Modeling the impact of carbon border policies on emissions, global value chains, and welfare

Francois, Joseph F.; Foster-McGregor, Neil Working Paper Modeling the impact of carbon border policies on emissions, global value chains, and welfare ADB Economics Working Paper Series, No. 792 Provided in Cooperation with: Asian Development Bank (ADB), Manila Suggested Citation: Francois, Joseph F.; Foster-McGregor, Neil (2025) : Modeling the impact of carbon border policies on emissions, global value chains, and welfare, ADB Economics Working Paper Series, No. 792, Asian Development Bank (ADB), Manila, https://doi.org/10.22617/WPS250274-2 This Version is available at: https://hdl.handle.net/10419/322393 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/3.0/igo/ ASIAN DEVELOPMENT BANK ASIAN DEVELOPMENT BANK 6 ADB Avenue, Mandaluyong City 1550 Metro Manila, Philippines www.adb.org MODELING THE IMPACT OF CARBON BORDER POLICIES ON EMISSIONS, GLOBAL VALUE CHAINS, AND WELFARE Joseph Francois and Neil Foster-McGregor ADB ECONOMICS WORKING PAPER SERIES NO. 792 July 2025 Modeling the Impact of Carbon Border Policies on Emissions, Global Value Chains, and Welfare This paper employs a computational general equilibrium model to estimate the impact of border carbon adjustment (BCA) policies on emissions and economic performance. Results suggest that while an expanded scheme of carbon prices and BCAs can reduce emissions, underlying growth trends quickly undo the highest emissions reductions modeled. Results also suggest that in some cases the potential impacts of mitigation actions through domestic and trade-related carbon taxes may fall disproportionately on poorer regions. About the Asian Development Bank ADB is a leading multilateral development bank supporting inclusive, resilient, and sustainable growth across Asia and the Pacific. Working with its members and partners to solve complex challenges together, ADB harnesses innovative financial tools and strategic partnerships to transform lives, build quality infrastructure, and safeguard our planet. Founded in 1966, ADB is owned by 69 members—50 from the region. ASIAN DEVELOPMENT BANK The ADB Economics Working Paper Series presents research in progress to elicit comments and encourage debate on development issues in Asia and the Pacific. The views expressed are those of the authors and do not necessarily reflect the views and policies of ADB or its Board of Governors or the governments they represent. ADB Economics Working Paper Series Modeling the Impact of Carbon Border Policies on Emissions, Global Value Chains, and Welfare Joseph Francois and Neil Foster-McGregor No. 792 | July 2025 Joseph Francois (joseph.fr[email protected]) is a professor of economics at the University of Bern and a fellow at the Centre for Economic Policy Research, London. Neil Foster-McGregor ([email protected]) is a principal economist at the Economic Research and Development Impact Department, Asian Development Bank. Creative Commons Attribution 3.0 IGO license (CC BY 3.0 IGO) © 2025 Asian Development Bank 6 ADB Avenue, Mandaluyong City, 1550 Metro Manila, Philippines Tel +63 2 8632 4444; Fax +63 2 8636 2444 www.adb.org Some rights reserved. Published in 2025. 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Corrigenda to ADB publications may be found at http://www.adb.org/publications/corrigenda. Note: ADB recognizes “China” as the People’s Republic of China. ABSTRACT This paper employs a computational general equilibrium model to examine the potential impact of the European Union’s Carbon Border Adjustment Mechanism (CBAM). The paper considers the impact of extending CBAM to other economies, examining whether approaches that require increased coordination of carbon pricing over a greater number of jurisdictions can increase the impact of CBAM. Results suggest that while an expanded scheme of carbon prices and border carbon taxes can reduce emissions, underlying global economic growth trends are more than enough to quickly undo the highest emissions reductions modelled here. As such, sustained technical innovation and major changes in the underlying structure of energy systems will be required to meet Intergovernmental Panel on Climate Change (IPCC) targets. The results also reinforce another message of recent IPCC reports, namely that in some cases the potential impacts of mitigation actions through domestic and trade-related carbon taxes may fall disproportionately on poorer regions. Keywords: computable general equilibrium, carbon pricing, border carbon adjustments JEL codes: C68, Q56 __________________________ This paper was a background paper for the Asian Development Bank’s Asian Economic Integration Report 2024: Decarbonizing Global Value Chains. Early drafts of this paper were presented in the Asian Economic Integration Report (AEIR) Theme Chapter Workshop (October 2023) and at the UK Trade Policy Observatory, University of Sussex (March 2024). 