Partial and full border carbon adjustment: Corrective effects, distortions, and sectoral trade-offs

Unilateral climate policies, such as the European Union’s Emissions Trading System (ETS), create challenges of carbon leakage and competitiveness loss. The EU’s Carbon Border Adjustment Mechanism (CBAM), with its exclusive focus on import tariffs, is a landmark response. This import-side design addresses only one margin of carbon leakage. We therefore incorporate export rebates as a complementary component in a more complete border carbon adjustment (BCA) framework and systematically compare import-side, export-side, and full BCAs in a quantitative trade model. Unlike previous studies that treat policy impacts as a “black box” by focusing on net outcomes, we apply a total differential decomposition to identify the mechanisms underlying changes in welfare and emissions, distinguishing each policy’s intended corrective effects from its unintended distortionary consequences. The results show that the import-side BCA, while shielding domestic upstream sectors, inadvertently harms domestic downstream industries and exporters by raising input costs. Conversely, the export-side BCA protects export competitiveness but weakens domestic abatement incentives. Together, these findings suggest that the two partial BCAs are not competing alternatives but structurally incomplete instruments, each addressing a distinct carbon leakage margin, while also generating distortions that the other helps counterbalance. The full BCA therefore emerges as the more balanced policy design, not only because it jointly mitigates leakage and preserves competitiveness more effectively across the value chain, but also because it partly offsets the distortions associated with partial approaches.