EU’s carbon border adjustment mechanism CBAM – industrial effects

This study examines the industrial effects of two measures aimed at mitigating carbon leakage: the EU’s Carbon Border Adjustment Mechanism (CBAM) and the allocation of free emission allowances. Currently, the EU allocates free emission allowances based on output (known as output-based allocation, or OBA) to emission-intensive and trade-exposed (EITE) sectors. This system is slated to be replaced by the CBAM, which imposes a tariff on imports of EITE goods and electricity into the EU. This paper analyses the effects of this transition using a computable general equilibrium model, focusing on EU EITE industries. OBA boosts output in the EU’s EITE sectors compared to a scenario without any anti-leakage policies. CBAM produces similar effects, except in the case of non-ferrous metals, where output declines. Beyond non-ferrous metals, the positive output effects of CBAM are modest for refined petroleum products and chemical products compared to OBA. Key factors influencing these differences include the sectors’ initial emission intensities, export shares, and reliance on intermediate inputs. These factors may also explain why some sectors are resisting the shift from OBA to CBAM. Whereas CBAM and particularly OBA increases EITE output overall, the macroeconomic effects are small. Last, implementation of CBAM reduces carbon leakage more than OBA as currently implemented.Key policy insights The EU ETS transition from free emission allowances to CBAM may reduce activity levels in the EU’s emission-intensive and trade-exposed (EITE) sectors.The loss of competitiveness will be most pronounced in sectors that (i) export a large share of their goods to non-EU markets and (ii) rely on inputs covered by the CBAM.The macroeconomic effects are small for both instruments.CBAM reduces carbon leakage more than free emission allowances, because of lower EU electricity imports.