The EU Carbon Border Adjustment Mechanism (CBAM) impact on member states and trade partners

The EU’s CBAM: implications formember states and trading partners Disclaimer:This paper should not be reported as representing the views of the European Central Bank(ECB). The views expressed are those of the authors and do not necessarily reflect those of the ECB. ABSTRACT The EU Carbon Border Adjustment Mechanism (CBAM) came into force on 1 October 2023, introducingreporting requirements for importers of covered products and, from 2026, an obligation to pay a fee on thecarbon content of imported goods. This paper uses indices of ad valorem tariffs to assess the incidence ofthe EU CBAM on both EU member states and the EU’s trading partners. Overall, the direct impact on EU Keywords: Carbon Leakage; Emissions Trading; Carbon Taxation; Trade Policy JEL Classification Numbers: F13; F64; Q54; Q56 NON-TECHNICAL SUMMARY On 1 October 2023, the EU introduced its Carbon Border Adjustment Mechanism (CBAM), a key componentof the EU’s Fit for 55 policy package. The CBAM is designed to address the risk of carbon leakage, whicharises from differences in carbon pricing between the EU and its trading partners. It achieves this by imposinga levy onimports of selected products based on their carbon content and the carbon price differential between The EU CBAM is poised to affect producers and consumers within the EU as well as a range of economicactors along international supply chains. Therefore,understanding its direct and indirect effects on both EUeconomies and those outside the EU—including through supply chain linkages—is essential to foster a This paper contributes to this understanding by examining the direct impact of CBAM on both EU memberstates and their trading partners,using indices of ad valorem tariffs.We develop a simple analyticalframework that enables us to carry out numerical simulations. Taking product-level bilateral trade databetween the EU and its trading partners for the year 2021, along with detailed input-output tables to derive The CBAM currently covers six categories of energy- and emissions-intensive products: aluminium, cement,electricity, iron & steel, and fertilizers. Our analysis focuses on these product categories.A key finding is thatthe overall direct impact of the current CBAM on EU countries’ trade is relatively contained, adding 0.1percent to the value of EU imports when averaged across all imports, and 0.04 percent to the average cost 1.Introduction The 2015 Paris Agreement requires countries to define their own contributions, known as NationallyDetermined Contributions (NDCs), towards the shared objective of global decarbonization, along with thepolicies they will implement to achieve these contributions. Countries are free to set the level of effort andambition of their NDCs and are only required to ‘ratchet up’ their commitments, meaning they must increase Tighter mitigation policy may adversely affect the international competitiveness of domestic industries(Carbone and Rivers, 2017) since it tends to increase production costs for regulated emitters, particularly inthe short term (McGuire, 1982; Pasurka, 2008; Dechezleprêtre and Sato, 2017). This is because measuresto cut emissions typically require affected firms to invest in clean technologies, pay a carbon tax, surrenderemission allowances, and/or comply with stricter environmental regulations, all of which lead to higherproduction costs.1Tighter mitigation policy may also lead to carbon leakage, i.e., a migration of CO2-intensive Consequently, jurisdictions that have been implementing or contemplating stringent domestic emissionreduction policies have also been seeking ways to shelter their most exposed sectors from adversecompetitive impacts and minimize the risk of carbon leakage. In theory, a comprehensive approach thatcombines full pricing of domestic emissions with a border carbon adjustment mechanism can help addressthese concerns. However, the implementation of border carbon adjustment mechanisms raises practicaldifficulties—most notably in accurately determining the carbon content of imported products, political 1Since the enactment of the first major environmental regulations in the 1970s, the impact on the competitiveness of affectedfirms has attracted significant attention in the literature, with two main perspectives being debated: the ‘pollution haven’hypothesis and the Porter hypothesis. The pollution haven hypothesis maintains that stringent environmental policies raisecompliance costs, leading to a shift of pollution-intensive production to regions with lower abatement costs, thereby creatingpollution havens and resulting in emissions leakage. Conversely, the Porter hypothesis posits that stricter environmental regulations can enhance the competitiveness of regulated firms by driving efficiency improvements and fostering innovation,potentially leading to international technological leadership. While the jury is still out on which effects prevail in the long term,it is generally agreed that the po