Climate Tariffs: Effect Depends on Design
ResearchZEW Study on Border Carbon Adjustments and the Trade-Off Between Environmental Ambition and Economic Protectionism
Border carbon adjustments (BCAs) are designed to reduce emissions and simultaneously protect domestic industries from competitive disadvantages. However, using the example of the global steel industry, a recent study by ZEW Mannheim shows that the specific design of these instruments is critical to their effectiveness. In particular, benchmark-based models – i.e. those based on emission intensities – significantly weaken the carbon-price signal. Compared to a quantity-based approach, they transmit only around 36 per cent of the CO₂ price required to achieve the same global emissions reduction, and result in greater losses of welfare.
“Our findings show that the choice of a BCA design is not a technical detail but has fundamental implications for climate action and competitiveness,” explains Eunseong Park, researcher in ZEW’s “Environmental and Climate Economics” Research Unit. “An intensity-based approach therefore acts as a combination of a CO₂ price and an implicit production subsidy, thereby diluting the steering effect.” Professor Sebastian Rausch, head of the Research Unit, adds: “Without a clear domestic CO₂ price incentive such instruments fail to achieve their objective and, above all, shift economic benefits towards domestic industries rather than reducing emissions.”
The steel industry as a key test case
The study focuses on the global steel industry because it is responsible for a significant proportion of industrial greenhouse gas emissions and trade in this sector is intensive. At the same time, steel production is characterised by very different technologies: Whilst integrated blast furnace routes are particularly emission-intensive, electric arc furnace routes use clean electricity and a high proportion of scrap, which significantly curbs production emissions. These differences make the sector particularly suitable for analysing the strength of the carbon-price signals actually transmitted by different BCA designs across global markets.
Weak price signals reduce climate impact
The analysis shows that benchmark-based border adjustment mechanisms systematically weaken the carbon-price signal. As a result, trading volumes remain higher, and emission reductions are achieved more through technological adjustments or production relocations. At the same time, the risk of ‘carbon leakage’ increases. Emission-intensive production steps are relocated abroad or shifted within global supply chains. In a scenario similar to an EU policy environment, the leakage rate rises from 16 to 36 per cent if an intensity-based approach is chosen instead of a volume-based one.
Supply chains reinforce distorted incentives
According to the study, the effects along global value chains, such as in the steel industry, are particularly problematic. If carbon costs are not adequately included in prices for intermediates such as pig iron, the imports of intermediate products rise significantly. In the model, pig iron imports into the EU double under a benchmark-based system, with their prices remaining artificially low. This leads to emission-intensive production stages being shifted to other countries and has negative consequences for the global carbon footprint.
About the methodology
The study is based on a theoretical equilibrium model that illustrates the fundamental mechanisms of different border carbon adjustment designs. The model distinguishes between upstream and downstream production stages, between domestic and foreign producers, and between a domestic carbon price and carbon pricing at the border.
In a second step, an empirically calibrated general equilibrium model of the global steel industry is used. This model covers around 350 steelworks worldwide and takes technological differences, trade flows and supply chains into account. The underlying data basis comprises microdata, trade statistics and technical production information to enable analysis of realistic effects on emissions, welfare and production relocation.
