Carbon Border Adjustments

carbon emissions. Finally, while the EU program is initially limited to a small number of carbon-intensive products, the scope of the program may be extended, especially if the pilot program appears to be insufficient in meeting the EU’s objective of reducing carbon emissions by 55 percent from 1990 levels by 2030. Hence, building the capacity to measure and verify carbon emissions will become increasingly important for producers throughout the world as programs to regulate carbon become more common and more expansive. In addition, as discussed below, private firms will be increasingly looking for suppliers that can demonstrate carbon competitiveness as part of their own corporate carbon management agenda.

Structural economic modeling using stylized scenarios of measures to achieve nationally determined contributions (NDCs) to the Paris Agreement and the bolder targets of the European Green Deal suggest that the impacts on most low-income countries will be limited.11 Box 5.2 summarizes the modeling approach and policy scenarios, which are explored in more detail by Chepeliev et al. (2021).

BOX 5.2 modeling the Impacts of nationally determined Contributions and Carbon Border Adjustments

The analysis presented here is based on a global, dynamic computable general equilibrium (CGE) model—the multiregional input-output (MRIO) version of the ENVISAGE model.a This approach allows for the analysis of global development and structural transformation, incorporating complex interactions of productivity differences at the country, sector, or factor level; shifts in demand as income changes; demographic and skill dynamics in factor markets; and changes in comparative advantages. It extends the standard modeling framework by incorporating MRIO tables that distinguish between imports of intermediate, final, and investment goods to better capture the nature of trade. The CGE model uses the Global Trade Analysis Project (GTAP) Version 10 database, with 2014 as the reference year, and is run until 2030. The analysis covers 27 sectors and 21 countries or regions.

The nationally determined contribution (NDC) targets are specified in the form of carbon dioxide (CO2) emissions reduction in 2030 relative to levels in the pre-COVID baseline scenario. The model reflects the impact of COVID-19 on emissions trajectories. It is assumed that countries implement carbon-pricing policies to reach their NDC commitments, and the model estimates the carbon price consistent with achieving these targets. Corresponding 2030 carbon prices range from less than US$5 per ton of CO2 in Sub-Saharan African countries, India, and Malaysia to more than US$30 per ton of CO2 in Brazil, Turkey, the European Union (EU), and some other high-income countries.

In addition to the NDC targets, the model explores the more ambitious climate mitigation efforts of the EU Green Deal to cut emissions by 55 percent in 2030 relative to the 1990 level (EC 2019). This goal is achieved by a further increase in the price of carbon used in the model, together with the Carbon Border Adjustment Mechanism to prevent carbon leakage. The border adjustment takes the form of an ad valorem equivalent tax imposed on region- and commodity-specific carbon content of imports into the EU. The carbon price used to determine the border tax rate is estimated as the difference between the carbon price in the EU and the carbon price in the exporting country or region. The tax is based on the carbon content of the product in the exporting country and not on some measure of emissions in production in the EU. Border taxes are only levied on products from sectors covered by the EU Emissions Trading System.

a. EnVISAgE is a CgE model that assesses interactions between economies and the global environment and the way in which these interactions are affected by anthropogenic greenhouse gas emissions. It is designed to analyze a range of issues related to the economics of climate change (including baseline levels of Co2 and greenhouse gases), the impact of climate change on the economy, adaptation to climate change, and distributional consequences of climate change.

FIGURE 5.1 Change in real Income and Carbon Prices Associated with Achievement of nationally determined Contribution targets in a Post-CoVId Scenario, by region, 2030

0.2 0.1 84.55

0.08

Change in real income (%)

0 –0.1 –0.2 –0.3 –0.4 –0.5 –0.6 –0.16 –0.15

–0.23

11.14 –0.13

29.03 –0.08 –0.11

17.74 –0.15 –0.16 –0.14

38.82 32.05

10.72

–0.7 –0.8 –0.72 2.72 0.44 0.00 4.75

East Asia and Pacific South AsiaSub-Saharan AfricaMiddle East and North AfricaEurope and Central AsiaLatin America and the Caribbean ChinaUnited StatesWestern Europe Rest of high-income countries World

Change in real income Carbon price

Sources: World Bank calculations; Chepeliev et al. 2021. Note: The world’s average carbon price is a weighted average carbon price. 90 80 70 60 50 40 30 20 10 0 Carbon price (US$ per ton)

The carbon prices that would be required to achieve NDC targets in a postCOVID world lead to moderately negative macroeconomic impacts, as per capita income reduction in most regions does not exceed 0.2 percent (figure 5.1). The only region with a larger reduction in income per capita is East Asia and Pacific (−0.72 percent), the result of its relatively ambitious emissions reduction target (24 percent relative to the 2030 baseline).

Table 5.1 shows the three sectors in each region with the largest reduction in output following the implementation of NDCs. As expected, the coal sector is the most affected sector in all regions. An increase in carbon prices under the NDC scenario leads to a reduction in global demand for coal, and the production of this commodity drops significantly in each region—ranging from between 6 percent and 7 percent in the Middle East and North Africa and China to between 20 percent and 30 percent in Europe, Latin America, the United States, and other high-income regions and countries. The gas sector (extraction and distribution) is the second-most-affected sector in almost half the regions analyzed. Given the increase in fuel prices following the implementation of carbon taxes, transportation (air, water, and ground transport) is likewise among the most affected sectors. All other sectors experience much less significant reductions in output.

Consistent with the observed changes in patterns of production, exports and imports of fossil fuels are affected the most. With lower global demand for fossil fuels, the volume of trade for these commodities declines, while trade is relocated modestly toward destinations with less stringent environmental regulations. For instance, China,