In December 2022, the European Union (EU) approved a green tax on carbon-intensive commodities called the Carbon Border Adjustment Mechanism (CBAM). It aims at reducing carbon leakage, a phenomenon in which manufacturers move carbon-intensive production to countries with laxer climate policies, resulting in decreased carbon emissions in one country but increased emissions in another. This policy is incredibly relevant to China because it is a significant trade partner with the EU and the world’s largest carbon emitter in 2021. This paper examines how the EU’s CBAM would affect EU-China relations due to its influence on China’s trade, finance, and environment. The article also offers a strategy for China to engage with the EU over the CBAM implementation.
Background
The CBAM is a policy that imposes a carbon tax on specific carbon-intensive imported commodities—such steel, aluminum, cement, fertilizer, and electricity. It was proposed by the EU as a new green mechanism for controlling products that are from outside the EU. The CBAM seeks to level the playing field for European businesses by requiring imported goods to be charged the same carbon tax as those made within the EU. It also aims to stop businesses from moving their operations to avoid EU climate regulations and take advantage of nations with weaker environmental regulations. Under CBAM, the EU categorizes imported goods into simple and complex categories. The former group specifies goods such as food and beverages with zero implicit carbon emissions. The latter requires simple goods in their manufacturing, mainly industrial products. The EU used default values for undetermined emissions based on the exporting country’s average or worst-performing 10% of EU emissions. As of July 2023, the EU has yet to define detailed calculation methods and emission boundaries.
Studies on the CBAM have focused on its general legal issues, economic, environmental, and financial impacts on China. However, the influence of it on China’s domestic decarbonization policies and the politics of EU-China relations has rarely been explored. Lehne and Sartor suggest that the EU should build a complementary cooperation agenda for its CBAM to succeed. For China, Xu and Li show that the EU carbon border adjustment mechanism will have a significant trade impact on China’s four major industries: steel, aluminum, cement, and fertilizer. China’s exports of machinery and transportation equipment to the EU comprise a relatively large proportion. According to the Eurostat, in 2021, China emerged as the top partner for EU imports of goods (constituting 22% of extra-EU imports) in the following categories: machinery and vehicles (accounting for 56% of imports from China), other manufactured goods (35%), and chemicals (7%). Thus, Pang and Chang believe that if the CBAM extended to downstream products, the impact on China’s exports would change fundamentally.
Furthermore, the influence of the CBAM on China’s environment is significant. Chen states that enterprises with stricter carbon emission management, low-carbon green technologies, and more advanced equipment that suit the CBAM will seize the opportunity to export to the EU market and promote China’s green development. The CBAM would also influence the financial investment between China and the EU. Although the impact is not apparent in the short term, in the medium and long term, it may increase the scale of Chinese enterprises’ investment in the EU, change the layout of Chinese investment in the EU, and promote investment in the energy sector to shift to new energy. Thus, the Chinese government should consider the influence of the CBAM on China.
However, it is hard to find any documents looking at the direct political ramifications resulting from the impacts of the CBAM. It can worsen the relationship between China and the EU; further distance the two countries from achieving strategic diplomatic engagement; and affect countries that depend on these two giant economic powers. Moreover, because of escalating US-China relations, it is not beneficial for China to blow up its relationship with other vital powers in the international community. Therefore, it is essential to look at the impacts of the CBAM on China from an international relations perspective and suggest some approaches that China should take to not only customize the CBAM to suit its needs but also utilize it to leverage its relationship with the EU.
The degrading EU-China Relations in recent years
The EU-China relationship has witnessed a long period of growing cooperation and partnership since China and the EU announced a long-term and stable constructive partnership in 1998. The two sides have established more than 70 consultation and dialogue mechanisms covering various fields—such as politics, trade and economy, humanities, science and technology, energy, and the environment. China and the EU are each other’s second-largest trading partners, with a total trade volume of USD 847.32 billion in 2022.
However, the EU-China relationship has shifted from cooperation and constructive partnership towards confrontation and rivalry in recent years. China and the EU, for the first time, disagreed on a joint statement at the annual China–EU Summits of 2016 and 2017, which was an unprecedented development since the launching of the annual summit and a signal of the change in the bilateral relationship. There is a more immediate and noticeable change in the EU’s attitude towards China. The EU’s official statement labeled China as a “systemic rival” and redefined China using the words “competitor” and “rival” rather than “partner” in the EU–China: A Strategic Outlook issued by the European Commission in March 2019. In May 2021, the European Parliament adopted a resolution to defer the agenda agreed upon at the completed EU-China investment agreement negotiations in December 2020 on the pretext of human rights issues in Xinjiang.
