Carbon leakage is a type of spillover effect in which a country’s adoption of stricter climate policies leads to a reduction in emissions in the country, and an increase in greenhouse gas emissions in another country. If a country’s emissions policies increase local costs, another country with less stringent policies may have a trade advantage. While the demand for the produced goods remains the same, production may shift to a country with lower prices and standards (offshore production), and ultimately global emissions are not reduced. Carbon leakage will undermine the effectiveness of national carbon markets; inter-regional carbon leakage brings uncertainty to the emission reduction effect of the carbon market.
On the one hand, regions with loose allowances will have greater influence in the market and lose the incentive to further reduce emissions. On the other hand, the fairness of allowances in regions with scarce emission permits is impaired. Enterprises no longer make decisions on the purchase and sale of carbon credits according to the laws of the market, bringing uncertainty to the overall emission reduction effect within the market and making it difficult to ensure the economics of emission reduction. Therefore, the European Parliament has been considering a Carbon Border Adjustment Mechanism (CBAM). The mechanism starts with the power and energy-intensive industrial sectors and imposes a carbon tax on imports of certain products from countries with less stringent greenhouse gas (GHG) emission regulations than the EU.
The most immediate impact is that CBAM implementation could increase the cost of importing carbon-intensive goods produced in Asia into Nordic/Europe. If Asian companies are unable to offer carbon pricing certificates equivalent to those in Europe, they may face additional cost burdens. As European customers are more likely to choose low-carbon products that meet CBAM requirements, Asia companies thus lose the competitiveness in the European market. At the same time, to avoid the cost of CBAM, some Nordic/European companies may consider shifting their carbon-intensive production from Asia to Europe, which could lead to a shift and repositioning of industries, with implications for Asian economies and employment.
On the bright side, such a shift may also create jobs in Europe and contribute to European countries’ carbon reduction targets. As one of the goals of CBAM is to encourage non-EU countries to adopt cleaner industrial production methods, Asian companies may take steps to reduce carbon emissions in order to avoid the additional costs associated with CBAM. Such measures may include improving production processes, introducing low-carbon technologies, or increasing the use of renewable energy. This will drive Asian companies to transition to cleaner production methods. Meanwhile, European companies may work with Asian suppliers to help them improve the energy efficiency of their production processes and reduce carbon emissions in order to comply with CBAM requirements. This could facilitate technology transfer and knowledge sharing, accelerating carbon reduction on a global scale.
Nevertheless, the implementation of a Carbon Border Adjustment Mechanism (CBAM) presents several challenges that need to be addressed for its successful execution.
First, the audit and administrative processes for CBAM are complex. CBAM requires accurate measurement and verification of the embedded carbon content of imported goods and determining the carbon footprint of products from different countries can be complex and resource-intensive, especially for industries with complex supply chains. At the same time, implementing biodiversity management involves significant administrative and regulatory complexity. It requires the establishment of a robust monitoring system to track imports, calculate carbon content, and determine the corresponding carbon price. Establishing such a system will require coordination between various government agencies, trade bodies, and industry stakeholders. Establishing the necessary infrastructure and expertise to handle the administrative burden of CBAM implementation can be a challenge, especially for resource-constrained countries. Accordingly, developing robust methodologies and establishing international standards for carbon accounting and verification will be critical to ensuring the effectiveness and credibility of CBAM.
Second, CBAM might trigger trade disputes and protectionist measures. Major exporters of carbon-intensive products may perceive CBAM as a trade barrier or discriminatory policy. Under World Trade Organization (WTO) rules, disputes may arise and the affected countries may retaliate by implementing their own trade measures, leading to a cycle of protectionism and trade tensions. At the level of international relations, CBAM needs to be implemented in a manner consistent with the rules and principles of the WTO. The measures should be designed in such a way that they do not violate the most-favored-nation treatment (MFN) principle of non-discrimination or create unreasonable barriers to trade. Striking a balance between climate change mitigation objectives and international trade obligations requires careful consideration and consultation with relevant stakeholders, including trading partners and WTO members. Addressing these issues and ensuring that CBAM complies with international trade rules is critical to avoiding the escalation of trade conflicts.
Finally, CBAM relies on accurate and transparent data on carbon emissions from domestic and foreign industries. However, the availability and reliability of data can vary from country to country, making it challenging to ensure a level playing field. Addressing data gaps and promoting transparency in reporting and disclosure is critical to the effective implementation of CBAM.In reality, there are a number of potential strategies that companies can adopt to reduce the impact of CBAM.
To begin with, one of the most effective ways is to reduce their carbon footprint. By implementing energy efficiency measures, adopting clean technologies, optimizing production processes, and transitioning to renewable energy sources, companies can reduce their emissions. This can help them comply with CBAM’s requirements and reduce the carbon costs associated with their products. However, in the process, companies need to re-evaluate their supply chains and work with their suppliers to improve their environmental performance. In the process of supply chain optimization, companies need to encourage their suppliers to adopt sustainable practices, reduce emissions, and improve the transparency of their operations that can help reduce the carbon footprint of the entire supply chain, thereby mitigating the potential impact of CBAM on imported goods.
Besides, companies can consider investing in carbon offset programs or purchasing carbon credits to compensate for their emissions. Offsets include supporting activities that reduce or eliminate greenhouse gas emissions elsewhere, such as reforestation projects or renewable energy initiatives. By participating in offsets, companies can demonstrate their commitment to carbon neutrality and potentially reduce the CBAM costs they face. In the process, companies can also work together to address the challenges of CBAM by participating in industry collaborations and trade associations, for example, to jointly negotiate and propose alternative policy approaches that balance climate goals and trade considerations.
In all, for Asian countries, they are heavily dependent on international trade and are major exporters of goods and services. Implementing CBAM-like policies will have an impact on their trade relationships, particularly with countries that do not have similar carbon pricing mechanisms. Asian countries will need to carefully consider the potential impact on their export industries and broader trade dynamics before adopting such policies. The implementation of CBAM-like measures has the potential to lead to trade disputes and inter-country tensions. Exporting countries without equivalent carbon pricing mechanisms may view such policies as unfair trade practices or discriminatory measures. Of course, Asian countries could also consider regional cooperation on carbon pricing mechanisms. For example, the Association of Southeast Asian Nations (ASEAN) has been discussing the possibility of establishing a regional carbon trading system. If such initiatives are taken seriously, it may reduce the need for individual countries to adopt CBAM-like policies, as regional coordination could collectively address the issue of carbon leakage. While CBAM may help protect domestic industries and advance climate goals, it might also disrupt international trade and create trade tensions with countries that do not have similar policies in place. Finding a balance between climate action and international trade will be crucial for the successful implementation of such policies.
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