EU's carbon border tax will hurt developing country SMEs

The EU prides itself in its progressive values, including its commitment to sustainable development. However, its incoming deforestation regulation and carbon border adjustment mechanism (CBAM) disproportionately burden developing countries–and within them, smaller and medium sized companies (SMEs) in particular. 

As part of the European Green Deal, CBAM — a tariff on carbon-intensive imports — will fully take effect in 2026. Ideally, the mechanism will help to drive corporate investment into decarbonisation in the EU’s trade partners.

But financial incentives to boost corporate investment, or for developing countries to mitigate and adapt to climate change, remain limited. Companies on the receiving end therefore face challenges in complying with the rules. 

Indian steel

Indian steel producers are some of the most at risk companies to the CBAM. India is a significant exporter of steel to the EU and Indian steel production is largely reliant on coal — a carbon-intensive fuel source. Within India, large industrial conglomerates are much better placed to deal with the EU’s green regulations. Tata Steel, a subsidiary of the Tata Group and one of the biggest players in the steel sector, already has production facilities in Europe and has described the CBAM as “an opportunity”. 

That large industrial companies are taking steps to green their heavy carbon emitting activities in order to remain competitive is a positive development — but the opportunity to do so is not equally accessible to all. Tata Steel (whose total revenue amounted to $28bn [€25.5bn] in the 2023 fiscal year) has the resources to invest in and comply with CBAM regulations, while smaller and medium sized companies (SMEs) — particularly in developing countries — will have a much harder time and are unlikely to view CBAM in opportunistic terms. 

Bigger companies are able to take advantage of economies of scale when it comes to regulation and financing that smaller companies are not afforded.

According to a UN study, 79 percent of SMEs surveyed in South-East Asia acknowledged the need to acquire new technical skills to effectively deal with climate change and leverage existing climate mitigation opportunities. Failure to comply with compliance requirements could in turn result in the exclusion of SMEs from global supply chains and trade.

Deforestation

Similarly, the EU’s incoming deforestation regulation is likely to hinder access to the EU market for small-holder farmers producing commodities including cocoa, coffee, and palm oil from countries like Indonesia, Ethiopia and Vietnam. 

The EU recognises the importance of protecting its own SMEs — the re-elected EU Commission president, Ursula von der Leyen, has highlighted helping European SMEs scale up and fully leverage the EU single market as part of the next commission's agenda.

Indeed, SMEs help to boost competition in what can otherwise be industries dominated by a few large players. They are also more likely to have localised operations and to invest in local communities compared to larger corporations. 

The impact of CBAM and the deforestation regulation on smallholder farmers and SMEs in developing countries adds fire to perceptions that these are unilateral measures imposed by Western countries —instead of being part of a globally negotiated solution to a critical issue.

Criticism of the regulations has built up — even from the US–the country whose companies are probably best placed to deal with the new rules. In June Gina Raimondo and Thomas Vilsack, the US secretaries of commerce and agriculture, and trade envoy Katherine Tai called on the EU to delay the deforestation legislation, which was set to come into effect in December 2024, over fears that it will hurt American producers. 

If American producers are afraid, then consider how SMEs or smallholder farmers in Indonesia are faring.

The new commission should give some greater consideration to how its climate regulations and development policies might be combined to take into account the unique challenges and vulnerabilities faced by developing countries.