Evaluating the EU Carbon Border Adjustment Mechanism with a Quantitative Trade Model

2025-06-29

AI Summary

This study evaluates the economic and environmental impacts of the EU’s Carbon Border Adjustment Mechanism (CBAM). We develop a multi-country, multi-sector general equilibrium model that—uniquely in trade-quantitative modeling—endogenizes both the allocation of EU Emissions Trading System (ETS) allowances and the CBAM price formation process. The model integrates input-output tables and production network structure to identify upstream supply-chain substitution and its associated embodied emission reductions. Results indicate that CBAM increases EU household expenditure by 0.005%, reduces direct and indirect import-embodied emissions by 4.80% and approximately 3%, respectively, decreases non-EU countries’ global net exports (GNE) by 0.009%, and mitigates carbon leakage by 0.11%. Our key methodological contribution lies in embedding ETS–CBAM pricing interdependence and production-network transmission effects within a general equilibrium framework—establishing a novel analytical paradigm for assessing trade spillovers and embodied mitigation in climate policy evaluation.

Technology Category

• Game Theory and Economic Paradigms: Mechanism Design
• Machine Learning: Calibration & Uncertainty Quantification
• Constraint Satisfaction and Optimization: Satisfiability Modulo Theories

Application Category

• Economics, Online Markets and Human Computation: Economic ramifications for generative AI infrastructure and applications
• Graph Algorithms and Modeling for the Web: Graph embeddings and representation learning for Web-related graphs
• User Modeling, Personalization and Recommendation: Accountability, Transparency, and Ethics for personalization

Abstract

This paper examines the economic and environmental impacts of the European Carbon Border Adjustment Mechanism (CBAM). We develop a multi-country, multi-sector general equilibrium model with input-output linkages and characterise the general equilibrium response of trade flows, welfare and emissions. As far as we know, this is the first quantitative trade model that jointly endogenises the Emission Trading Scheme (ETS) allowances and CBAM prices. We find that the CBAM increases by 0.005% the EU Gross National Expenditure (GNE), while trade shifts towards domestic cleaner production. Notably, emissions embodied in direct EU imports fall by almost 4.80%, but supply chain's upstream substitution effects imply a decrease in emissions embodied in EU indirect imports by about 3%. The latter involves a dampening effect that we can detect only by explicitly incorporating the production network. In contrast, extra-EU countries experience a slight decline in GNE (0.009%) and a reduction in emissions leakage (0.11%).

Problem

• Evaluates economic and environmental impacts of EU CBAM.
• Develops trade model with ETS and CBAM price integration.
• Assesses EU and global trade, welfare, and emission changes.

Innovation

• Multi-country, multi-sector general equilibrium model
• Endogenises ETS allowances and CBAM prices
• Explicitly incorporates production network effects