The introduction of local or regional carbon pricing can give rise to two key concerns: carbon leakage and reduced competitiveness for domestic firms. Carbon leakage occurs when companies shift production to countries with laxer emission regulations or imports increase from such locations, thereby undermining the environmental benefits of the pricing policy. To counter these risks, mechanisms like the Carbon Border Adjustment Mechanism (CBAM) have been proposed. As part of the EU’s “Fit for 55” package—which aims to reduce greenhouse gas emissions by at least 55% by 2030 compared to 1990 levels—the CBAM imposes a carbon price on certain carbon dioxide-intensive imports to the EU. This is intended to level the playing field between EU-based firms and foreign competitors that operate under less stringent CO₂ regulations.
In this project, we will investigate how a system combining the EU ETS and CBAM tariffs may influence imports and foreign direct investment (FDI) in oligopolistic markets. We construct a stylized model in which non-EU firms compete with EU firms by exporting to the Single Market. In our model, both production and international transport contribute to CO₂ emissions. A foreign firm faces several strategic choices: it can produce using existing emission-intensive facilities in its home country, acquire older emission-intensive plants within the EU, or invest in new, emission-neutral (greenfield) facilities within the EU.
We will explore if an ETS-system combined with CBAM-type tariffs can increase the incentive for EU firms to engage in entry-deterring, emissions-increasing acquisitions—in particular, when carbon prices and border tariffs are high. More generally, we will also examine how different regions' trade and industrial policies (such as the EU and the US) interact and how this affects the possibility of reducing global carbon dioxide emissions.
Why CBAM may lead to higher CO2 emissions
To address the accelerating challenge of climate change, many economists advocate for policies that include a global price on CO₂ emissions. However, due to slow progress in implementing such a global pricing mechanism, some regions—most notably the European Union through its Emissions Trading System (EU ETS)—have taken the lead in establishing regional CO₂ pricing initiatives.
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