Carbon Leakage Protection—Model-Based Comparison of the Macroeconomic Effects of Different Instruments

Abstract

The implementation of the ambitious European Green Deal package and the intensified pursuit of sustainability goals are accompanied by many challenges, particularly for energy-intensive industrial sectors in Germany and the EU. In addition to the rising cost of CO₂ certificates as a burden for companies, the transformation of local production requires enormous investments in CO₂ emission reduction technologies. In order to accelerate the EU’s transition within the EU-ETS to climate neutrality while maintaining the competitiveness of European companies and avoiding the risk of large parts of the industry migrating to less ambitious regions, the European Commission has decided to replace the current system of free allocation with a Carbon Border Adjustment Mechanism (CBAM). This mechanism is intended to ensure that local companies are not disadvantaged by the CO₂ emission costs they have to pay compared to imports from countries with lower CO₂ prices (exports are not included in the protective effect of this instrument). This study compares the effects of various protection instruments in terms of macroeconomic indicators and CO₂ emissions. In addition to the comparison between CBAM and free allocation, the possibility of establishing a climate club in different design variants to expand the protection of the public climate good and avoid carbon leakage is also analyzed.

1. Introduction

Back in 2015, the 193 member states of the United Nations set 17 global Sustainable Development Goals (SDGs) to shape a better future on Earth. The specific aim is to enable people around the world to live in dignity and to preserve the natural foundations of life in the long term. These economic, ecological and social goals must be supported by governments as well as companies, institutions, and citizens, and must be achieved by 2030, according to the joint resolution. In addition to people, the promotion of prosperity, and the protection of the earth, peace should also be promoted and partnerships established. Climate protection is particularly important in terms of protecting our living environment, and the EU wants to play a pioneering role in this area in particular [1]. Compared to the rest of the world, it has committed itself to an ambitious target, i.e., climate neutrality by 2050, with the adoption of the Green Deal and the EU-ETS as the main instrument. Various studies have shown the impact of politically initiated environmental regulations on production costs and the competitiveness of affected companies [2,3]. As a result, Europe’s concerns about possible competitive disadvantages and a slowdown in domestic economic growth have been on the rise for some time, while other nations such as China and the USA continue to show significant growth. Measures to boost stagnating European productivity growth in particular have not yet been successful.

The recently published report by former Italian Prime Minister and former President of the European Central Bank Mario Draghi on the future competitiveness of the European Union (EU) shows that a new global trade situation has emerged, not only as a result of the coronavirus crisis, but also due to the Russia–Ukraine conflict, the overall decline in geopolitical stability, the digital and AI revolution triggered by the Internet and the associated productivity gains outside Europe, our dependencies on other regions, and numerous other factors. Competition from abroad is increasing and technological change is gaining momentum and speed, while population growth within the EU is declining. The report therefore concludes that economic growth must be increasingly driven by a rising productivity rate in the future and that this is the only way to finance the necessary investments in, for example, Europe’s decarbonization, digitalization, and expansion of defense capacities. This is the only way to ensure that our companies remain competitive. According to Draghi [4], if Europe does not successfully overcome these challenges, we will not be able to achieve our climate targets, maintain the prosperity we are accustomed to, nor be a competitive leader in new technologies or an independent player in the global market. Europe is thus forced to further develop itself and its technologies and to utilize its innovative potential. Draghi’s focus is primarily on maintaining competitiveness and optimizing the interplay between the risks and opportunities arising from the planned decarbonization under various necessary conditions for Europe’s positive development. For example, the adopted climate targets and the taxation of CO₂ emissions under the EU ETS should have been motivating European industry to develop and apply new low-GHG technologies more quickly for some time now. As a result of this technological lead, an economic advantage over non-European competitors could arise. However, the climate protection measures that have so far been limited to the EU, as well as the development and application of cost-intensive decarbonization measures, are at the same time associated with enormous costs and investment expenditure, especially for the manufacturing industry.

There is a trade-off between different sustainability goals. While SDGs 7 and 8 call for affordable, clean energy and decent working conditions, a productive economy and industry should grow at the same time (SDG 8), and deliver future-oriented innovations and provide sufficient and resilient infrastructure (SDG 9). Measures should also be taken immediately to combat climate change and its effects (SDG 13), which may lead to competitive disadvantages in ambitious regions and make partnerships to achieve goals more difficult (SDG 17).

