The CBAM effect

Edward Norton Lorenz’s most famous Butterfly Effect rests on the notion that one small occurrence can influence a much larger complex system. Fifty years later, a metaphorical application of this can be found in the EU’s proposed Carbon Border Adjustment Mechanism.

Edward Norton Lorenz’s most famous Butterfly Effect rests on the notion that one small occurrence can influence a much larger complex system. Fifty years later, a metaphorical application of this can be found in the EU’s proposed Carbon Border Adjustment Mechanism. Seeking to help fight climate change by putting a tax on raw materials based on their CO2 emissions, it would not only fall short of its very objective but also drive production and investments outside of Europe, triggering a substantial loss of European jobs, with no positive impact on the environment. One occurrence influencing a much larger complex system. 

Products which are manufactured abroad and imported into the EU will have an unfair competitive advantage over European manufactured products on the EU Single Market. The Mechanism was in fact originally designed for raw materials and electricity, while the inclusion of finished products was discarded due to administrative complexity. Finished products that are manufactured with the same raw materials covered by CBAM and therefore become less competitive when manufactured in the EU, than equivalent goods manufactured outside of the EU. 

The carbon will simply be emitted elsewhere. If carbon-intensive downstream products are more competitive than sustainable alternatives, the total balance of carbon emissions may be aggravated. Let’s take the case of a washing machine manufactured in Europe. The cost of carbon emissions will apply on the aluminium, iron and steel used in the production process, whether these have been supplied in the EU (subject to the EU-ETS) or imported from elsewhere (subject to CBAM). However, the same washing machine manufactured outside of Europe will not be subject neither to the EU-ETS, nor to CBAM. Such a scenario not only falls short of the objectives set by the European Green Deal, as it does not reduce CO2 emissions outside of the EU, but it also negatively affects European competition, ultimately creating an incentive for industrial delocalisation and jeopardising EU exports, accordingly. Overall, EU-based manufactures will face an increase of at least 5-10% of manufacturing costs to produce one single washing machine. The same cost increase will not be faced by the same manufacturer, with a factory located outside of the EU. As a result, European consumers will be incentivised to purchase cheaper imported goods to which no equivalent carbon pricing is applied, rather than EU-made goods at a higher price. 

If corporate investments are diverted away to non-EU countries, employment will also suffer. It is likely that certain European manufacturing sites will close to be ultimately relocated in non-EU countries. According to a study conducted by the French Federation of Mechanical Engineering (FIM), replicating unpublished investigations of the French Ministry of Economic and Financial Affairs, many downstream sectors would be adversely affected by the Measure. Products like home appliances, agriculture equipment, and transport would be exposed to carbon leakages. Only in France, this quantifies in 3.000 companies and 300.000 jobs. 

The method for carbon leakage risk calculation as defined in Art. 10b of the EU-ETS Directive could serve as a compass to detect downstream products at risk of carbon leakage, in a similar fashion to what has been done for raw materials over the years. The relative levels of global trade and emissions intensity could reveal downstream sectors mostly exposed to non-EU competition. This is where the introduction of a complementary legislative proposal would come into play to prevent carbon leakage in the relevant sectors, while safeguarding European jobs and industrial competitiveness.

The decisive trialogue among EU negotiators to agree on a definitive carbon levy is expected to take place later today.