What to expect from the EU Carbon Border Adjustment Mechanism?

The EU Carbon Border Adjustment Mechanism (CBAM) represents a pioneering initiative to tackle carbon leakage by aligning carbon pricing between imported and domestically-produced goods in the EU market. It requires EU importers to pay a levy corresponding to the embedded carbon emissions in 303 emission-intensive products. Concurrently, the EU Emissions Trading System (EU ETS) will undergo significant reforms, including gradual elimination of free carbon allowances and stricter emission caps, thereby substantially raising intra-EU carbon emission costs. Despite its ambitious design, CBAM’s scope is modest, affecting only around 3% of the EU’s imports from non-EU countries. CBAM-covered sectors constitute 7.0% of EU manufacturing production, 2.3% of total gross output, 1.1% of value-added, and 0.6% of employment. OECD simulations highlight several key outcomes: without CBAM, the EU ETS reforms would likely result in significant carbon leakage and reduced competitiveness for EU industries. CBAM effectively mitigates carbon leakage by redirecting EU imports from less carbon-efficient to more carbon-efficient countries. However, while partially offsetting competitiveness losses for protected sectors in the EU, CBAM introduces competitiveness challenges for downstream EU sectors. As other regions contemplate similar mechanisms, this analysis underscores CBAM’s dual role as both proof of concept and cautionary illustration of the complex economic impact of Carbon Border Adjustment policies.