As described in the Ariadne policy brief on “Industrial turnaround: Competitive Effects and Carbon Leakage”, the regionally restricted pursuit of ambitious climate policy goals is therefore accompanied by the risk of carbon leakage (CL), i.e., the relocation of CO₂ emissions to non-EU countries. Energy-intensive sectors in particular, such as the steel industry, could relocate their investments, production facilities, and carbon emissions to less regulated and therefore possibly more economically profitable countries, which would increase overall climate damage. Although there is little empirical evidence on the impact of, for example, the EU ETS on competitiveness or the associated occurrence of carbon leakage [5,6], economic models repeatedly show clearly that potential CO₂ emission savings could be prevented by carbon leakage. Ex ante, the risk of carbon leakage can be estimated in particular using general equilibrium models (CGE). Yu et al. [7] show an overview of the range of estimates of the extent of carbon leakage based on the results of 20 studies. The carbon leakage rate (i.e., the ratio between CO₂ emission quantity changes in areas with and without emission reduction targets) ranges from 2% to 49%, although it should be noted that the results depend heavily on the assessment methodology, the datasets used, and the assumptions and parameter values (e.g., on substitution elasticities, prices, or the consideration of NDCs and other international agreements such as the Paris Climate Agreement).

There are currently two main instruments for avoiding carbon leakage. In addition to the free allocation of CO₂ emission allowances to certain companies or sectors, indirect electricity price compensation is also being used in an attempt to ease the burden on industry. These two measures are supplemented by carbon leakage protection subsidies in connection with national fuel emissions trading (BEH). However, these mechanisms are also accompanied by weaknesses. In addition to the conflict associated with falling quantities of freely allocated certificates, which means that not all companies in need of protection can be provided with sufficient free certificates in the future, the Ariadne study also discussed the lack of investment incentives, particularly in urgently needed climate protection technologies, as a challenge for the further development of climate policy [8]. Due to the continuing global differences in regional incentives for greenhouse gas reduction and the resulting ongoing challenge for the competitiveness of European companies, the risk of European companies relocating production to countries with no or less ambitious or cost-intensive climate protection targets would nevertheless remain.

In response to this problem and to create a level playing field for European industrial sectors facing international competition, the Council of the EU and the European Parliament agreed on the introduction of a Carbon Border Adjustment Mechanism (CBAM), which came into force on 1 October 2023. More specifically, this instrument is intended to align the CO₂ prices of imported goods with the higher price that European companies have to pay for their production under the EU Emissions Trading System (EU ETS) [9]. CBAM certificates must therefore be purchased for goods imported into the EU in order to compensate for the difference between the CO₂ prices paid in the country of origin and the EU ETS prices. The details of the design of this mechanism, its legal framework, and the existing weaknesses of this instrument were also previously analyzed in more detail as part of the Ariadne project by Jana Nysten and her contribution to “The EU border adjustment mechanism as a logical consequence of EU emissions trading” [10].

An economic assessment of the consequences of implementing such protective measures has also already been carried out in the past using general equilibrium models (CGE). For example, Böhringer et al. [11] found that a border adjustment mechanism can reduce the negative consequences of ambitious regional climate protection targets on energy-intensive and trade-intensive sectors and thus reduce carbon leakage. In addition to the potential protective effect of a CBAM for the EU industry, however, research has also examined the impact of the introduction of the EU CBAM on its trading partners. For example, Magacho et al. [12] examined the adverse socio-economic and foreign trade consequences for developing countries and emerging economies. In addition to numerous other studies, Böhringer et al. [13] also showed that carbon border taxation tends to shift part of the burden associated with European emissions pricing to less developed countries. Based on a refined multi-regional input-output model (MRIO), Ren et al. [14] showed quantitatively the effects of CBAM on China’s provincial exports to the EU under various scenarios. According to the model, China’s export costs increase significantly, and the competitiveness of individual sectors declines considerably. Mörsdorf [15] focused his analyses more on the various options for designing a CBAM. In his study, he was mainly interested in the effect of taking into account indirect emissions or additional relief for exports in preventing carbon leakage. According to his results, both adjustments to the EU carbon border adjustment version proposed by the European Commission in July 2021 would significantly increase the effectiveness of the measure and thus reduce the carbon leakage rate.

