Carbon Border Adjustments

Disparities in carbon pricing between trade partners raise the risk of carbon leakage, whereby emissions shift from regions with stricter regulations to those with more lenient ones. To address this, the EU introduced a Carbon Border Adjustment Mechanism (CBAM) with a transitional period starting in October 2023. EU importers of certain emission-intensive trade-exposed goods will be required to pay an adjustment on emissions embedded in their imports at the European border.

The paper presented in this Decarbonization Seminar studies the potential effects of CBAM on carbon leakage and the performance of affected sectors throughout the value chain, building on multiple micro-level data sources to simulate the CBAM's impact on European and non-EU industries. An input-output model is used to assess the direct and indirect effects of CBAM, factoring in input substitution, price elasticities and quantity changes, thereby providing insights into the potential impacts of this new mechanism on imports and exports, output and carbon emissions.

The current CBAM regulation covers a minor fraction of total emissions and trade, affecting 0.18% of global emissions and 0.5% of global trade in intermediary goods and services. The authors find, that the CBAM's introduction, combined with the removal of free allowances, has a modest impact on EU and non-EU value-added. In the EU, the removal of free allowances would lead to a marginal reduction of 0.48% in the value added generated across these sectors. However, the CBAM mitigates this impact, bringing the net effect to -0.30%. Redistributing revenues generated by the removal of free allowances and the CBAM would further diminish the overall impact on EU value-added. Beyond the EU, the impact is close to negligible for all industries, but nevertheless varying among countries. Looking at carbon emissions, the CBAM, coupled with free allowance reduction, leads to a 0.05% decrease in global emissions, effectively mitigating carbon leakage and suggesting modest emission reductions outside the EU. Moreover, an extended CBAM-covered product list slightly reduces global emissions (-0.01%). The findings remain robust across various sensitivity analyses, including alternative carbon prices and trade elasticities.