Explained: How To Decarbonise Global Trade, Equitably

Questions such as these are being debated at the ongoing 26th Conference of Parties, where world leaders are negotiating on rules on carbon markets under Article 6 of the Paris Agreement. These rules would put a price on carbon emissions and allow international sales of carbon credits.

A carbon border tax is one of the tools of carbon pricing that developed countries have suggested. But unless rich countries help developing economies like India access the funds and technology needed to transition to clean alternatives, a carbon border tax penalising the export of carbon-intensive products such as steel and cement would be unfair, say experts. It would impact growth and employment opportunities in developing countries, they point out.

Decarbonising international trade

Why did decarbonising of global trade become imperative? Around 27% of global carbon dioxide emissions in 2015 were linked to international trade, according to an Organisation for Economic Co-operation and Development (OECD) paper published in 2020. These emissions are concentrated in exports from seven industries--mining and extraction of energy producing products; textiles and apparel products; chemicals and non-metallic mineral products; computers, electronic and electrical equipment; machinery and equipment; and motor vehicles.

There are already carbon taxes on domestically manufactured goods. The European Union (EU), for instance, has an Emissions Trading System (ETS) where it caps greenhouse gas emissions for industrial units and those that fail to cap their emissions can buy "allowances" from those who have made deeper cuts.

However, domestic carbon tax differs between EU countries. For instance, Sweden's carbon tax costs about $137 (Rs 10,191) per metric tonne of carbon dioxide while Switzerland charges $101 (Rs 7,521).

'Burdening poor countries'

The carbon tax is a fee imposed on burning of carbon-based fuels while producing a product. When a country sells carbon-intensive products, these are taxed at the border of the importing country.

In July 2021, the EU imposed a border tax on imports of carbon-intensive products as part of its strategy to cut greenhouse gas emissions by at least 55% by 2030. But the move drew criticism from India, Brazil, South Africa and China for being "discriminatory".

The EU is India's third largest trading partner and accounted for €62.8 billion ($74.5 billion) worth of trade in goods in 2020, or 11.1% of India's total global trade. By increasing the prices of Indian-made goods in the EU, this tax would make Indian goods less attractive for buyers and could shrink demand, we reported in July 2021.

The idea of a carbon border tax imposed by developed countries was criticised in October 2021 by the UN Conference on Trade and Development for potentially burdening developing economies that still depend heavily on coal, limiting their exports and constraining their budget for climate action. If imposed, taxed countries could face a substantial loss of revenue from tariffs imposed on exports, lose their competitive edge and be forced to remain net importers with poor production capacity, stated the report. In 2019, export tariff revenues earned by developing countries amounted to $15 billion.

Pros of carbon tax

Domestic carbon tax, as opposed to one imposed at the global level, has a problem as the EU experience has shown. It leads to carbon leakage: This means that given how expensive it is for some businesses to operate within the EU, they relocate to countries with more relaxed emission limits.

It was to deal with this that the EU suggested the extension of the carbon tax to cross-border trade because this would allow countries to hold on to their competitive edge.

The strength of a carbon border tax is its potential ability to shift the burden for mitigating the damage caused by climate change to market players who are actually responsible for it, according to the World Bank. It would encourage producers to adopt clean technologies and market innovation.

There are produced and consumed emissions in an interconnected global economy, said Aman Srivastava, fellow at the Centre for Policy Research. The tax would pinpoint the exact origin of the emissions and reduce instances of exported emissions.

Cons of a carbon border tax

The carbon border tax expects developing countries to stick to the environmental standards set by developed countries and this violates the principle of 'common but differentiated responsibility' (CBDR) in the Paris Agreement, said the October 2021 UNCTAD report. The principle acknowledges and compensates for the fact that wealthy nations have historically emitted far more carbon than poorer nations, who also suffer far more from the impacts of climate crises.

For developing countries, a carbon trade tax has several pitfalls, as we said earlier. In countries whose economic structures depend on energy-intensive activities, as is the case with major steel and cement exporters, competitive disadvantages in international markets could result in job losses, according to the July 2021 UNCTAD report. The report analysed the implications of Europe's carbon border tax on developing countries.

"With the EU's carbon border tax, countries, including developing countries, stand to be taxed for emissions that aren't even contributing to their own domestic consumption. It adds an element of unfairness, in addition to the trade and other climate equity concerns," said Srivastava of CPR.

There are no protocols in place yet on how a carbon border tax would look like but they would need to take into consideration the needs of developing economies, said experts. "The developing world has already suffered from the failure of the rich countries to both reduce their emissions fast enough, and their failure to live up to their finance commitments," said Ashish Fernandes, chief executive officer at Climate Risk Horizons, a Bengaluru-based organisation working on the impact of the climate crisis on financial systems. "A carbon border tax that will hurt exports and employment in developing countries would be rubbing salt in the wound."

As we reported in October, in 2009, developed countries had pledged to deliver to developing countries an annual climate fund of $100 billion by 2020. But only about 65% of the $100 billion promised has been delivered by developed countries on average between 2013 and 2019 and most of it in the form of expensive loans.

Alternative approaches

The one-size-fits-all approach would not be equitable in carbon taxing, said Srivastava of CPR, adding that countries have different capabilities in dealing with competition.

The October 2021 UNCTAD report has also suggested a differential approach for developing and developed countries that would be more equitable. This requires developed countries to make clean technology more accessible--doing away with intellectual property rights or patents on it, for instance, or providing financial support to help poor countries cover the incremental cost of sourcing it, the report said.

Countries could also develop a carrot-and-stick carbon tax system, said Fernandes of Climate Risk Horizon. For instance, developed countries could set gradual emissions reduction targets on products imported from developing countries, based on which they could provide access to finance.

New clean technologies like cheaper solar panels, green hydrogen technology and methods of extracting energy from ocean tides need to be prioritised for climate action because global emissions cannot be stabilised with existing technologies, say experts.

In developed countries, where most technological developments occur, patents are used to incentivise innovation but these also end up making them unaffordable for poorer economies. For instance, green hydrogen based steel is already being developed by European companies like ArcelorMittal and Thyssenkrupp, we reported in September 2021. But, in India, the challenge is to make this transition economically competitive and commercially viable, we said.

We reached out to the Ministry of Trade and Commerce for their comments on the EU's carbon tax on November 3. We will update when we receive a response.

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