1. Introduction Carbon pricing policies are a central feature of mechanisms designed to balance the societal costs of carbon emissions against associated economic costs linked to emission reductions. The design of such schemes can vary widely, reflecting the non-binding and bottom-up approach to national commitments within the Paris Agreement. Given heterogeneity in both the design and the effectiveness of carbon polices, the more ambitious Parties to the Paris Agreement face a dilemma. How do you scale up your own climate ambitions for higher costs for carbon domestically without being undercut by carbon leakage from abroad? It is in this context that the European Union (EU) is implementing an ambitious, full-fledged climate policy package that heavily relies on both a revised and much strengthened Emissions Trading System (ETS) alongside the introduction of a carbon border tax (CBAM) on imported products. CBAM is intended to reduce the risks of carbon leakage. Carbon leakage involves carbonintensive production stages being shifted from economies with carbon pricing to economies with less-stringent carbon markets and regulations. The potential for carbon leakage relies upon differences in carbon intensities across economies as well as an open trade regime with low trade costs that allows for production to shift across borders. Carbon leakage has several negative implications. By shifting production beyond legislative boundaries, carbon leakage makes it more difficult for national governments to legislate against carbon emissions and can undercut the policy objectives driving carbon pricing mechanisms. Since production will be shifted to economies with weaker environmental legislation and, consequently, more emissions-intensive production techniques, this redirection is also likely to result in higher emissions for a given level of production. Such an outcome is further likely to lead to push back from local producers, which could lead to a reversal of climate policies. Evidence to date suggests that carbon leakage is not a major activity (Grubb et al. 2022). Yet, the incentives for carbon leakage from the EU are expected to rise as the price of EU emission allowances is increased in coming years. The EU’s CBAM is thus a response to this risk of carbon leakage. The response involves introducing CBAM as a flanking mechanism alongside tighter carbon credits and higher carbon prices within the EU ETS, with the mechanism taking the form of a notional ETS, and the importers of covered products being required to purchase nontradable ‘CBAM certificates’ at a price that mirrors that of EU emission allowances.1 The stated aim is to both ensure a fair price for carbon emitted during production of goods entering the EU and to encourage lower carbon intensity in production outside the EU economies. The move toward higher carbon prices and the parallel introduction of carbon border taxes has driven more intensive discussion about designing policies to limit greenhouse gas emissions. In this paper we employ a computational general equilibrium (CGE) model of world production and trade to examine the potential impact of various policy scenarios on carbon emissions, on the structure of production and trade, and on other socioeconomic outcomes. The starting point is to examine the impact of the EU’s CBAM on these indicators for the EU and other regions, with a specific focus on different regions in Asia. Acknowledging that the contribution of imports into the EU to global emissions remain limited, the paper also considers the impact of extending CBAM (and ETS) to other economies and regions. Given the potential for firms to shift production to outside of the EU in response to CBAM, a concern is that domestic reductions in the EU may be matched by increases outside of the EU. One way of avoiding this is to coordinate carbon pricing 1 The EU’s CBAM policy has reignited a longstanding controversy regarding the legality of such measures. The debate itself is not new, as the idea of imposing some form of border carbon adjustment (BCA) has been discussed in the policy literature for over 15 years. See Espa, Francois, and van Asselt (2022) for further discussion on the legal issues at play. 2 over a greater number of jurisdictions, limiting the opportunities for this reallocation of emissions intensive production. As such, we consider extending CBAM to other OECD economies and to Asian regions, comparing estimated outcomes to those when CBAM is only implemented in the EU. Besides expanding the coverage of CBAM, the paper also considers the possible contribution of flanking policy-driven changes in the carbon intensity of industry in low and middle-income economies. The intention is to consider the relative importance of technology improvements— specifically the diffusion of technologies to low and middle-income economies that results in a convergence of emissions intensities toward those in more efficient advanced economies—in reducing emissions, and whether this approach can mitigate any negative economic consequences of carbon pricing. The paper begins with a brief overview of the literature on CBAM and its estimated impacts in Section 2. Section 3 then discusses the CGE model adopted, the data used in the analysis, and the different policy scenarios examined, with Section 4 describing the results of the analysis. Section 5 concludes. 