China’s negative responses to the CBAM
Because of these negative events, China’s attitude toward the CBAM has been negative. The Chinese government has repeatedly criticized it. According to Chinese state media in April 2021, President Xi told French President Macron and German Chancellor Merkel, “Tackling climate change is a shared responsibility… and should not become a geopolitical bargaining chip or used to attack other countries (or impose) trade barriers.” A month later, former premier Li Keqiang reaffirmed the same warning, adding that the international community should be “wary of new green barriers to trade” and “China asks the EU to justify the upcoming carbon tax at the World Trade Organization.”
The Chinese government argues the CBAM could lead to trade protection and undermine global efforts to combat climate change. They also indicated an urgent need to avoid unilateral measures and discriminatory practices that can lead to market distortions and exacerbate the trust deficit between parties. In July 2021, the Ministry of Ecology and Environment held a press conference in Beijing where Liu Youbin stated that the CBAM is essentially a unilateral measure that unjustifiably expands climate issues into the field of trade. It is against WTO regulations and the tenets and requirements of the United Nations Framework Convention on Climate Change. In particular, the institutional arrangement of “bottom-up” nationally determined contributions and the principle of common but differentiated responsibilities. The initiative and capacity of all parties to address climate change will be severely harmed if unilateralism and protectionism are encouraged. In March 2023, China proposed “multilateral discussions on trade aspects and the impact of certain environmental measures” at the WTO Committee on Trade and Environment, and discussions on CBAM began at the Committee on Trade and Environment (CTE) meeting in June 2023. China’s proposal indicates that the WTO is essential for supervising and reviewing trade policies. Thus, trade policies aimed at achieving environmental goals, such as the CBAM, should conform to the basic principles and rules of the WTO and avoid protectionist measures and green trade barriers. Acknowledging a worsening relationship between China and the EU and China’s negative responses, the CBAM is likely to blow up into a potential trade dispute between these two economic powers.
CBAM and Questions about Fairness and Coercion
The CBAM pressures China’s carbon pricing and financial mechanism and raises concerns about fairness and coercion on China’s environmental policies to adapt to the EU requirements. China is the EU’s second-largest trading partner, so the impact of the CBAM is intimidating to China’s economy. Mo states that China is charged more than USD 20 million dollars annually in carbon tax for 382,000 tons of forged and unforged aluminum exported to the EU. According to requirements by the CBAM, EU importers will pay for the carbon price difference between the EU and third-country producers only from 2026 onwards. Although Chinese manufacturing products remain cheaper than European products due to lower carbon manufacturing costs, they will lose their price advantage when EU importers need to pay the carbon price difference in the future. If China wants to maintain its comparative advantage on exports and prevent the increase in the EU’s green tax at the cost of China’s income, China should improve its carbon price under its emissions trading scheme (ETS) and equate it with the EU’s carbon price. However, the current carbon price difference between China and the EU is huge. In March 24, 2023, the closing price of carbon emissions allowances (CEA) in China is CNY 56.00/ton (USD 8.15/ton), whereas in the EU it is EUR 91.64/ton (USD 98.80/ton)—almost a 12 times difference.
Advancements in clean technology is another demonstration of the unfairness of the CBAM. State-owned enterprises (SOEs) have direct or indirect control in the value chain of the energy and industrial sectors which are responsible for many emissions in China. SOEs contribute to approximately half of China’s carbon emissions. However, SOEs in carbon-intensive industries have a worse performance than non-SOE peers in terms of total factor productivity, an indicator of technology or management improvement of businesses. China is still behind the EU in the use of clean technologies in the industrial sector. This difference is explained by China and the EU having different economic capabilities and resources to invest in clean technologies. The CBAM favors wealthier nations that can more easily afford to transition to cleaner technologies. Suppose China wants to continue exporting to the EU countries. In that case, the country is pressured to alter and update its financial framework to limit carbon emissions based on the EU requirement and waive the CBAM carbon tax on Chinese products. In June 2021, China’s national emissions trading mechanism (ETS) went into effect, requiring more than 2,000 major power sector emitters to report their emissions for 2019 and 2020. Around 40% of China’s total yearly emissions, close to 4.5 billion tons, are included in the ETS’ current coverage area. Given the start of the ETS, it is unfair for China to abide by the CBAM. The EU began operating its ETS in 2005, the world’s first international emissions trading system, whereas China launched its ETS in 2021. That means China only has five years to match Europe’s 11 times higher carbon price, while the EU ETS has been operating for 18 years. The current carbon price disparity and the operation time of the ETS force China to raise its carbon price significantly in a short period; otherwise, Chinese manufacturing products within the scope of the CBAM would face the threat of exiting the EU market.
Although the EU might still recognize China as having an explicit carbon price, it is still ambiguous how to clarify that status since it is an intensity-based cap and it is only limited to some sectors. On the micro-level, China encounters the matter of enterprises’ compliance with reporting and disclosing data. They need policy frameworks to enhance the data verification, update emission factor databases in real-time, and require disclosure of carbon emissions for private enterprises. The CBAM will likely significantly impact China’s financial regulations, particularly in the country’s ETS and data disclosure policies. With the weaknesses and incompatible carbon system compared to the EU, China will need help harmonizing its carbon market regulations with EU norms. The EU could share its methodology for measuring and reporting emissions with China to help them implement strict monitoring and verification mechanisms.
