Competitive disadvantage as an argument for a carbon border adjustment mechanism: an empirical investigation of EU-15 countries, 1996-2020

Abstract

CO2 concentrations continue to rise significantly, and it is responsible for about two-thirds of the total energy imbalance that is causing Earth’s temperature to rise. Fortunately, CO2 emission certificates, as implemented under EU ETS, help internalise effects of fossil fuel consumption on global climate. But in a world with uneven climate policies, risk of carbon leakage and competitive disadvantage prevent us from reaching optimal allocation of resources. This explains the decision of the Commission to adopt a Carbon Border Adjustment Mechanism (CBAM). However, this unilateral measure that sets a carbon price for imports coming into the EU is highly controversial from an international trade perspective. Therefore, this paper aimed to verify if ETS competitiveness effects on European economy can be an argument for the introduction of CBAM, when considering the complete three first ETS phases (2005 – 2020). The gravity model approach has been applied to trade flow data, from EU-15 to 216 NON-EU countries, collected mainly from the CEPII’s Gravity database. Our findings indicate that when the EU ETS is in place, exports from EU-15 countries are 24.4% higher. Thus, EU ETS had a positive impact on export and the estimates are statistically significant even at 1% level, no matter how the model is specified. Consequently, competitive disadvantage cannot be an argument for CBAM in this case. In fact, looking further ahead, we may conclude that CBAM is more motivated by anticipation of forthcoming changes due to increased climate ambition and current EU ETS directives for revision. Hence, some recommendations for the design and implementation of CBAM are provided, as such mechanism should be handled with care to achieve desired environmental and economic objectives.