2. Literature Review A growing literature assesses the potential impacts of CBAM on the EU and other economies, with many studies adopting a CGE approach to examine these impacts. The intention of this review is not to provide a comprehensive survey of these studies, but to highlight some of the more recent approaches and results. A range of studies examine the consequences of CBAM on non-EU economies, with Xiaobei, Fan, and Jun (2022), for example, adopting a dynamic CGE model to examine the consequences for other economies from the EU’s CBAM. Their results suggest that CBAM could widen the GDP and welfare gap between developed and developing economies and may also make it more difficult for some developing economies to decarbonize their economies. Given the potentially negative consequences on developing economies, they propose using the revenue from CBAM to create a decarbonization fund. Related studies focus on the impacts of CBAM on specific economies. Takeda and Arimura (2024) use CGE to consider the impacts of CBAM on Japan. Their results suggest an overall positive impact of CBAM on GDP and welfare, but a negative impact on the economy’s energyintensive and trade-exposed sectors. None of these effects are found to be large, however, leading the authors to conclude that CBAM is not a great concern for Japan. Chen (2023) adopts a dynamic CGE model to consider the impact of CBAM in the People’s Republic of China (PRC), finding that CBAM will reduce the price of the PRC’s exports and real GDP, further reducing the carbon intensity of 18 affected sectors. These impacts are estimated to be small, however. Perdana, Vielle, and Oliveira (2023) consider the impacts of CBAM on Brazil, finding that CBAM will improve the trade balance of Brazil’s energy-intensive industries. This is because the carbon dioxide (CO2) content of Brazil’s energy-intensive industries is relatively low. Beyond the effect on production, trade, and welfare in other economies, some literature considers the impacts of CBAM on carbon leakage and global emissions reductions. UNCTAD (2021), consistent with other work (e.g., Bednar-Friedl, Schinko, and Steininger 2012; Böhringer, Carbone, and Rutherford et al. 2012; Perdana and Vielle 2022), finds using a CGE model that CBAM is associated with reduced carbon leakage, as well as reductions in emissions by EU producers and a shift in trading patterns toward relatively carbon efficient economies. However, their results further indicate that the emissions reduction in response to the EU’s CBAM is limited; results consistent with some of those presented in this paper. 3 A third set of studies moves beyond the question of the impact of the EU’s CBAM and examines whether extending CBAM to other economies will enhance the effectiveness of the policy. More closely related to the current paper, for example, is Perdana and Vielle (2023). They adopt a CGE model but, rather than focus on the EU’s unilateral CBAM policy, examine the impacts of a climate club between the EU, US, and the PRC. Considering a coalition of large economies implementing a border carbon adjustment, the authors find—consistent with results in this paper—that a coalition reduces carbon leakage, improves production on energy-intensive industries, and increases the club’s welfare relative to either no CBAM or unilateral implementation. 3. Methodology 3.1. Overview of the Economic Modelling To estimate the impact of the ETS and CBAM, we use a large-scale CGE model of the global economy that allows for an examination of sector and macroeconomic effects on different economies and regions. We employ the CGE model developed in Bekkers and Francois (2018) and Bekkers, Francois, and Rojas-Romagosa (2018), which includes multiple economies, multiple sectors, intermediate linkages, and multiple factors of production that is calibrated using the Global Trade Analysis Project (GTAP) database.2 The approach also allows for an estimation of the impact of ETS and CBAM on emission patterns. This impact follows from changes in the mix of production, the level of overall activity, and how goods and services are produced. 3.2. The CGE Model of Global Production and Trade A CGE model is an extensive economic framework that allows for assessment of the effects of both the ETS and the CBAM on industry, translating these effects into national and global economic impacts. It estimates various economic changes, including shifts in values, quantities, and prices related to domestic activities (such as output and employment) and their corresponding trade flows. The model’s general equilibrium approach allows for complex interactions among sectors through supply linkages and factor markets, simulating changes in specific economic sectors resulting from the application of ETS and CBAM. A CGE model comprises three key components: the general equilibrium economic model (mathematical structure), the multiregional input-output (MRIO) data integrated within the model, and a set of exogenous parameters and variables (like elasticities) that guide endogenous responses. The integration of these components creates a calibrated general equilibrium baseline, fulfilling all accounting and market-clearing conditions. In this model, each region has a single representative composite household that allocates expenditure between personal consumption and savings. This household owns production factor endowments and earns income by selling their endowments to firms, along with income from tariff revenues and rents from import/export quota licenses. Some of this income is distributed as subsidy payments, primarily to the agriculture sector. The model’s structure aligns closely with the standard GTAP model (Corong et al. 2017), enhanced by a micro-founded theoretical model based on Eaton and Kortum’s (2002) trade framework. The main distinction is the incorporation of their demand structure, enabling the derivation of the gravity equation for estimating trade elasticities and changes in trade costs (Bekkers and Francois 2018; Bekkers, Francois, and Rojas-Romagosa 2018). This structurally 2 Version 11 with base year 2017 (Aguiar et al. 2019). 