Due to the characteristics generally associated with the climate as a global public good, the success of such climate policy measures is limited. No actor or region can be excluded from its consumption (healthy environment), and there is no rivalry in use (simultaneous use by several people is unproblematic). Particularly in the context of the challenges described in relation to carbon leakage, it is therefore clear that a joint motivation and effort by as many countries as possible is essential in order to achieve the goal of global climate neutrality [16]. Although CO₂ emission tariffs can provide incentives to tighten climate policy in unambitious/unregulated regions, Europe going it alone can only be a first step on the road to achieving global greenhouse gas neutrality. In the long term, the transition to a common global climate protection regime should be pursued, in particular taking into account the major developing countries. Approaches to joint ambitions, such as the Paris Climate Agreement, have been around for some time. However, at the latest G7 summit since the merger of the G7 countries in Elmau in June 2022, initiated by Chancellor Scholz, the topic of “climate clubs” became a popular part of political discussions as a concrete intermediate step. According to Nordhaus [17], climate clubs describe a group of countries that agree on key climate regulation elements and do not impose carbon border adjustment measures on each other. With the aim of rapidly and successfully implementing the Paris Climate Agreement, the club initiated between the G7 is intended in particular to accelerate the decarbonization of industrial processes, reduce the risk of production relocating to countries with less ambitious climate policies (“carbon leakage”), and promote general progress in the development of measures to reduce CO₂ emissions [18].

Although the definition of the objective is undisputed, such a club can take on completely different forms. In order to increase the benefits of such an association at a global level, a targeted design of its membership requirements and the code of conduct within the club is essential. For example, issues relevant to implementation, such as the design of protection mechanisms for industries particularly affected by increased climate policy ambitions, are associated with various effects on different economic sectors and economies. For example, Hagen & Schneider [19] examined the potential consideration of outsiders to take retaliatory measures, and Devarajan et al. [20] examined the effects of different climate club compositions on global CO₂ emissions and the incentive to increase ambition in other regions. However, there is very limited analysis of the impact on potential carbon leakage.

The aim of this study is therefore to show the effects of various carbon leakage protection measures on global CO₂ emissions and the European economy. In particular, it will analyze which instruments can support European energy-intensive sectors in their transformation and how less ambitious countries can also receive the greatest possible incentives to implement their own climate protection measures.

2. Method, Data, and Scenario Definition

The NEWAGE general equilibrium model developed at the IER of the University of Stuttgart was used to analyze this issue. CGE (Computable General Equilibrium) models simulate interactions between different sectors and actors. From a macroeconomic perspective, they can be used to estimate the effects of energy and climate policy strategies in terms of their economic consequences (here specifically for production, trade, and energy-related CO₂ emissions). It should be noted at this point that the model used here only takes into account energy-related emissions. Although they play an important role in heavy industry, process-related emissions are not included in the model, but could be supplemented in the future by including an additional commodity. However, the substitution elasticity for those emissions would be significantly lower than is the case for energy-related emissions, as there are no alternative reduction options apart from the use of CCS. As a multi-regional model, NEWAGE comprises a total of 28 regions and 24 sectors that are linked to each other via trade. A particular focus of the model is on the energy production sectors, and the input-output table from GTAP11 [21] is used as the most important data basis. The detailed GTAP11 data had to be aggregated at both regional and sectoral level for use in NEWAGE. Documentation of the model, an explanation of the key parameters and various application examples can be found, for example, in Sievers et al. [22] or Montenegro & Fahl [23]. In addition to direct effects in individual sectors, NEWAGE can also be used to identify indirect feedback effects in the economy as a whole [24]. As this is an economic model, risks such as potential trade disputes that a CBAM may cause (e.g., over compliance with WTO regulations) are not discussed further here. Analyses with NEWAGE are usually carried out by comparing different policy scenarios. In the present case, the investigation extends over two strands of analysis.

In the first strand of analysis, all policy options to be evaluated are compared with two baseline or reference scenarios: “Ref_noGreenDeal_ETS” and “Ref_GreenDeal_ETS”. For these, as for all other comparative cases, the assumptions to be determined for EU policy are defined in particular.

Table 1. Uniform EU27 framework across scenarios.