Finally, the fairness of the CBAM is controversial because it ignores other efforts to reduce carbon footprint than carbon pricing. The European Commission regards the CBAM as a landmark tool to promote cleaner production practices outside the bloc. However, it does not consider other emissions reduction schemes in China. China has supplied its heavy-emitting industrial clusters with green electricity since 2015. In 2021, China invested over USD 380 billion in developing renewable energy, the highest investment amount worldwide. The country also observed a renewable surge for power heavy-emitting industrial clusters with green electricity. China is also dedicated to improving the energy efficiency of its existing large industrial companies. An example is the Top-10,000 program, introduced in 2011, which aimed to save 250 million tons of coal equivalent by 2015, contributing to 37% of the total national energy saving target in the 12th Five-Year Plan. China develops renewable energy and implements policies to decarbonize the industrial sector rather than welding carbon pricing to force companies to decarbonize because a high carbon price increases companies’ production costs and negatively impacts their operation. Despite a different path, China still achieves emissions reduction in industrial production, which is a goal of the CBAM. Therefore, the CBAM, which only recognizes carbon pricing, is unfair for China to take other ways to decarbonize manufacturing goods.
Implications on EU-China Relations and Prospects for China’s Engagement
The issues of fairness and coercion and the response of China to the CBAM up until now can potentially ignite trade disputes between the two actors. Whether the CBAM conforms to the World Trade Organization’s (WTO) principle of non-discrimination as stipulated in the General Agreement on Tariffs and Trade (GATT) is a vital question for China. The EU would violate the principle if it were to differentiate between products based on their carbon content, especially if these products are otherwise identical. While the GATT does permit exceptions for environmental reasons, the CBAM would have to be meticulously designed to meet these exception requirements precisely in order to get the approval from other countries. Furthermore, the current practice of providing free allocations to industries at risk of carbon leakage could be interpreted as an export subsidy by the WTO. As noted in a European Roundtable on Climate Change and Sustainable Transition paper, such subsidies are prohibited under the WTO’s Agreement on Subsidies and Countervailing Measures (SCM). However, EU institutions have maintained that the CBAM fully complies with WTO rules, partly due to its association with the phasing out of free allowances under the Emissions Trading System. Yet, other countries such as China do not agree with the EU’s claims. The belief that the CBAM is not compliant to international trade law can flame up the discontent of China. As a result, it will deteriorate the existing strained relationship with the EU. Countries that face penalties under the CBAM, such as China, may even consider retaliatory measures, such as imposing tariffs on EU imports or challenging the mechanism at the WTO because of discrimination or inconsistency with WTO rules. Such trade disputes could escalate into broader conflicts, straining diplomatic relations and potentially leading to trade wars undermining global economic growth and cooperation.
Nevertheless, due to its economic links with the EU and the importance of this region to balance against the US, China may not want to commit itself to a rigid anti-EU bloc or adopt an openly confrontational approach. Instead, China can still utilize a one-year transitional period to enhance its Emission Trading System (ETS) and engage in dialogues to get EU approval on the carbon tax exemption. The CBAM can catalyze collaboration between China and the EU on climate policy and trade issues, fostering partnerships in clean energy research and development, technology transfer, and capacity-building. To capitalize on these opportunities, rather than exercising a concrete attitude against the CBAM, China can seek to establish a network of affected countries. This network will play as an intermediate to facilitate open discussions and consultations with the EU to address the concerns over fairness and coercion, and explore potential avenues for the enhancement of China-EU cooperation to harmonize their carbon markets.
Conclusion
In conclusion, China’s response to the CBAM has been multifaceted, involving policy adjustments, diplomatic efforts, and industrial strategies to mitigate the green tariff’s economic and political impact. Through these measures, China has demonstrated its commitment to addressing climate change while safeguarding its economic interests and global competitiveness. Moreover, the CBAM has far-reaching implications for international relations, raising questions of fairness, coercion, and the potential for trade disputes and retaliatory measures. However, it also offers opportunities for enhanced cooperation on climate change, provided that the EU adopts a transparent, inclusive, and collaborative approach to implementing the mechanism.
Hanh (Minh) Duong is a MS in Foreign Service candidate at Georgetown University Edmund A. Walsh School of Foreign Service (SFS).
Fan Yang is a MA in International Relations candidate at the Johns Hopkins University School of Advanced International Studies (SAIS).
Yidi Zeng is a junior student in Public Policy at both Keele University and Beijing Foreign Studies University.
Jingyi Zhu is a sophomore in Economics at Institute of Economic and Social Research (IESR) of Jinan University.
Kun Li is a sophomore in Energy Economy at the China University of Petroleum (Beijing), School of Economics and Management (SEM)
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