4 estimated model utilizes trade elasticities derived from econometric analysis of the underlying data. Implementation follows the methodologies laid out by Bekkers, Francois, and RojasRomagosa (2018) and Bekkers et al. (2023), with extensions that enable direct estimation of changes in greenhouse gas emissions, focusing particularly on CO2. The calibration of the model merges features of traditional CGE models (Dixon and Jorgenson 2013) with the micro-foundations of contemporary quantitative trade models (Costinot and Rodríguez-Clare 2014). This means we utilize the enhanced micro-founded Eaton and Kortum (2002) structure to model trade linkages, alongside structurally estimated trade parameters based on a gravity model that derives from the same structural general equilibrium framework. As such, our state-of-the-art CGE model addresses recent academic critiques of standard CGE models, advocating for micro-foundations grounded in current trade theories and ensuring that key model parameters are structurally estimated from the same foundational data (Bekkers et al. 2023; Costinot and Rodríguez-Clare 2014). In this structural general equilibrium model, the economy is represented as a series of simultaneous equations. It categorizes the entire economy into production and consumption sectors, which are collectively modeled. Production sectors are interconnected in value-added chains, progressing from raw materials to the final assembly of goods for households and governments. These links traverse both borders and industries, including direct connections (like steel used in transport equipment) and indirect links (such as the relationship between chemicals and agriculture through fertilizers and pesticides). In addition, sectors compete for resources in primary factor markets (capital, labor, and land). The overall conceptual framework of a regional economy within the GTAP class of structural general equilibrium model is illustrated in Figure 1 and Figure 2.3 Figure 1: Production Structure in the CGE Model CES = constant elasticity of substitution, CGE = computable general equilibrium. Source: Authors. 3 Note that with the Earon-Kortum specification, the CES functional form has a different interpretation in terms of parameterization but otherwise follows the same basic structure as in the diagrams. A key difference is that imports and domestic products compete on the same level. This corresponds technically to a non-nested aggregation of imports and domestic products. See Bekkers et al (2023). 11 Figure 4: Patterns of Carbon Dioxide Intensity ADB = Asian Development Bank, CBAM = Carbon Border Adjustment Mechanism, ETS = Emissions Trading System, MT CO2 = megatonne of carbon dioxide, OECD = Organisation for Economic Co-operation and Development, PRC = People’s Republic of China. Source: Authors’ calculations based on model database. 4. The Estimated Impact of Carbon Pricing Scenarios We turn next to estimated results from the application of our general equilibrium model to the scenarios defined in Table 2. We first discuss changes in emissions. We then focus on economic effects. Full results are reported in the appendix. 4.1. Emission Impacts Table 4 and Figure 5 present estimated changes in CO2 emissions relative to our benchmark data. Comparison of scenarios 1 and 2 illustrates the issue of carbon leakage, which is the rationale for application of CBAM in the first place. In the first specification, CO2 emissions are estimated to fall by 358.1 million tonnes of in response to an increase in the carbon price to €100. This reflects a reduction of 490.9 million tonnes in the EU and OECD Europe4 and an increase of 132.8 million tonnes in other regions. This suggests that about 27% of the emissions reduction in the EU is shifted to other regions. When introducing CBAM, the overall estimated reduction in emissions is larger (418.1 million tonnes). While the reduction in emissions in the EU is roughly similar (425.4 versus 435.8 million tonnes), the increase in emissions in other regions under Scenario 2 is estimated to be smaller (62.4 versus 132.8 million tonnes), meaning that the estimate for carbon leakage drops by 14 percentage points from 27% to 13%. While we still see 4 We add values for OECD Europe to those for the EU since some of the former economies are also part of the EU ETS. 0 2 4 6 8 10 12 14 0 200 400 600 800 1,000 1,200 1,400 1,600 OECD Asia ADB Central and West Asia East Asia South Asia Southeast Asia Pacific PRC India Republic of Korea European Union OECD Europe Eastern Europe North America Latin America West Asia and North Africa Sub-Saharan Africa MT CO₂per million $ value added (right axis) MT CO₂per million $ value added in manufacturing (left axis) MT CO₂per capita (right axis) 12 an increase in emissions outside the EU under Scenario 2, global emissions are substantially lower than under Scenario 1, an effect driven almost entirely by a reduction in carbon leakage. While emissions reductions are substantially larger with a carbon price of €200 (scenarios 5 and 