	Ref_noGreenDeal_ETS	Ref_GreenDeal_ETS
EU27 framework conditions	Stated Policies within EU27	Green Deal Target path for EU: greenhouse gas neutrality 2050
EU-ETS (CO2-targets)	Continuation of currently implemented policies	Climate neutrality 2050: −100% by 2050
	CO2 tax for consumption and non-ETS industry by 2020: electricity generation and energy-intensive industry From 2025: for all sectors
National measures (DEU)	Additional national target:	climate neutrality 2045: −100% by 2045, plus CCS
	Fuel Emissions Trading Act	Increasing path: 50 € (in 2025) to 240 € (in 2050)

provides an overview of the framework conditions that are initially assumed here. The entire EU27 region is subject to the familiar “cap-and-trade” system of the EU ETS, and the two scenarios differ only in terms of their climate target ambition. While “Ref_noGreenDeal_ETS” assumes that the EU follows the “stated policies” path of the WEO (World Energy Outlooks 2023), “Ref_GreenDeal_ETS” maps the current political situation as realistically as possible for all regions under consideration. For the EU27, this specifically means the validity of the Green Deal, while for Germany in particular, the stricter Climate Protection Act with the goal of climate neutrality in 2045 is also taken into account.

The specific national framework conditions are also modeled for non-EU regions. This is performed via the separate but representative implementation of regional cap-and-trade systems with targets based on the “Stated Policies” scenario of the World Energy Outlook 2023. Possible capacities for BECCS technologies, carbon leakage measures such as free allocation or a border adjustment tariff, and the implementation of a climate club are not taken into account in the reference case.

In order to estimate the extent of the carbon leakage phenomenon triggered by European climate policy, the two reference scenarios are compared in the first step. To analyze the (protective) effect of various carbon leakage (CL) measures for the European economy, these comparative cases are then compared with a total of five alternative scenarios (1. stage of analysis).

For the first comparison scenario “EU_FreeAllocation”, the determinants described are supplemented by the system previously in place in Europe for the free allocation of CO₂ certificates as protection for the competitiveness of the economy. The quantity of available certificates is automatically reduced over time as the climate target is tightened. This scenario is to be contrasted with the protection of European energy-intensive industries by means of a CO₂ border adjustment system, i.e., a CBAM. The CBAM system ensures that imports are subject to the same CO₂ emission prices as products manufactured within the European Union (EU27). In the “EU_CBAM_FrAllocSec” scenario, the same selection of sectors is initially protected as in the case of free allocation. In a further “EU_CBAM” case, the sector selection is adapted to the CBAM design implemented at the European level since October 2023. Both CBAM scenarios only protect the sectors against imports. Exports are not taken into account. Finally, the effect of abandoning the EU27 Green Deal and joining the climate club (via a joint ETS system with a uniform CO₂ price and joint CBAM protection for the outside world) is examined if the non-European regions remain in the lower ambition range. The two scenarios analyzed for this purpose, “KC_COP36_ETS_low_Amb” and “KC_COP35_ETS_low_Amb_noUSA”, differ only in terms of the role of the USA. While the first case assumes that the USA will participate in the climate club as decided at the climate summit, the second scenario is influenced by the outcome of the US elections and represents the possibility that Donald Trump and his country might not participate in a joint club.

Table 2. Scenario overview cluster 1.

	Ref_ noGreenDeal _ETS	Ref_ GreenDeal _ETS	EU_ FreeAllocation	EU_CBAM_ FrAllocSec	EU_CBAM	KC_COP35_ETS_ low_Amb_noUSA	KC_COP36_ETS_ low_Amb
CL protection instrument	Without any carbon leakage (CL) protection in the EU27		Free allocation in the EU27 → Reduction in quantities (target tightening over time)	EU27-CBAM from 2025		Formation of a climate club from 2025 based on the COP proposal
						35 Member states	36 Member states
						common CBAM on imports from non-member regions
			Protected sectors:		Protected sectors:
			cem, irs, nfm, rch,		cem, irs, nfm, rch
			and		and
			gls, oil, ppp, rnm		ele, hyd
Climate protection ambition level outside the EU	Weaker ambitions in Non-EU27 (WEO “Stated Policies”) tracking of stat. Policies path via tax system
EU policy	Stated policies within the EU (tracking via an EU-wide cap-and-trade system)	Green Deal (EU: greenhouse gas neutrality 2050)				Abandonment of EU targets → Common CO2-price, within the club (methodically based on ETS system)

highlights the differences between the individual scenarios and provides an overview of their general structure.

