European Union Emissions Trading Scheme (EU ETS): Addressing competitiveness and carbon leakage under unilateral climate policy – impact analysis of the implementation of a Border Carbon Adjustment (BCA)

In order to comply with its climate change commitments, the European Commission implemented in 2005 the European Union Emissions Trading Scheme that includes the most greenhouse gases emitting sectors, mostly industrial activities. This mechanism provides an incentive for these sectors to reduce their carbon emissions by investing in cleaner technologies, and sets a cap for total European emissions. Because it consists in a unilateral climate policy, European firms have a competitive disadvantage against foreign competition. Moreover, a part of the mitigation efforts made by the European Union is wiped out by the relocation of production to climate policy-free countries. This phenomenon is known as carbon leakage and is tackled by the European Commission through important subsidies under the form of free allowances. A potential alternative to these subsidies is a Border Carbon Adjustment that would rebalance the uneven climate costs for imports and/or exports at the European Union borders. The present paper aims at analysing the impact of a Border Carbon Adjustment on sectoral competitiveness, carbon leakage and welfare, using a static Partial Equilibrium model. Better understanding the effects of this climate measure on the market and on the environment will allow to assess its effectiveness. Overall, it appears that while BCAs are efficient at rebalancing sectoral competitiveness and reducing carbon leakage, their effect is detrimental to European welfare, among others because of the drop in consumption. However, if the European Union wants to reach its greenhouse gases emissions mitigation target of 60% by 2040 compared to its 1990 level, it seems that it should not only base its hopes on technology improvements, but also on consumption reduction.