Alleviating Adverse Implications of EU Climate Policy on Competitiveness: The Case for Border Tax Adjustments or the Clean Development Mechanism?

Ambitious unilateral EU environmental policy has raised concerns about adverse competitiveness implications for European energy-intensive and export-oriented sectors. We analyze the economic and environmental implications of two different measures to address these concerns in the EU Emission Trading Scheme (EU ETS): border tax adjustments (BTA) and the Clean Development Mechanism (CDM). Numerical simulations with a computable general equilibrium model of the global economy demonstrate that alternative BTA regimes are suitable to alleviate adverse competiveness implications of unilateral European climate policy on energy-intensive and export-oriented industries. The regulatory protection of these industries via subsidies for EU exporters and tariffs for non-EU importers goes, however, at the expense of sectors which are excluded from the EU ETS. We show that the choice of alternative benchmarks (i.e. carbon intensities) for the level of BTA substantially affects these competitiveness implications. The simulations further indicate that limited access to low-cost emission abatement via the CDM in the EU ETS alleviates adverse competitiveness impacts to a comparable extent as the most ambitious BTA scheme. Increasing where-flexibility of emission abatement thus represents an attractive market-based alternative to the application of border tax adjustments in unilateral climate policy.