The rocky path to global carbon pricing

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Carbon pricing — seen by some economists as the closest thing to a silver bullet for tackling climate change — recently suffered a high-profile setback with the demise of Canada’s consumer-facing carbon tax on fuel.

Yet industrial carbon pricing schemes have been proliferating in the past few years — growth that is set to be boosted by the EU’s imminent carbon border levy. But as the global impact of such policies grows, so too will the controversy surrounding them…

Could the ‘climate club’ actually work?

As an elegant, intellectually satisfying economic model for tackling climate change, Nobel laureate William Nordhaus’s “climate club” concept is unmatched.

In Nordhaus’s vision, first laid out in 2015, a few major economies — perhaps the EU and the US — could start a snowball effect for carbon pricing all over the world by founding a new sort of international club.

To be a member, each country must set and properly enforce a national carbon price above a specified level. All nations in the club would impose carbon-linked levies on imports from non-member nations — but not on each other.

One by one, Nordhaus suggested, governments would be driven to join the club by introducing their own carbon pricing schemes. Why not collect carbon revenue from your own companies, rather than letting foreign governments collect that money through carbon levies on your exports? As carbon pricing spread around the world, companies would have an unprecedented financial incentive to reduce their emissions.

It all sounds great on paper. Could it actually be starting to take shape?

Perhaps so, judging by recent international studies. Last month the World Bank published its latest annual report on global carbon pricing systems. There are now 80 such national or subnational systems — 37 emissions-trading schemes and 43 carbon taxes — it found, up by five since last year. They cover 28 per cent of global emissions and raised $102bn in 2024.

“All large middle-income economies have either implemented or are considering direct carbon pricing,” the World Bank noted — and the same goes for most high-income nations, with the notable exception of the US (though 13 states including California have introduced schemes).

A major driver of momentum here has been the EU. Instead of starting by trying to form a club, as Nordhaus imagined, Brussels has gone ahead on its own by introducing a carbon border adjustment mechanism (CBAM), which will come into effect from the start of 2026. The idea is to level the playing field for high-emitting European companies, which have been required to pay carbon fees at a rising level for two decades, by putting corresponding carbon levies on imports.

The policy has drawn strong criticism internationally, as a useful new paper from the International Emissions Trading Association highlights. Brazil, India and China have suggested it may breach the rules of the World Trade Organization, where Russia has initiated a formal dispute.

But even as they attack the EU’s CBAM, nations around the world have been acting much as Nordhaus predicted. Brazil, India and China have all made moves to create or strengthen domestic carbon pricing systems, as have other nations including Japan and South Korea. The UK has moved to align its carbon pricing system closely with the EU’s; Turkey is doing much the same with its new scheme.

This is not to say that developing nations’ concerns about carbon levies are unwarranted. In many lower-income countries, introducing carbon pricing schemes will be a difficult, expensive and potentially economically disruptive undertaking.

As they hammer out the full details of the new CBAM in the coming weeks, EU officials should consider a valuable study published on Wednesday by the International Institute for Sustainable Development. It was based on two years of interviews with officials, experts and private-sector voices in two countries considering carbon border levies — Canada and the UK — as well as in Brazil, Vietnam and Trinidad and Tobago, which stand to be affected by such levies.

The study highlights a raft of dilemmas presented by carbon levy schemes — some of them so complicated that the authors couldn’t reach a consensus on how to tackle them.

Consider, for example, the question of whether poorer nations should be exempted from carbon border levies. That might sound eminently reasonable — but as the authors note, it risks perverse outcomes in which foreign companies shift high-emitting operations to those low-income countries in order to game the system.

There are many more. Should the proceeds of a carbon border levy be retained by the country imposing it, or used to help developing countries build their own carbon pricing systems? How should authorities assess the carbon footprint of imported goods, when precise data is not available? Should companies be allowed to use carbon credits to reduce their exposure to the border levy? And how will all this fit with international trade law?

These are thorny questions, on which there will be a wide range of clashing views — with particular potential for disagreement between wealthy and developing nations. They cannot be avoided if the world is to move towards a system of more widespread and effective carbon pricing. Yet — slow and difficult as it may be — that appears to be the direction of travel.

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