To avoid stricter climate policies, countries often shift their production towards countries with lower carbon costs, known as ‘carbon leakage’. Since the world is struggling with these uncertainties, it demands collective climate efforts and robust policies. One such response to counteract this leakage is applying the transitional EU’s Carbon Border Adjustment Mechanism (CBAM), also known as carbon tariffs, that minimizes carbon leakage and promotes global decarbonization by imposing a carbon cost on specific imported goods based on their production-related emissions. Here I explore CBAM as a transformational policy that examines the synergies between economic and environmental factors and covers the tradeoffs, such as trade conflicts and economic challenges, by aligning the trade practices with carbon neutrality goals.

While the policy aimed at leveling the emission production between domestic and foreign producers, most studies criticize CBAM as a protectionist mechanism that only incorporates its emissions from production-based emissions without accounting for consumption-based emissions and historical emissions responsibilities. Moreover, in redefining competitiveness across regions, this instrument breaks traditional paradigms of global trade by placing environmental costs on foreign producers, redefining competitiveness across areas, particularly countries producing carbon-intensive goods such as China, Indonesia, and South Africa. Thus, given the increasing role of trade openness in economies worldwide, the paper focuses on a comprehensive assessment of CBAM’s broader implications for international trade and sustainable development. It emphasizes the need for inclusive and adaptive policy frameworks that account for trade tensions, economic vulnerabilities, and the differentiated capacities of nations in the global climate regime.

In light of the worsening climate crisis and rising global carbon prices, countries are under pressure to implement effective strategies to internalize the environmental damage without compromising trade competitiveness. A major problem is the phenomenon of carbon leakage, where countries relocate their carbon-intensive production to countries with weaker or no carbon regulations to avoid stricter domestic regulations. This undermining effect on the global climate initiative has resulted in policy responses, particularly within the borders of the European Union (EU). The EU has taken the lead in this area by introducing the CBAM, which was first proposed in 2021 and is set for full implementation in 2026. It supports a broader agenda of ‘carbon diplomacy’ by equalizing carbon costs on domestic and foreign producers under the Emission Trading System (ETS), linking environmental sustainability to international trade policy (Hancock et al. 2021).

Policy implications

CBAM incentivizes the reduction of carbon footprints on imported goods by imposing a carbon price on these products. Exporters are encouraged to maintain their market access by adopting cleaner technologies. Furthermore, investments in global sustainable industries support the transition to lower-carbon production methods. Recent studies indicate that CBAM could boost revenue from €0.1 billion to €2.8 billion by reducing exports across various sectors by 0.6% to 14.2% by 2030. This revenue increase can be reinvested in green technologies and redirected toward low-carbon industries. However, the global effect of the CBAM is expected to be less than 1%; its sectoral and regional implications are considerable (Korpar et al., 2023). For instance, the restriction on import-dependent goods by the EU has, in turn, increased domestic steel production from 1.31% to 5.24%, as EU countries are now more interested in domestic production and less in imported goods. In contrast, Japan, which has been producing less carbon-intensive products due to energy-efficient sectors, would have lower costs and is likely to extend its exports to the EU under CBAM (Mortha et al., 2023). Thus, it can be assumed that CBAM not only considers environmental responsibilities but also leads to economic growth.

Policy challenges

Despite its climate goals, CBAM’s implementation has faced controversy and resistance from stakeholders globally. Critics suggest that CBAM is likely to encounter significant opposition from fossil fuel-dependent economies such as Iran, Ukraine, the U.S., China, India, and Russia, which perceive CBAM as a threat to their industrial competitiveness and export trade (Overland and Sabyrbekov, 2022). The Asia-Pacific (APAC) region consists of developing economies with limited carbon pricing mechanisms, is expected to be most vulnerable to the EU's CBAM. A reduction in global exports is expected, with global declines ranging from -0.29% for metal products to about -1.49% for steel. For example, crude steel exports from South Asia could go down by -10.52%. Such results suggest that the CBAM is a protectionist policy that negatively affects a country’s exports and GDP, raising issues of economic and environmental efficiency of such carbon border measures. (Mothreal et al., 2023) This concern is particularly relevant for China, the EU's largest trading partner, whose carbon-intensive and export-oriented industries could be severely affected if the scope of this policy were fully applied.

Thus, CBAM primarily triggers responses from developing economies, which argue that it slows their economic growth, causes trade conflicts, legal challenges in World Trade Organization (WTO) rules, and regional trade inequalities among exporters with a gap in trade equality. Moreover, Global South countries with limited financial and technological resources for decarbonizing their industries may face the negative consequences of CBAM, leading to diminished export capabilities and economic challenges. The latest simulations show that CBAM will produce only marginal effects on global emissions and mainly declines in exports and distributional risks. This brings into question the effectiveness and fairness of the policy, especially given the EU's global climate leadership.

Policy recommendations

To create fair and efficient systems for CBAM, a balanced policy is required that minimizes the tradeoffs between environmental responsibility and economic growth. First, the policy should be gradually implemented by providing financial assistance (in the form of subsidies and tax breaks) to support specific sectors, particularly in developing economies, to encourage them to continue their trade and economic growth by adopting energy-efficient technologies. Second, providing financial incentives to countries, such as carbon certificates to reduce their emissions, and generate revenues by selling their surplus credits to nations that have exceeded their limits. Third, EU countries also need to cut down internal emissions. For instance, 68.4% of EU energy comes from fossil fuels. Other policy recommendations include: a strong monitoring system that inspects the effects of the CBAM on trade, industry, and emissions by drawing data-based conclusions to be used for supporting possible modifications to the mechanism, and engaging stakeholders, NGOs, businesses, and industry associations in international discussions and negotiations to develop a unified carbon pricing approach. By integrating these policy recommendations, CBAM can serve as an effective policy tool in promoting global decarbonization while supporting sustainable economic growth.