The EU Carbon Border Adjustment Mechanism $($CBAM$)$ is a relatively new policy tool launched by the European Union in October $2023.$ It aims to address two key concerns:

$1.$ Carbon Leakage: This refers to the phenomenon where industries within the EU$,$ facing stricter carbon emission regulations and higher costs, relocate production to countries with weaker environmental regulations and lower costs. This effectively shifts emissions outside the EU without actually reducing global emissions. $2.$ Level Playing Field: The CBAM seeks to level the playing field for EU businesses by imposing a financial levy on imports of certain carbon$-$intensive goods from non$-$EU countries. This discourages the import of such goods and incentivises their production within the EU under stricter emission standards.

Here's how the CBAM works:

Scope: Currently, the CBAM applies to six product categories deemed at high risk of carbon leakage: cement, iron and steel, aluminium, fertilisers, electricity, and hydrogen.

Mechanism: Importers of these goods from non$-$EU countries must surrender CBAM certificates equivalent to the CO$2$ emissions embedded in those products. The price of these certificates is linked to the EU's Emissions Trading System $($ETS$)$ carbon price.

Transitional Phase: The CBAM started with a reporting phase in October $2023,$ where importers report the embedded emissions of their imports without incurring financial liabilities. The full levy will come into effect from $2026$ onwards.

Potential Impacts of the CBAM:

Increased costs for importers: Non$-$EU producers of covered goods may face higher costs due to the CBAM, potentially influencing their pricing strategies.

Stimulating cleaner production: The CBAM could incentivise non$-$EU producers to adopt cleaner production processes to reduce their carbon footprint and avoid the CBAM levy.

Trade disputes: Some countries have raised concerns about the CBAM's compatibility with World Trade Organization $($WTO$)$ rules, potentially leading to trade disputes.

Explanation:

Overall, the EU Carbon Border Adjustment Mechanism is a complex and ambitious policy with the potential to both address carbon leakage and level the playing field for EU businesses. Its long$-$term impact remains to be seen, but it represents a significant step in the EU's efforts to achieve its climate change goals.