The carbon border adjustment mechanism is inefficient in addressing carbon leakage and results in unfair welfare losses

Abstract

The European Commission has proposed a Carbon Border Adjustment Mechanism (CBAM) to reduce carbon leakage and create a level playing field for its domestic products and imported goods. Nevertheless, the effectiveness of the proposal remains unclear, especially when it triggers threats of retaliation from trading partners of the European Union (EU). We apply a Computable General Equilibrium (CGE) model - Global Trade Analysis Project (GTAP) - to assess the economic and environmental impacts of different CBAM schemes. Here we show that the effectiveness of the CBAM to address carbon leakage risks is rather limited, and the CBAM raises concerns over global welfare costs, GDP losses, and violation of equality principles. Trade retaliation leads to multiplied welfare losses, which would mostly be borne by poor countries. Our results question the carbon leakage reduction effect of a unilateral trade policy and suggest that climate change mitigation still needs to be performed within the framework of international cooperation.