In order to investigate the effects of non-European climate policy, a second cluster of analysis is added (

Table 3. Scenario overview cluster 2.

Low Climate Protection Ambitions of the USA
	EU_ CBAM_high_Amb_ noUSA	Reg_CBAM_ high_Amb_noUSA		KC_ COP35_noUSA			KC_ COP35_ETS _noUSA
CL- protection instrument	EU-CBAM from 2025 protected sectors: cem, irs, nfm, rch, ele, hyd			Formation of a climate club from 2025 based on the COP proposal
				35 Member states
	Increased ambition but no carbon leakage protection in other potential member states of a climate club	Regional carbon leakage protection: further potential climate club members with amb. climate policies raise regular CBAM against imports from all regions		Joint carbon leakage protection in the form of a CBAM on imports from non-member regions
		Club regions outside the der EU27: ACU, ANZ, CAN, ETA, IDN, JSK, REU
	Protected sectors: cem, irs, nfm, rch
	and
	ele, hyd
Climate protection ambition level outside the EU	Planned member states pursue “Announced Pledges” (WEO) path via a cap-and-trade system with regional CO2 prices						Common CO2 price within the club (methodically based on the ETS system)
	Klimaschutz without USA
EU Politics	Green Deal (EU: Greenhouse gas neutrality 2050)
Increased Climate Protection Ambitions of the USA
	EU_CBAM_high_Amb		Reg_CBAM_ high_ Amb		KC_ COP35	KC_COP35_ETS
CL- protection instrument	EU-CBAM from 2025 protected sectors: cem, irs, nfm, rch, ele, hyd				Formation of a climate club from 2025 based on the COP proposal
					36 Member states
	Increased ambition but no carbon leakage protection in other potential member states of a climate club		Regional carbon leakage protection: further potential climate club members with amb. climate policies raise regular CBAM against imports from all regions		Joint carbon leakage protection in the form of a CBAM on imports from non-member regions
			Club regions outside the EU27: ACU, ANZ, CAN, ETA, IDN, JSK, USA, REU
	Protected sectors: cem, irs, nfm, rch
	and
	ele, hyd
Climate protection ambition level outside the EU	Planned member states pursue “Announced Pledges” (WEO) path via a cap-and-trade system with regional CO2 prices					Common CO2 price within the club (methodically based on the ETS system)
	Klimaschutz with USA
EU Politics	Green Deal (EU: Greenhouse gas neutrality 2050)

). To this end, the “EU_CBAM” case described above is first modified. Specifically, potential climate club members in the new reference scenario “EU_CBAM_high_Amb_noUSA” or “EU_CBAM_high_Amb” now increase their climate protection ambitions compared to the previously pursued “Stated Policies” pathway and follow the “Announced Pledges” pathway of the WEO 2023 via regional cap-and-trade systems. Throughout the rest of the world, the ambition remains at the lower level. Although China’s accession would have a significant impact on the effects of a climate club or on the collection of a joint CBAM, as China’s accession is not foreseeable given the current political situation, this region was consistently treated as a non-climate club region for the present analyses.

First of all, the effects are analyzed under the condition that the ambitious non-EU27 regions were to protect themselves against energy-intensive imported goods from other regions by means of separate regional CBAM implementations (“Reg_CBAM_high_Amb”). Finally, the effects of joint (cross-regional) CL protection (CBAM) in the form of the establishment of a climate club are also investigated. A comparison of two climate club designs allows a better understanding of the consequences of the different instruments. While “KC_COP36” initially assumes high climate protection ambitions in all climate club countries, all regions continue to pursue these goals via regional cap-and-trade systems, and there is no common uniform CO₂ price. In contrast, the “KC_COP36_ETS” scenario is based on the assumption of a unified ETS system within the climate club. This means that the 36 (or 35) member states are part of an overarching CO₂ emissions trading system, resulting in a uniform CO₂ price in the climate club. All three scenarios are shown for the case with and without an ambitious USA (indicated by the addition “noUSA” in the scenario name). Table 3 provides an overview of the scenario information described.

