Climate Policies and Competitiveness: Options for Border Adjustment Measures

The introduction of unilateral climate policies, and the absence of a climate constraint in many parts of the world raise questions about the distortions in competitiveness and CO2 leakage that may result. Therefore, proposed climate policies are often accompanied by corrective measures intended to limit competitiveness losses. These corrective measures are called Border Carbon Adjustment Measures (BAMs). The objective of this paper is to analyze carbon-related BAMs as potential instruments to reduce emissions leakage and loss of competitiveness. To attain this objective we use a Computable General Equilibrium Model and simulate different climate policies regimes with and without BAMs. We analyse the environmental and welfare effects of these scenarios.We use a multi-regional computable general equilibrium model, the GEMINI-E3 model, in order to investigate the issues of BAMs. First, we describe the main features of GEMINI-E3 that we use on our analysis. Second, we describe our reference scenario. Third, we present the scenarios that we tested and the main results stemming out from them. Finally, we present how we introduce carbon-related BAMs in our model and the main effects that this have on leakage and welfare. We simulate five scenarios that suppose different degrees of participation in a climate agreement. In each of them we compute the loss of competiveness and the carbon leakage. The introduction of border adjustment measures will be done within the second scenario that assumes that only industrialized countries (OECD countries) undertake GHG emission reductions. We simulate 4 different BAMs: - the introduction of tariffs to imports; - the inclusion of imports into a domestic permit trading schemes; - the introduction of tax rebate on exports done by OECD countries; - the introduction of a tax on exports done by non OECD countries. We use two different definitions of CO2 content based on (i) direct CO2 content and (ii) direct & indirect CO2 content. The direct CO2 content is based on the fossil energy consumed by firms in non-OECD countries. In the second definition, we take into account not only direct emissions but also indirect emissions representing the carbon content of goods used as intermediate inputs. We find that the level of leakage is rather limited concerning GHG emissions (12%) and output losses of Energy Intensive Industries. This does not mean that, at the industry level, the problem is not serious. We find that although leakage may be reduced after the introduction of a BAM, this reduction is not really important. Moreover, we find that the welfare effects are not always unambiguous. However, the concrete implementation is not obvious at an economic point of view (e.g. measures of CO2 content, definition of instrument, administrative cost). The integration of main emerging countries into the climate agreement seems more efficient and BAMs could be used as a stick to force the participation of these countries. However a crucial assumption is linked to Armington elasticities which represent the substitution between domestic good and imported goods.