Lost in the smoke

The missing global dimension of Europe’s climate debate

Photo by mikhail serdyukov on Unsplash

Europe’s summer of extreme weather has triggered another round of climate‑politics angst, neatly captured in Politico’s recent coverage. Heatwaves and floods are impacting Europe’s economic outlook, according to the article’s chorus of experts, and climate change is the cause. Bob Ward of the LSE’s Grantham Institute puts it bluntly: “There is still a mindset, which is completely wrong, that there’s a trade-off between the economy and climate policy. The impacts of unmitigated climate change are going to cost us far more than any action.”

Yet even as Europe burns, calls from some businessmen and industrialists to water down climate policies like the Emissions Trading System (ETS) have never been louder.

In a Financial Times opinion article in June, steelmaker ArcelorMittal’s Lakshmi Mittal warned, somewhat apocalyptically, that higher costs due to the ETS “…will pass down the value chain, causing a decline in competitiveness and activity, accelerating deindustrialisation, collapsing investment and a further reduction in manufacturing employment in Europe.”

At the heart of carbon-pricing-sceptic view is, on the face of it, a reasonable question: why should European businesses pay more when Europe is responsible for only a fraction of global emissions and the solution to global decarbonisation lies elsewhere?

This is the real tension between European policymakers and the business leaders most impacted by higher costs. It’s not simply between climate action and business performance. It is rather the asymmetry between Europe’s comparatively tiny (5%) share of global emissions and the very real costs associated with climate action imposed on European firms.

To become palatable to business, then, European climate policy needs to be presented differently: not as a cost, but as a compelling competitive strategy.

The missing piece of the discussion is the Carbon Border Adjustment Mechanism (CBAM), which subjects imports into the EU to the same carbon prices paid by EU firms. When it’s discussed at all, CBAM is all too often described defensively as a tool to prevent foreign suppliers from undercutting their EU counterparts, or to ensure fairness for European producers.

But this undersells CBAM’s true power. CBAM is not merely a shield. It is a sword. Europe may not be able to decarbonise the world alone, but it can push the world to decarbonise by making the price of entering the EU market include a carbon cost. CBAM also incentivises foreign governments to follow suit: adopt your own carbon pricing system and your exporters avoid Europe’s CBAM charges; refuse, and your producers will pay Europe instead.

CBAM thus gives Europe’s relatively small role in global emissions outsized global influence. By ensuring that foreign producers face the same carbon price European firms do, CBAM not only neutralises the competitive disadvantage EU industry faces, but also rewards efficiency and innovation – areas where Europe can potentially excel.

Exporting carbon pricing is only half the story, though. Europe must also address its own structural competitiveness problems. European businesses operate with chronically higher energy prices than most of their American or Asian competitors. Electricity costs, gas prices and grid constraints all combine to create a persistent cost disadvantage. This isn’t just a temporary crisis like the recent and painful energy price spikes caused by Russia’s invasion of Ukraine or the closure of the Strait of Hormuz. It’s a structural reality, caused by a combination of geographic factors and ageing and fragmented infrastructure. And it is precisely why, rather than being absorbed into the general ledger, more ETS and CBAM revenues should be strategically reinvested to lower Europe’s energy costs.

To demonstrate the near-term value to business of its climate policy, Europe should recycle these revenues into accelerating the build-out of cheap renewables, expanding grid infrastructure, supporting industrial electrification, and reducing the levies that inflate electricity bills*. A climate policy that raises costs without lowering them elsewhere is politically fragile. But a climate policy that uses its own revenues to reduced long-term energy prices becomes both economically coherent and politically durable.

(*Regular readers will know I’m a strong advocate of household dividend payments funded by carbon taxes. A full discussion is beyond the scope of this article but suffice it to say that it is possible for the EU to use industrial carbon pricing to invest in infrastructure and allocate consumer carbon pricing revenue to providing household dividends.)

The leaders of carbon-intensive businesses can’t be expected to support climate policy unless CBAM is promoted as a mechanism for projecting Europe’s regulatory standards globally, and more ETS revenues are allocated towards lowering Europe’s energy prices. When climate policy is understood as competitiveness policy, the political coalition behind it broadens. Industries that benefit from lower energy prices become natural advocates for stronger climate policy. Member states that see tangible gains in competitiveness become defenders of ETS and CBAM.

Businesses don’t need to become environmentalists. But they do need to understand that undermining Europe’s climate policies will have a disproportionate impact on the global climate, the economic impact of which is impossible to ignore. Strengthening these policies on the other hand addresses Europe’s structural weaknesses and boosts its competitiveness, something that all responsible business leaders can get behind.