6), the pattern of results is similar to that for a carbon price of €200. Global emissions reductions are substantially larger with CBAM than without (624.5 versus 749.8 million tonnes), an effect driven by reduced carbon leakage. Without CBAM emissions reductions in the EU and OECD Europe are about 885 million tonnes, while emissions elsewhere increase by 261 million tonnes, a carbon leakage rate of 29.4%. When CBAM is introduced, however, the reduction in emissions in the EU is 867.6 million tonnes, the increase elsewhere 117.8 million tonnes, and the carbon leakage rate 13.6%. The introduction of CBAM thus reduces the carbon leakage rate by about 16 percentage points. The regions seeing the largest increase in emissions in response to the higher priced ETS and CBAM in the EU tend to be in North America and regions that are geographically close to the EU such as Eastern Europe and West Asia and North Africa. Within Asia, relatively large increases in emissions are estimated for the PRC and India, and to a lesser extent Central Asia and Southeast Asia. Table 4: Changes in Carbon Dioxide Emissions Scenario 1 2 3 4 5 6 7 8 9 Regions applying ETS €100/MT CO2 €200/MT CO2 ETS only ETS and CBAM ETS only ETS and CBAM Europe Europ e All of OECD OECD and Asia Europ e Europ e All of OECD OECD and Asia CO 2 intensity convergen ce OECD Asia 5.7 5.3 -238.1 -192.2 10.7 10.2 -410.7 -327.6 -364.0 ADB Central and West Asia 4.2 2.1 11.2 -51.0 8.2 3.7 24.0 -108.6 -86.8 East Asia 2.2 1.4 6.3 -66.2 3.9 2.4 12.4 -116.4 -120.0 South Asia 0.5 0.4 3.1 -10.2 1.0 0.6 6.2 -20.4 -26.0 Southeast Asia 5.4 2.4 19.7 -147.1 9.9 4.2 39.1 -279.3 -350.2 Pacific 0.1 0.0 0.0 0.3 0.2 0.0 0.1 0.7 -3.7 PRC 10.7 3.7 43.2 -1,429.3 18.7 5.5 88.1 -2,546.1 -3,094.1 India 11.6 7.1 30.5 -398.5 23.5 14.6 60.9 -723.8 -524.8 Republic of Korea 2.5 1.7 -99.5 -80.4 4.7 3.2 -178.5 -144.3 -190.8 European Union -435.8 -425.4 -395.4 -334.4 -777.2 -759.6 -706.7 -594.8 -642.8 OECD Europe -55.1 -55.2 -50.8 -43.6 -107.9 -108.0 -100.6 -87.7 -92.7 Eastern Europe 37.3 13.6 35.4 99.2 79.4 28.7 75.5 216.9 318.8 North America 22.7 14.5 -659.8 -570.4 44.0 27.9 -1,240.1 -1,070.5 -1,268.7 Latin America 4.4 1.6 10.5 36.7 8.6 3.0 22.1 78.4 34.2 West Asia and North Africa 18.2 4.6 45.6 154.6 33.6 6.4 94.1 335.1 184.0 Sub-Saharan Africa 7.3 3.9 11.9 38.8 14.2 7.5 24.1 82.2 21.7 World, MT C0 2 -358.1 -418.1 -1,226.2 -2,993.7 -624.5 -749.8 -2,190.1 -5,306.3 -6,205.8 World, % CO 2 change -1.1 -1.3 -3.7 -8.7 -1.9 -2.2 -6.4 -14.9 -17.2 ADB = Asian Development Bank, CBAM = Carbon Border Adjustment Mechanism, ETS = Emissions Trading System, MT CO2 = €100 per megatonne of carbon dioxide, OECD = Organisation for Economic Co-operation and Development, PRC = People’s Republic of China. Source: Authors’ calculations based on model database. 13 The remaining scenarios show that broadening the economy coverage of ETS-type carbon pricing contributes to a substantial reduction in CO2 emissions relative to the baseline. Not surprisingly, the higher carbon price scenarios (€100 versus €200) yield greater reductions. When extending ETS and CBAM to all of the OECD (scenarios 3 and 7), the reduction in emissions is about three times larger than that when ETS and CBAM is implemented in the EU only, while the reduction is more than seven times larger when also extending to Asian economies (scenarios 4 and 8). The greatest reductions in emissions, however, are under Scenario 9, where we have modeled partial convergence of higher emission economies to average OECD emissions intensity by sector. Based on the results in the table, and as expected, the overall reduction in estimated annual emissions is greater when the number of economies covered by carbon pricing are greatest, and when carbon prices are higher. Effective transfer of existing technology (the stylized convergence in Scenario 9) also contributes substantively to CO2 reductions. However, none of this is enough on its own. Figure 5 reports the estimated global percentage reductions in emissions in response to each of these policy interventions. The EU ETS and CBAM is estimated to reduce global emissions by about 2% or less, depending on the carbon price and whether a CBAM is introduced or not. The estimated reductions become greater when coverage is expanded, but even when all OECD and Asia is included, and with a carbon price of €200, emissions reductions are 15% at most. This increases to 17% once convergence in emissions intensities is allowed. According to the IPCC, “global temperature will stabilise when carbon dioxide emissions reach net zero. For 1.5°C (2.7°F), this means achieving net zero carbon dioxide emissions globally in the early 2050s; for 2°C (3.6°F), it is in the early 2070s … limiting warming to around 2°C (3.6°F) still requires global greenhouse gas emissions to peak before 2025 at the latest and be reduced by a quarter by 2030” (IPCC 2022). Underlying global economic growth trends mean that 4 years of trendline growth are more than enough to undo the highest emissions reductions modeled here (scenarios 8 and 9). Price incentives under existing industrial techniques simply do not do enough. Innovation and major changes in the underlying structure of energy systems will be required. Figure 5: Change in Global Carbon Dioxide Emissions CBAM = Carbon Border Adjustment Mechanism, ETS = Emissions Trading System, MT CO2 = €100 per