The Network Effects of the EU Carbon Border Adjustment Mechanism with a Quantitative Trade Model

We investigate the economic and environmental impacts of the European Carbon Border Adjustment Mechanism (CBAM) using a multi-country, multi-sector general equilibrium model with input-output linkages adapted from Caliendo, Parro, and Tsyvinski, 2022. We quantify the general equilibrium responses of trade flows, expenditures, and emissions. To our knowledge, we are the first to endogenize both carbon prices and the CBAM price. We find that, when CBAM is at full force, it could contribute to reducing carbon emissions by 5.19%, a rate that could have been higher (-8.84%) without the moderating role of global production networks. As a consequence of CBAM, we observe substitution effects towards non-targeted carbon-intensive inputs located upstream in the supply network. Notably, CBAM marginally increases EU Gross National Expenditure (GNE) due to changes in the terms of trade, and it shifts sourcing towards domestic and environmentally cleaner inputs. In contrast, extra-EU countries experience only a slight decline in GNE (-0.02%) and emissions (-0.11%). Finally, we propose counterfactual exercises that show the relative importance of technological progress on economic integration in global supply networks. Nonetheless, we argue that supply-chain-wise policies are useful for capturing the full carbon footprint in production.