Advisory Council to German Ministry of Economics pleads for establishment of international climate club and CO2 border adjustment

"There are narrow limits to a unilateral climate policy for solving an inherently global problem," says Klaus Schmidt (LMU Munich), chairman of the advisory board on the occasion of the presentation of the report. If the EU unilaterally pushes ahead with the targeted 55 percent reduction in CO2 emissions by 2030, there is a risk that emissions in foreign countries without CO2 pricing go up significantly because production will be relocated and because a fall in the world market price of fossil fuels drives up demand for fossil fuels there. This phenomenon is known as carbon leakage. The EU Commission is therefore mulling a border adjustment mechanism that would make imported goods more expensive in proportion to the CO2 emissions generated during production.

However, the advisory board is skeptical about the introduction of a unilateral CO2 price adjustment system by the EU: "If it is not possible to involve a sufficient number of other countries in an ambitious climate policy strategy, such an adjustment mechanism threatens to trigger new trade disputes and undermine the effectiveness of EU climate policy," warns Gabriel Felbermayr  (Kiel Institute), who was in charge of the report.

US government and others should join climate club

The EU should therefore use the opportunity offered by the new US administration to establish a climate club with the US and other important trading partners who agree on a common minimum CO2 price. Within this club, CO2 price adjustment can be waived. Towards third countries, the climate club should introduce a joint CO2 border adjustment. This would give non-members an incentive to join the climate club. "As long as there are no technologies in the energy sector that are more cost-effective than burning fossil fuels, global greenhouse gas emissions can only be curbed through cooperation between a sufficient number of countries," says Schmidt. Any climate policy approach that does not include all major countries must be scrutinized to see whether it strengthens or weakens incentives for global cooperation.

Against this background, the report examines two possible instruments for the subsequent charging of imported goods, firstly an import-side CO2 border adjustment and secondly a consumption levy. Under the CO2 border adjustment, importers from certain energy-intensive and trade-intensive sectors would have to purchase emission certificates issued by the EU. The consumption levy would have to be paid on important CO2-intensive goods sold domestically (e.g., cement, steel). It would be the same for domestic and foreign products and would be based on the physical weight of the goods involved. Domestic producers would have to receive free emission allowances from the European Emissions Trading Scheme (ETS) so that they are not burdened twice and do not suffer any disadvantages in international competition.

Border adjustment is superior to consumption levy

"A border adjustment scheme would be more suitable, but it should not be introduced unilaterally by the EU but within a larger climate club," Felbermayr says. A consumption levy, on the other hand, is not suitable in several respects. It does not encourage third countries to join the climate club and would not be consistent with the existing EU-ETS.

The Council also emphasizes that a CO2 border adjustment should not be introduced with the aim of gaining resources for financing the EU's tasks. This is being discussed on various occasions. "It would not be a sustainable and stable source of revenue," Schmidt says. A successful adjustment mechanism would make itself redundant because it would encourage other countries to introduce CO2 pricing comparable to that of the EU.