regions like the EU, where implementing carbon adjustment mechanisms is much more feasible. For countries earlier in their development, it is more difficult to subsidize the greener technologies necessary for decarbonization, and many must still rely on fossil fuels for electricity and powering their factories. A carbon-levy could price them out of the market against middle-income countries like China and India. One method of rectifying this problem could be similar to a financial aid stipulation in the 2015 Paris Climate Accord, wherein the tariffs are paid back to the developing country as a dividend that must be used in clean energy investment.
While its goal is to help reduce global emissions and address the problem of carbon leakage, carbon tariffs are inherently political by impacting the relations between states and crucial parts of their economies. If a country or bloc like the EU is to implement them, it is likely that many conflicts will arise in terms of rhetoric, and perhaps even legal action through the World Trade Organization. Discussion on carbon tariffs comes at a precarious time for global trade and economic recovery, but also for the state of the climate, and leaders will have to decide which one warrants the most decisive action.