megatonne of carbon dioxide, OECD = Organisation for Economic Co-operation and Development. Source: Authors’ calculations based on model database. -20 -18 -16 -14 -12 -10 -8 -6 -4 -2 0 Europe Europe All of OECD OECD and Asia Europe Europe All of OECD OECD and Asia CO₂intensity convergence ETS only ETS and CBAM ETS only ETS and CBAM €100/MT CO₂€200/MT CO₂ % 14 4.2. Macroeconomic Effects In this section, we turn to estimated overall macroeconomic impacts of the various carbon pricing scenarios. Estimated changes in GDP by economy and region in response to enhanced carbon pricing in the EU are summarized in Figure 6 (see Appendix Table A1 for full results). The figure shows that all economies and regions suffer in terms of GDP from the higher ETS price and the introduction of CBAM in the EU, with the negative effects increasing as the price of carbon rises. Reductions are estimated to be largest for the EU and OECD Europe, with relatively large declines also observed in economies and regions that are geographically close to the EU (e.g., West Asia and North Africa, Eastern Europe, and ADB Central and West Asia). Globally, the enhancement of the EU’s carbon pricing is expected to reduce GDP by about 0.5% at a price of €100 per MT/CO2 and by about 1.0% at a price of €200 per MT/CO2. At the global level, the difference in estimated GDP reductions between an ETS only and an ETS with CBAM is minimal, though differences are more pronounced for some regions, specifically those that are more proximate to the EU. Figure 6: National and Regional Changes in GDP in Response to Carbon Pricing in the European Union CBAM = Carbon Border Adjustment Mechanism, ETS = Emissions Trading System, GDP = gross domestic product, MT CO2 = €100 per megatonne of carbon dioxide, OECD = Organisation for Economic Co-operation and Development, PRC = People’s Republic of China. Source: Authors’ calculations based on model database. -5.0 -4.5 -4.0 -3.5 -3.0 -2.5 -2.0 -1.5 -1.0 -0.5 0.0 OECD Asia ADB Central and West Asia East Asia South Asia Southeast Asia Pacific PRC India Republic of Korea European Union OECD Europe Eastern Europe North America Latin America West Asia and North Africa Sub-Saharan Africa World, % GDP change % 200 €/MT CO₂, ETS and CBAM 200 €/MT CO₂, ETS Only 100 €/MT CO₂, ETS and CBAM 100 €/MT CO₂, ETS Only 15 Figure 7 reports estimated changes in GDP for the remaining scenarios that involve an extension of carbon pricing to other regions and convergence in emissions intensities. The first thing to note is that in comparison to the results in Figure 6, the GDP impacts in the EU are lower when carbon pricing is expanded to other regions, such that the broader the economy coverage, the lower the costs for global emissions reductions carried by Europe (as a percent of GDP). At the same time, the cross-region pattern of GDP effects varies substantively across scenarios. East Asia, Southeast Asia, and South Asia (excluding India), for example, are all hurt as measured by GDP under the broadest and most ambitious carbon pricing scenario (Scenario 8), while other regions outside of Asia often benefit. However, with our scenario incorporating partial technical convergence to OECD carbon efficiency profiles, the impact becomes one of substantial GDP gains. Figure 7: National and Regional Changes in GDP in Response to Carbon Pricing, OECD and Asia ADB = Asian Development Bank, CBAM = Carbon Border Adjustment Mechanism, ETS = Emissions Trading System, MT CO2 = €100 per megatonne of carbon dioxide, OECD = Organisation for Economic Co-operation and Development, PRC = People’s Republic of China. Source: Authors’ calculations based on model database. -10 -5 0 5 10 15 20 OECD Asia ADB Central and West Asia East Asia South Asia Southeast Asia Pacific PRC India Republic of Korea European Union OECD Europe Eastern Europe North America Latin America West Asia and North Africa Sub-Saharan Africa World, % GDP change % CO₂intensity convergence €200/MT CO₂, OECD and Asia €200/MT CO₂, All OECD €100/MT CO₂, ETS and CBAM, OECD and Asia €100/MT CO₂, All OECD 16 The example of these Asian economies and regions also highlights how some economies may suffer from the enhanced carbon pricing in the EU but may gain when CBAM is extended to other OECD economies. This presumably arises because some production from the OECD is shifted to Asia. This hints at the possibility of a free-rider problem: in an environment of expanding carbon pricing, there may be an incentive for some regions to not engage in carbon pricing, since as others join carbon pricing initiatives they may gain from the reallocation of production. The cross-economy pattern of economic effects that emerges from these scenario estimates reinforces another message of recent IPCC reports. In the scenarios spelled out here, we see that in some cases the potential impacts of mitigation actions through domestic and trade-related carbon taxes may fall disproportionately on poorer regions. The specific path followed to reach emission reductions has important implications for the GDP impact across lower versus higher income economies, with implementation choices (including transfer of existing and new technologies) therefore being critical in this regard (IPCC 2018). Tables 5 and 6 decompose the output changes by region to those occurring in ETS and non-ETS sectors. Outside the EU and OECD Europe, the higher