3. Results and Discussion

The presentation of the results begins with an analysis of the actual extent of the risk of carbon leakage and then examines the effects of various carbon leakage protection instruments on the EU27 regions. Initially, the comparisons and evaluations in Chapter 0 are limited to the first strand of analysis and thus to the protection of the EU27 alone, as well as the possible expansion of the system-wide emissions trading system (i.e., cap-and-trade system for all sectors) to additional regions outside the Union. Chapter 0 also compares various measures for extending the CL protection program beyond the Union.

3.1. Europe Goes It Alone with Regard to Carbon Leakage Protection (Cluster 1)

In order to be able to assess the consequences of a strengthening of European climate protection ambitions and the effects of carbon leakage protection within the EU27 under different framework conditions, an analysis of the effects on CO₂ emissions is first carried out.

As Figure 1 and in particular the comparison of the two reference scenarios “Ref_noGreenDeal_ETS” and “Ref_GreenDeal_ETS” show, the intensification of climate protection targets in the form of the introduction of the EU Green Deal tends to result in significant CO₂ price-increasing effects within the EU (>+165% in 2045). As a result of this development and thus the increase in the price of CO₂ emissions within the EU, global CO₂ emissions in the aggregate fall (<−1% in 2045). However, as Figure 1 also shows, CO₂ emissions in the rest of the world will increase if European CO₂ emission allowances become more expensive. This indicates that CO₂ emissions caused under less stringent conditions within the EU27 are partly outsourced to other countries with continued favorable framework conditions as a result of the increase in prices due to the Green Deal. Carbon leakage is the result. Energy-intensive sectors in particular (such as steel, chemicals, or cement) are relocating their production to non-European countries.

In comparison, the further analyses examine whether and with which instrument the carbon leakage observed here can be reduced or prevented and what effects the various measures have in particular on global CO₂ emissions and economic interrelationships or the prosperity of our society. As the comparison of the unprotected EU27 states in the “Ref_GreenDeal_ETS” reference scenario (which are challenged in terms of the Green Deal) with the results of the other scenarios in the first stage of the analysis (in which various CL protection instruments are activated) shows, the world can fundamentally benefit from the introduction of CL protection within the EU27 from a climate protection perspective. If ambitions outside the EU27 remain low, the additional greenhouse gas reduction effects are not significantly strong (<−1%) compared to the “Ref_GreenDeal_ETS” scenario, regardless of the design of the protection instrument or the sector selection considered here, but they are nevertheless more pronounced. One explanation for this is that every introduction of a CL protection measure represents an intervention in the optimal market solution, which tends to increase CO₂ prices (up to approx. +9% for “EU_CBAM” compared to “Ref_GreenDeal_ETS” in 2045).

The increase in CO₂ prices is caused by various effects (not only by differences in CO₂ emissions). If the form of free allocation analyzed here is introduced, CO₂ emissions in selected sectors are “subsidized”. Compared to the “Ref_GreenDeal_ETS” reference case, this results in increased CO2 emissions in these sectors, which in turn causes the (CO₂) price development observed. If the CBAM design considered here is implemented, however, the possibility of using CO₂-emission-intensive inputs from cheaper imports is eliminated. This increases the demand for CO₂ emission-intensive intermediate products produced in the EU (such as those from the steel or chemical industries). This in turn leads to higher market prices for these goods, which means that the carbon-emission-intensive sectors are prepared to pay higher prices for CO₂ emissions. CO₂ emissions in the rest of the world show lower values than in the “Ref_GreenDeal_ETS” case (adjustment of less than −1%). This indicates that the CL protection instruments are having an effect and preventing some of the migration of European production facilities to other “CO₂ emission-friendly” regions. The CBAM design based on the EU decision (“EU_CBAM”), in which the protected sectors differed slightly from the selection for free allocation, has the highest protective effect among the CL protection measure designs considered here. Figure 1 also shows that carbon leakage occurs in particular in energy-intensive sectors that are not protected by the CBAM under consideration here (such as the glass industry (gls), the paper industry (ppp), or the production of other non-mineral materials (rnm)).

