Effect of a European carbon border adjustment mechanism on Asia and the Pacific

Most studies that simulate the impact of the EU’s planned carbon border adjustment mechanism only incorporate its effect on emissions from production. This column uses a structural gravity model to demonstrate that while the mechanism is expected to reduce emissions, the majority of this reduction will come from shipping activities. The largest reductions in emissions are expected in the Asia and Pacific region.

In an attempt to slow down climate change, policies aiming at taxing carbon emissions are gradually being implemented all around the world. Pioneering in this field, the EU introduced an emission trading scheme (EU ETS) in 2005 which has been recognised as the first cross-border cap-and-trade scheme of its kind. The EU ETS now boasts one of the highest carbon prices in the world, with estimated allowance price nearing €100/tCO2 in 2022.

A high allowance price brings concern over the competitiveness of industry, as production costs are expected to rise. Industrial relocation, coupled with higher demand for relatively cheaper foreign products, may lead to emissions being relocated to countries with lower or no carbon pricing, a phenomenon economists refer to as ‘carbon leakage’. Ever since the implementation of the EU ETS, studies have tried to assess whether the introduction of the EU ETS has resulted in this phenomenon. Even now, there is no academic consensus regarding the existence of such leakage (Böhringer et al. 2022). However, as the EU ETS price has increased rapidly in recent years, this will increase the likelihood of carbon leakage occurring.

Carbon border adjustment: A solution to carbon leakage

In this context, in July 2021 the EU announced its plan to introduce a Carbon Border Adjustment Mechanism (CBAM) to tackle carbon leakage. This takes the form of an additional carbon pricing mechanism implemented at the EU border, whose value is determined based on the difference between the carbon price paid by EU producers and foreign producers, for a given product. By doing so, the EU aims to ensure a level playing field for its industry. Carbon border adjustments are thought to be an effective instrument against carbon leakage, but many highlight that they may result in a decrease in exports, exacerbate regional inequalities between exporters, and be difficult to implement due to legal issues arising from WTO treaties (Böhringer et al. 2010, Böhringer et al. 2012, Fischer and Fox 2012, Monjon and Quirion 2011).

The EU’s is the first carbon border adjustment mechanism to be implemented, and thus, since its announcement, many studies have simulated its potential impact. A common trend emerging from their findings is that the CBAM would have a negligible effect on global welfare but a negative impact on exports (Korpar et al. 2023, Pyrka et al. 2020, Takeda and Arimura 2023). Most importantly, the CBAM is expected to have a small impact on emissions (Korpar et al. 2023, Zhong and Pei 2022), despite the policy’s main objective being to decrease global emissions.

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