priced ETS in the EU—either €100 or €200/MT—is estimated to reduce output in non-ETS sectors and increase it in ETS sectors. Such results suggest that the higher EU carbon price leads to carbon leakage of ETS sectors to other economies, with the negative income effect of the higher carbon price reducing output in non-ETS sectors across the different regions. Results are similar when introducing CBAM in the EU, though with somewhat smaller positive (negative) effects on output in ETS sectors in other regions (the EU). Extending the ETS and CBAM to other regions is estimated to have varied effects on other regions. In most cases, however, the extension of ETS and CBAM to the OECD and to Asia leads to increases in output in both ETS and non-ETS sectors in other regions, suggesting the presence of carbon leakage in ETS sectors, but also the shift of downstream production to regions not covered by carbon pricing. Table 5: National and Regional GDP Impacts of Carbon Pricing by Sector Type, €100/MT CO2 (%) €100/MT CO2 ETS only ETS and CBAM Region applying policy Europe Europe All of OECD OECD and Asia Region ETS sectors nonETS sectors ETS sectors nonETS sectors ETS sectors nonETS sectors ETS sectors nonETS sectors OECD Asia 0.3 -0.2 0.2 -0.1 -4.9 -1.3 -1.8 0.1 ADB Central and West Asia 0.5 -0.4 0.1 -0.4 1.6 0.4 -1.2 0.8 East Asia 0.5 -0.2 0.2 -0.2 1.3 0.1 -4.3 -0.6 South Asia 0.1 -0.2 0.0 -0.2 0.9 0.5 -2.5 0.2 Southeast Asia 0.5 -0.3 0.2 -0.3 1.5 0.1 -1.8 -0.1 Pacific 0.6 -0.3 0.2 -0.3 1.3 -0.7 3.8 -0.2 PRC 0.3 -0.1 0.2 -0.1 0.9 0.1 -4.7 -1.7 India 0.4 -0.1 0.3 -0.1 1.1 0.3 -7.9 -1.5 Republic of Korea 0.4 -0.2 0.2 -0.1 -7.3 -1.9 -4.2 -0.4 European Union -5.8 -1.4 -5.3 -1.5 -4.4 -1.1 -2.4 0.4 Continued on the next page 17 €100/MT CO2 ETS only ETS and CBAM Region applying policy Europe Europe All of OECD OECD and Asia Region ETS sectors nonETS sectors ETS sectors nonETS sectors ETS sectors nonETS sectors ETS sectors nonETS sectors OECD Europe -4.0 -0.5 -3.8 -0.6 -3.0 -0.5 -1.2 0.1 Eastern Europe 1.6 -0.5 0.6 -0.5 1.7 -0.1 4.7 1.5 North America 0.5 -0.2 0.3 -0.1 -3.9 -0.5 -2.0 1.0 Latin America 0.5 -0.2 0.3 -0.2 1.3 0.1 3.8 1.1 West Asia and North Africa 0.9 -0.5 0.3 -0.5 2.0 0.0 6.3 1.7 Sub-Saharan Africa 1.2 -0.3 0.7 -0.3 2.0 0.0 5.7 1.0 ADB = Asian Development Bank, CBAM = Carbon Border Adjustment Mechanism, ETS = Emissions Trading System, MT CO2 = €100 per megatonne of carbon dioxide, OECD = Organisation for Economic Co-operation and Development, PRC = People’s Republic of China. Source: Authors’ calculations based on model database. Table 6: National and Regional GDP Impacts of Carbon Pricing by Sector Type, €200 /MT CO2 (%) €200/MT CO2 ETS only ETS and CBAM Region applying policy Europe Europe All of OECD OECD and Asia CO2 intensity convergence Region ETS sectors nonETS sectors ETS sectors nonETS sectors ETS sectors nonETS sectors ETS sectors nonETS sectors ETS sectors nonETS sectors OECD Asia 0.5 -0.3 0.4 -0.3 -9.9 -3.2 -3.9 -0.1 -7.8 -0.9 ADB Central and West Asia 0.9 -0.9 0.2 -0.9 3.5 1.1 -4.2 0.5 21.0 6.4 East Asia 1.0 -0.5 0.5 -0.4 2.8 0.3 -8.9 -2.3 -6.8 0.3 South Asia 0.3 -0.5 -0.1 -0.4 2.1 1.1 -5.1 0.1 -7.0 1.9 Southeast Asia 0.9 -0.6 0.3 -0.6 3.1 0.3 -4.6 -1.0 6.2 2.8 Pacific 1.2 -0.6 0.5 -0.7 3.0 -1.3 8.8 -0.3 1.9 2.6 PRC 0.5 -0.2 0.3 -0.1 1.8 0.2 -10.3 -4.4 6.1 2.9 India 0.7 -0.2 0.6 -0.2 2.2 0.5 -15.6 -3.9 6.6 3.2 Republic of Korea 0.7 -0.4 0.3 -0.3 -14.2 -4.2 -8.1 -1.3 -11.5 0.2 European Union -11.8 -3.4 -11.0 -3.7 -9.1 -2.7 -5.1 0.4 -9.5 -0.1 OECD Europe -8.4 -1.4 -8.0 -1.7 -6.3 -1.4 -2.8 -0.1 -8.2 -0.1 Eastern Europe 3.4 -0.9 1.2 -1.0 3.4 0.1 10.1 3.7 37.7 7.9 North America 1.0 -0.3 0.6 -0.3 -8.1 -1.2 -4.0 1.9 -1.9 1.5 Latin America 0.9 -0.4 0.5 -0.4 2.7 0.2 8.0 2.6 1.1 1.8 West Asia and North Africa 1.6 -1.0 0.5 -1.0 4.2 0.1 13.8 4.3 4.0 2.8 Sub-Saharan Africa 2.2 -0.6 1.2 -0.6 3.9 0.2 11.6 2.5 1.8 1.5 ADB = Asian Development Bank, ETS = Emissions Trading System, MT CO2 = €100 per megatonne of carbon dioxide, OECD = Organisation for Economic Co-operation and Development, PRC = People’s Republic of China. Source: Authors’ calculations based on model database. 18 Turning to the estimated impacts on exports, Figure 8 reports information on the estimated impact of carbon pricing scenarios in the EU on exports of the different regions. Under all scenarios exports of all regions are estimated to decline. As expected, the estimated declines are large in the EU and OECD Europe, and close to 6% in the most stringent case in the EU. In other regions, declines are estimated to be large in those regions close to the EU, including Central and West Asia, Eastern Europe, and West Asia and North Africa. On average, exports decline by 1% in the case of the higher priced ETS of €100/MT, with the average decline being 2.7% in the case of an ETS and CBAM of €200/MT. Figure 8: Estimated Impact of EU ETS and CBAM on Exports by Region ADB = Asian Development Bank, CBAM = Carbon Border Adjustment Mechanism, ETS = Emissions Trading System, EU = European Union, MT CO2 = €100 per megatonne of carbon dioxide, OECD = Organisation for Economic Cooperation and Development, PRC = People’s Republic of China. Source: Authors’ calculations based on model database. -7 -6 -5 -4 -3 -2 -1 0 OECD Asia ADB Central and West Asia East Asia South Asia Southeast Asia Pacific PRC India Republic of Korea European Union OECD Europe Eastern