Carbon Pricing's Promise Versus Reality in Climate Action
Carbon pricing continues to dominate global climate policy discussions as a preferred market-based solution. Many experts present it as the most efficient path forward for reducing greenhouse gas emissions. However, mounting evidence suggests this approach delivers disappointing results in practice. Instead of significantly lowering emissions, carbon pricing mechanisms often distort economic conditions and trade patterns.
The EU's Carbon Border Adjustment Mechanism in Focus
The European Union recently implemented its Carbon Border Adjustment Mechanism, commonly called CBAM. This policy took effect from January 1st, 2026. CBAM aims to prevent carbon leakage while leveling the playing field for emission-intensive goods like steel and aluminum. The mechanism places a carbon price on imports based on their embedded production emissions.
This ensures imported goods face similar carbon costs as products manufactured within the EU under its Emissions Trading System. The current market-driven carbon price under the ETS ranges between €85 and €90 per tonne. Despite this substantial price signal, the mechanism appears more effective at redirecting trade flows than reducing overall emissions.
Market Faith Versus Practical Evidence
Economic theory presents carbon pricing as an elegant solution to climate challenges. By internalizing the social cost of carbon, a uniform price theoretically ensures emissions reductions where abatement costs are lowest. This logic has shaped climate economics for decades. It assumes markets function reasonably well and can efficiently allocate resources toward emission reduction.
Practical evidence tells a different story. Import demand for carbon-intensive goods shows high sensitivity to carbon prices. Even moderate price increases trigger sharp declines in trade volumes, particularly for products with high embedded emissions. Yet these trade disruptions don't translate into meaningful emission reductions in exporting countries.
If CBAM functioned primarily as an environmental instrument, we would expect significant emission decreases in countries exporting carbon-intensive goods to Europe. Instead, the mechanism seems more effective at protecting European industries than achieving climate goals. This reality raises legitimate concerns about green protectionism disguised as environmental policy.
Alternative Approaches Deserve Consideration
Globally, explicit carbon pricing covers only about 23% of emissions. Many countries, including India, have adopted different approaches to climate action. India employs regulatory standards, renewable energy mandates, technology support, and sector-specific policies that implicitly limit emissions. These alternatives often prove more practical than carbon pricing mechanisms.
Carbon pricing makes clean technologies cheaper over their lifetime, but the substantial upfront investment remains unaffordable for many small firms and households. Higher energy prices resulting from carbon costs intensify affordability and equity concerns across economies. The theory of the second-best reminds us that when multiple distortions coexist, fixing just one may worsen overall outcomes.
Carbon pricing works optimally under specific conditions: competitive markets, available information, and manageable distributional concerns. In their absence, insisting on first-best solutions can prove counterproductive. Regulatory standards, technology mandates, sector-specific interventions, and targeted subsidies represent viable alternatives that deserve serious consideration alongside market mechanisms.
A Balanced Path Forward for Climate Policy
The relevant policy question shouldn't focus on whether a country implements an economy-wide carbon tax. Instead, we should examine whether a nation's policy mix delivers comparable emission outcomes. Different approaches can achieve similar environmental results through varied means. Penalizing trade using default carbon values without considering alternative policy tools only makes commerce costlier without delivering proportional climate benefits.
Markets represent powerful yet imperfect tools for addressing complex challenges like climate change. We shouldn't abandon market-based approaches entirely, but we must apply them with greater humility and realism. A pragmatic combination of market mechanisms and regulatory interventions likely offers the most effective path toward meaningful emission reductions while minimizing economic disruption.
Climate policy requires flexibility and openness to diverse approaches rather than rigid adherence to any single solution. As evidence accumulates about carbon pricing's limitations, policymakers worldwide should reconsider their exclusive faith in this market mechanism and explore more comprehensive strategies for genuine climate action.
