Carbon border adjustment mechanism: a systematic literature review of the latest developments

ABSTRACT

Carbon border adjustment mechanism aims to level the playing field and reduce carbon leakage through import taxes and/or export subsidies based on the carbon content for products from countries with different levels of carbon policy stringency. The introduction of an EU carbon border adjustment mechanism (CBAM) has triggered a lively debate on its potential impacts, especially among developing countries. In fact, introducing CBAM is not a new idea; researchers in fields of economics and law have investigated this policy over the last decade. Against this backdrop, this study conducts a literature review of the most recent economic studies of CBAM and provides an exhaustive synthesis of this literature. We employ the so-called ‘Preferred Reporting Items for Systematic Reviews and Meta-Analysis’ approach (PRISMA), which includes an exhaustive screening of studies. Specifically, we identified 97 relevant studies on CBAM from 2004 to 31 August 2021, and conducted descriptive and content analysis of these. Our content analysis highlights the potential impacts of CBAM in terms of its effectiveness across 3 policy objectives: protecting fair competition; reducing carbon leakage; and limiting global welfare costs. We synthesize findings on how policy design and characteristics of an economy lead to different levels and types of effectiveness of a CBAM, and we contrast alternative policy designs across various objectives. Armed with this systematic review of the literature, we spell out insights and challenges in formulating effective CBAM polices. This review thus offers evidenced-based guidance for the policy design of a CBAM and a foundation for further research.

Key policy insights:

• There is no one-size-fits-all approach to design and implement CBAM to tackle competitiveness and carbon leakage; policy design and characteristics of the economy matter.

• According to the effectiveness of CBAM across the 3 policy objectives, alternative policy designs should account for the coverage of trade, of sector(s), and also the means to determine carbon content of traded commodities, the use of revenues collected through CBAM, and the adjustment price.

• In formulating sound CBAM policies, competitiveness, carbon leakage and welfare evaluation are central economic concerns; however, consistency with the latest international climate policy architecture and fairness issues should also be addressed.

KEYWORDS:

• Carbon border adjustment mechanism
• systematic literature review
• competitiveness
• international trade
• carbon leakage
• policy design

Acknowledgements

We thank four anonymous reviewers and the Editor, and participants at various seminars for their suggestions and encouragement. Remaining errors are our own.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 The externality problem can be dated back to the classical discussions, for example, Pigovian tax in Pigou (1920) and Coase theorem in Coase (1960). A thorough discussion concerning this line of research is beyond the scope of this study.

2 Noting that it is not a normative statement concerning whether the protection of competitiveness is justified. The question of whether CBAM should be used to protect competitiveness, especially in developed countries, is controversial. For example, given historical responsibility and capacity, developed countries are often regarded to be more responsible for emission reductions. Also, in legal literature, such as the World Trade Organization compliance discussions, it is emphasized that CBAM should not be applied with the goal of protecting competitiveness for equity considerations.

3 For the complete list of 97 articles, please see the Appendix.

4 See Ward et al. (2019) and Zhong and Pei (2022) for useful extensions.

5 Recall that the only difference between the two control groups is the presence or absence of carbon border adjustment, and that countries receiving CBAM cannot adjust their domestic carbon policy or take other measures.

6 Noting that there is no unambiguous definition of competitiveness in the literature. Usually, the deterioration of economic indicators such as export volume, production, profitability, or GDP is seen as a deterioration of competitiveness. To synthesize the literature, four indicators were used in this study as indicators of competitiveness: export volume, output, profitability, and GDP. A CBAM causing any of them to change is regarded as competitiveness impact, which refers to whether it causes a variation in export volume, output, profitability, or GDP.

7 Reshuffling is where product is redistributed among buyers in different regions such that regulated regions receive low-emitting products while unregulated regions receive high-emitting ones.

8 In contrast, for countries where CBAM exhibits a negative competitiveness effect, increasing the carbon price also amplifies it.

Additional information

Funding

The research was supported by the National Natural Science Foundation of China (no. 72273149; 41675139) and China Scholarship Council (no. 201808080249).