Europe North America Latin America West Asia and North Africa Sub-Saharan Africa % €200/MT CO₂, ETS and CBAM €200/MT CO₂, ETS Only €100/MT CO₂, ETS and CBAM €100/MT CO₂, ETS Only 19 Extending the ETS and CBAM to the OECD and Asia results in larger average reductions in exports (Figure 9). On average, exports decline by 2% when extending ETS and CBAM to the OECD at €100/MT, with the decline being 3.8% for the same scenario at a price of €200/MT and 3.1% when expanding to Asian economies at a price of €200/MT. Declines tend to be larger in those regions that implement carbon pricing, with the declines deepening as the pricing becomes more stringent. There are exceptions, however, with the extension of carbon pricing to Asia leading to increases in exports in South Asia. Figure 9: Estimated Impact of ETS and CBAM Extended to the OECD and Asia on Exports by Region ADB = Asian Development Bank, CBAM = Carbon Border Adjustment Mechanism, ETS = Emissions Trading System, MT CO2 = €100 per megatonne of carbon dioxide, OECD = Organisation for Economic Co-operation and Development, PRC = People’s Republic of China. Source: Authors’ calculations based on model database. -10 -5 0 5 10 15 OECD Asia ADB Central and West Asia East Asia South Asia Southeast Asia Pacific PRC India Republic of Korea European Union OECD Europe Eastern Europe North America Latin America West Asia and North Africa Sub-Saharan Africa % CO₂intensity convergence 200 €/MT CO₂, All OECD and Asia 200 €/MT CO₂, All OECD 100 €/MT CO₂, ETS and CBAM, All OECD and Asia 100 €/MT CO₂, All OECD 20 Finally, we consider global changes in sector trade volumes in response to the carbon pricing scenarios (Table 7). The results suggest that export volume declines are likely to be larger in sectors that are emissions intensive, including Electricity, Petrochemicals, Mineral products, Transport, Mining, and Ferrous metals. The case of Gas distribution is interesting, with export volumes estimated to increase with an ETS in the EU only, but see relatively large declines once CBAM is implemented. Table 7: Change in Sectoral World Trade Volumes (%) €100/MT CO2 €200/MT CO2 ETS only ETS and CBAM ETS only ETS and CBAM Sectors Europe Europe All of OECD OECD and Asia Europe Europe All of OECD OECD and Asia CO 2 intensity convergence Agriculture, forestry, fishing -1.2 -1.3 -1.2 -1.6 -2.6 -2.7 -3.0 -3.9 2.1 Mining -2.8 -2.5 -4.8 -9.5 -5.1 -4.6 -8.0 -16.1 -19.8 Food -1.0 -1.2 -1.2 -0.5 -2.6 -2.8 -2.9 -1.5 -0.3 Textiles -0.9 -1.0 -1.0 -0.3 -2.1 -2.2 -2.4 -0.5 -2.3 Wood -2.1 -2.4 -2.4 -1.2 -4.5 -5.2 -5.3 -2.9 -0.7 Chemicals, rubber, plastics -2.0 -2.6 -3.1 -1.8 -4.1 -5.3 -6.3 -4.0 -0.6 Pharmaceuticals -0.6 -1.0 -0.8 0.6 -1.5 -2.2 -2.0 1.9 3.0 Ferrous metals -2.2 -3.1 -4.2 -1.8 -4.5 -6.3 -8.0 -2.4 15.6 Nonferrous metals -1.6 -2.3 -2.4 3.3 -3.3 -4.7 -4.9 5.0 -8.6 Metal products -1.6 -1.9 -1.7 -2.2 -3.5 -4.2 -3.6 -4.7 2.6 Mineral products nec -2.6 -5.0 -7.3 -3.4 -5.2 -9.5 -13.0 -6.2 -3.7 Computer, electronic and optic -0.8 -1.0 -1.0 -0.5 -1.9 -2.1 -2.3 -1.2 1.9 Machinery and equipment nec -1.2 -1.5 -1.5 -0.1 -2.7 -3.3 -3.2 -0.4 0.9 Motor vehicles -1.1 -1.3 -1.4 0.1 -2.5 -2.9 -3.2 0.0 0.7 Motor vehicles and parts -1.0 -1.3 -1.2 0.3 -2.3 -3.0 -2.7 0.5 1.7 Manufactures nec -1.1 -1.2 -1.5 -0.4 -2.5 -2.8 -3.4 -1.1 -0.8 Construction -0.7 -0.9 -0.5 0.4 -1.6 -2.1 -1.0 0.8 3.1 Petrochemicals, coal products -2.3 -3.8 -6.2 -6.5 -4.6 -7.4 -11.8 -12.9 -14.3 Electricity -2.4 -9.2 -10.1 -8.9 2.3 -13.1 -14.4 -11.0 -11.6 Gas manufacture, distribution 1.7 -5.1 -8.1 -14.0 12.7 -0.6 -5.9 -13.0 -17.4 Transport nec -1.4 -3.1 -4.1 -3.3 -2.5 -5.9 -7.7 -6.2 -3.0 Commercial services -0.8 -0.9 -0.7 0.3 -1.9 -2.1 -1.8 0.5 1.4 Public services -0.4 -0.5 0.1 -0.1 -0.8 -1.0 0.4 -0.2 5.7 ADB = Asian Development Bank, ETS = Emissions Trading System, MT CO2 = €100 per megatonne of carbon dioxide, nec = not elsewhere classified, OECD = Organisation for Economic Co-operation and Development, PRC = People’s Republic of China. Source: Authors’ calculations based on model database. ASIAN DEVELOPMENT BANK ASIAN DEVELOPMENT BANK 6 ADB Avenue, Mandaluyong City 1550 Metro Manila, Philippines www.adb.org MODELING THE IMPACT OF CARBON BORDER POLICIES ON EMISSIONS, GLOBAL VALUE CHAINS, AND WELFARE Joseph Francois and Neil Foster-McGregor ADB ECONOMICS WORKING PAPER SERIES NO. 792 July 2025 Modeling the Impact of Carbon Border Policies on Emissions, Global Value Chains, and Welfare This paper employs a computational general equilibrium model to estimate the impact of border carbon adjustment (BCA) policies on emissions and economic performance. Results suggest that while an expanded scheme of carbon prices and BCAs can reduce emissions, underlying growth trends quickly undo the highest emissions reductions modeled. Results also suggest that in some cases the potential impacts of mitigation actions through domestic and trade-related carbon taxes may fall disproportionately on poorer regions. About the Asian Development Bank ADB is a leading multilateral development bank supporting inclusive, resilient, and sustainable growth across Asia and the Pacific. Working with its members and partners to solve complex challenges together, ADB harnesses innovative financial tools and strategic partnerships to transform lives, build quality infrastructure, and safeguard our planet. Founded in 1966, ADB is owned by 69 members—50 from the region.