Climate Change Mitigation and Policy Spillovers in the EU’s Immediate Neighborhood

Wednesday, March 6, 2024, 14:00-15:30 Vienna time (CET)

Presenter
Serhan Cevik, Senior Economist, International Monetary Fund
Yueshu Zhao, Research Analyst, International Monetary Fund

Moderator
Patrick Imam, Deputy Director, Joint Vienna Institute

The EU is a global leader in decarbonization and its immediate neighbors (EUN), namely, Albania, Bosnia and Herzegovina, Kosovo, Moldova, Montenegro, North Macedonia, Serbia, and Türkiye, are significantly affected by direct and indirect spillovers from the EU’s green transition. More immediately, the question whether and how the EU’s forthcoming carbon border adjustment mechanism (CBAM)—an import tax on carbon intensive imports—will affect EUN countries is attracting greater attention. 

The IMF working paper on Climate Change Mitigation and Policy Spillovers in the EU’s Immediate Neighborhood, discussed at the webinar,  assesses the performance of EUN countries to date on reducing carbon emissions, their policies on that front, the extent to which they have experienced spillovers from the tightening of EU climate mitigation policies, and how further environmental policy stringency in the EU would likely to affect them. The paper also studies the consequences of EUN countries trying to keep pace with the EU’s green transition through a unilateral and upfront adoption of economywide decarbonization policies.

EUN countries have lagged behind the EU significantly in reducing emissions, which arise, mainly, from carbon-heavy power generation and industrial sectors. The high natural endowment of coal, the highest carbon emitting fossil fuel, has been a major source of cheap locally available energy. While EUN countries benefited from being reliant on coal during the recent energy crisis, a more sustainable way towards achieving energy security would involve a higher reliance on renewables, convergence to EU standards, and eventually EU accession, directly benefiting from EU-wide policies that also help with energy security.
EUN countries’ climate change mitigation efforts have been generally weak, lagging behind the EU and moving only gradually towards market-based instruments since 2000. They still have substantial fossil fuel subsidies in place and, as a group, compare unfavorably in terms of implicit subsidies, i.e., the cost of fossil fuel externalities not covered by consumer prices.

The EU’s significant push to decarbonize its own economy over the past two decades appears to have spilled over and influenced emissions mitigation in EUN countries. The paper’s empirical findings suggest that as the EU has increased the stringency of its climate policies, EUN countries have lowered their emissions, more so than other countries. Over the 2000-2020 period, a near doubling of EU environmental policy stringency was associated with a potential reduction in emissions in EUN countries by as much as 10 to 20 percent, after controlling for other factors.

An important question the paper considers is how much impact the CBAM will have on EUN countries in the coming years as it becomes fully operational, as well as in the more distant future when the policy is expected to be tightened further by expanding it to a wider set of the Union’s imports. The study finds that output effects of the CBAM, once its currently proposed form is fully operationalized in 2026, would be limited. However, exports of EUN countries’ carbon-intensive industries could be directly impacted, particularly metals and energy industries, and North Macedonia and Serbia are heavily exposed in this regard. In addition, over the long run, further tightening of the CBAM could affect the competitiveness of EUN countries given their trade integration with the EU, necessitating the tightening of emission mitigation policies.

Putting a price on carbon is the most economically efficient and equitable policy response to the emerging challenge of decarbonization in EUN. The study finds that the fear that a tax on carbon will adversely affect output by hitting firms and reduce household welfare, particularly for the poorer ones, is overdone. At the same time, policymakers need to be mindful of the industries that could be hit hard by a decarbonization policy and provide social assistance and safety nets, where needed. The analysis indicates a significant fiscal impact, particularly when an effective recycling mechanism is in place. Under a $75 carbon tax and relative to a business-as-usual scenario, fiscal revenues from the tax would amount to about 3 percent of GDP on average, and it would result in a reduction of CO2 emissions of around 25 percent by 2030. 

Given the strong economic integration of EUN and EU, it would be in the interest of the former to keep pace with the speed of emission mitigation in the latter in the future. Most of the EUN countries are at different stages on the path to EU accession and hence adhering to EU standards in this area will likely be required under the accession process. Broadly, the EU accession process would bring a host of long-term benefits, including a reorientation of the economy to achieve higher growth and living standards. Realigning the economy with EU’s climate goals and its standards on emissions would also be a key part of the accession process. An up-front adoption of a comprehensive decarbonization strategy, such as through the introduction of an economywide carbon tax, would be of greater benefit to these countries than postponing action for later.

Serhan Cevik, Nadeem Ilahi, Krzysztof Krogulski, Grace Li, Sabiha Mohona, and Yueshu Zhao