CBAM — a green squeeze for developing countries like Pakistan

The European Union’s (EU’s) Carbon Border Adjustment Mechanism (CBAM) is as divisive as it is novel. Where you stand, depends on where you sit. But whatever one’s position it is important to understand the implications and the potential response options of countries with affected industries.

In Pakistan, the discussion around a potential carbon levy, following the securing of IMF funding, has drawn significant attention.

However, many platforms have adopted a narrow, tax-centric perspective, focusing solely on its imposition rather than its broader implications. Instead, a holistic review is essential—one that considers its economic, environmental, and trade-related impacts.

This approach could provide valuable insights for the Ministry of Commerce, the Ministry of Climate Change & Environmental Coordination, and other relevant departments, helping them craft a balanced and strategic response.

For European policymakers, CBAM reflects the EU honouring its Paris Agreement commitments, ‘leading by example’ to lower carbon emissions where others lag behind, at no small cost to its own economy. European industries see it as applying the same rules to others that they are already subject to within the EU market.

For affected non-Europeans, the CBAM reflects a unilaterally imposed EU measure, with minimum consultation with ‘partner’ countries, arguably outside the World Trade Organization (WTO) rules. They portray the EU as overreaching to protect its own industries while imposing the costs of lowering global carbon emissions on other less well-off countries, undermining their industrialisation ambitions in a context of already low manufacturing employment and rapidly expanding populations.

CBAM is seen as blind to the resources available to developing countries to decarbonise, and going against the more country-driven process of Nationally Determined Contributions.

Characterized by some as a ‘green squeeze’ on countries dependent on energy-intensive exports to the EU for export earnings and employment, the EU’s response that CBAM is not a trade measure but a climate measure rings hollow. If it looks, acts and sounds like a tax, they say, its name matters little.

At WTO Platform, during the Committee on Market Access – Formal’s meeting of 25-26 March 2024, the Russian Federation representative mentioned that the CBAM is incompatible with Articles I, II, III, and XI of the GATT 1994.

The representative of China indicated that the Carbon Border Adjustment Mechanism (CBAM) launched by the EU is essentially a unilateral measure. It is suspected of violating the basic principles of Common but Differentiated Responsibilities (CBDR) and Respective Capabilities and Nationally Determined Contribution Arrangements of the UNFCCC and the Paris Agreement. It is also inconsistent with certain WTO fundamental principles, such as non-discrimination.

The Indian representative mentioned that the CBAM forces an emissions reduction path on the EU’s trading partners. It disregards the Nationally Determined Contributions made by the EU’s trading partners and effectively impinges on sovereign decisions.

The worst effects of the EU’s CBAM will be felt by Micro, Small and Medium-Sized Enterprises (MSMEs), who will not be able to meet the complexities of emissions tracking, measuring, and reporting.

Over time, MSMEs may be replaced by big firms in the EU’s trading profile, thus having a negative impact on the sustainable development objective of the WTO enshrined in the Marrakesh Agreement.

Türkiye’s representative mentioned that verification and accreditation under CBAM will use already existing verifiers and accreditors appointed under Regulation (EU) 2018/2067 in the EU.

This would create administrative and financial burden for companies in third countries, as opposed to their counterparts within the EU, and constitute a technical barrier to trade for our operators, which would have to go through double verification processes.

The representative of Argentina mentioned that the CBAM is presented as a means to combat what the EU calls “carbon leakage”, which would occur if enterprises relocated to countries that did not impose carbon limits. This clearly proves that the measure in question is not an environmental measure, but rather an economic, industrial policy and employment measure.

Environmental agreements do not require any country or regional union to adopt specific emission reduction measures; rather, reductions are based on nationally determined measures. Imposing such penalties on products from another country is an arbitrary measure aimed only at stopping the exodus of companies and jobs.

The representative of Thailand mentioned that the CBAM disregards the principle of “Common but Differentiated Responsibilities and Respective Capabilities” enshrined in the Paris Agreement and the UNFCCC.

In short, the CBAM ignores historical carbon emissions, neglects to take into account differing economic, social, and developmental aspects of Members, and most worrisome of all, it discounts Members’ sovereign decisions with the imposition of unilaterally determined emission reduction policies and approaches upon the EU’s trading partners.

Two, it risks inconsistency with the MFN principle as it appears to discriminate like products of different Members based on different non-product-related processes, production methods, or emission reduction schemes.

Three, it risks inconsistency with the National Treatment principle as it appears to put products of Members’ countries with different emission reduction schemes from the EU’s emission trading scheme in a disadvantageous position compared to like products made in the EU.

Moreover, when reliable data for the exporting country cannot be applied for a type of goods, the default values for the charges imposed on imports will be based on the average emission intensity of the 10% worse performing EU installations for that type of goods, putting imports at an even greater disadvantage vis-à-vis EU products.

The South African representative mentioned raised the following concerns: (i) possible inconsistency with MFN and national treatment principles; (ii) reduced competitiveness, complex administrative procedures, and related costs; (iii) that the proposed measures do not take into account differences in levels of development, and do not consider NDCs; (iv) the impact on downstream industries in developing countries, particularly SMMEs; (v) lack of clarity regarding equivalence and mutual recognition of standards with measures adopted by trading partners or third countries; (vi) the handling of proprietary information of exporters into the EU; (vii) the effectiveness of CBAM remains questionable, especially in terms of the environmental impact on reduced greenhouse gas emissions. The Japanese and Republic of Korea representatives also raised their concerns to bring all stakeholders in the loop.

The foregoing in view, countries like Pakistan can use more than one strategy at a time, and can seek to strengthen their position by combining and or sequencing strategies over time. Pakistan, for example, focus on challenging, and avoiding in the short term, while also preparing to emulate - developing carbon pricing - in the medium term, and building a long-term pathway for decarbonisation and green industrialisation.

A fifth potential strategy we do not discuss is to ‘do nothing’. Governments can choose to accept the outcome of CBAM, and allow their carbon-intensive exports to become less competitive on the European market, either directly, or in the event of more indirect emissions being included in the future. They may seek to absorb some of the costs by compensating affected businesses.

All this has strategic implications for developing countries like Pakistan and how they respond to the rollout of CBAM, both in the short and long-term. In the short term, they must prepare their industries to meet CBAM requirements, ensuring compliance with new trade conditions while avoiding (if possible) internalising the penalties.

Simultaneously, they should engage diplomatically to advocate for adjustments that reflect their unique economic realities, such as longer transition periods or differentiated policies.

Over the long term, however, the real challenge lies in reshaping their industrial and trade strategies to align with a decarbonizing global - not just EU - economy, investing in green technologies, and positioning themselves for a more sustainable future.