If climate protection ambitions outside the EU27 remain low, a relaxation of European climate protection efforts in the form of an abandonment of the European Green Deal and an extension of the ETS trading system to potential climate club members is also examined here. The variants examined according to the design of a climate club described in Chapter 2 (“KC_COP35_ETS_low_Amb_noUSA” and “KC_COP36_ETS_low_Amb”) differ only in the participation of the USA. Both design options lead to significantly lower ETS prices within the EU27 (approx. up to −84% and −89% compared to “Ref_noGreenDeal_ETS” and “Ref_GreenDeal_ETS” in 2045) compared to the reference cases (with and without the Green Deal) but also compared to the previously considered carbon leakage protection measures. In the other member regions of the climate club, the merger results in a significant increase in CO₂ prices, which can lead to a global reduction in CO₂ emissions of up to approx. −2.2% or −2.7% in 2045. Carbon leakage is therefore not verifiably occurring under these framework conditions. Even outside the club, CO₂ emissions would fall as a result of this merger compared to all variants considered with the Green Deal within the EU27 (not in the significant range, i.e., <−1% compared to the “Ref_GreenDeal_noETS”). From a climate protection perspective, US participation would generally be preferable.

An analysis of the developments in real European GDP in the scenario comparison of the first line of analysis also discusses the economic consequences of high European climate ambitions and various CL protection instruments below.

Figure 2 clearly shows that climate action under the Green Deal is associated with macroeconomic costs for the EU27. Compared to the reference, i.e., “Stated Policies” targets for the EU27, the scenario with the implemented Green Deal shows a weakening of GDP development within the EU27. The stricter greenhouse gas emission targets lead to GDP losses of around −1% in the affected countries in the aggregate compared to the reference (“Ref_noGreenDeal_ETS”). At the same time, however, gross domestic product outside the EU27 also falls in the aggregate here. An increase in the price of European exports (particularly in the crude oil (CRU), service (SER), machinery (MAC), and rest of industry (ROI) sectors) appears to be having an impact.

Under the assumptions implemented here, the form of free allocation under consideration cannot mitigate the negative economic consequences of climate protection for the EU27, as Figure 2 shows. Due to rising consumer and CO₂ prices and their negative effects on the balance of trade, the measure has a rather negative impact on the overall economic situation of the EU27 compared to the situation without CL protection (“Ref_GreenDeal_ETS”).

If, on the other hand, the EU27 were to opt for a CBAM as an instrument (“EU_CBAM_FreeAllocSec”) with an analogous selection of sectors to be protected, there would tend to be lower price increases and positive effects on the balance of trade and thus also on the overall economic situation of the EU27 compared to the reference with the Green Deal (“Ref_GreenDeal_ETS”) and under the framework conditions assumed here. The relatively lower long-term protective effect of free allocations compared to a CBAM system is also largely due to the increasing reduction in quantities (freely allocated CO₂ allowances). An adjustment of the sector selection to the EU CBAM actually adopted (in accordance with EU Regulation 2023/956) weakens the advantages somewhat due to a tendency towards higher consumer prices and thus somewhat reduced positive effects on the balance of trade. As already explained in the above analysis of regional CO₂ emission volumes, a CBAM can mitigate the observed extent of carbon leakage. In general, however, it should be noted that the real GDP deviations of the scenarios considered so far (“EU_FreeAllocSec”, “EU_CBAM_FreeAllocSec”, and “EU_CBAM”) compared to “Ref_GreenDeal_ETS” are not significant in either the short or long term (≤1%). At a global level, the effects of implementing CL protection limited to the EU27 are negligible compared to the situation without protection but with the Green Deal, but tend to be negative.

Finally, the economic effect of abandoning the ambitious European Green Deal is also examined here, if the EU were instead to join forces with equally unambitious potential climate club regions (“Stated Policies”) in the form of a joint ETS trading system to form a kind of climate club (with and without the USA), and this club were to jointly pursue carbon leakage protection (in the form of a CBAMS; “KC_COP35_ETS_low_Amb_noUSA” and “KC_COP36_ETS_low_Amb”). The EU27’s abandonment of its plan to be a climate pioneer and the implementation of a common carbon price with other regions has a significantly relaxing effect on the economic development of the EU27. Due to significantly falling aggregate consumer prices (up to approx. −3% with US participation compared to “Ref_GreenDeal_ETS” in 2045) and CO₂ certificate prices (up to approx. −89% with US participation compared to “Ref_GreenDeal_ETS” in 2045), there is a significant increase in consumption and investment under the design of the climate club assumed here. At the same time, the trade balance would be negative compared to the other scenarios due to the lower prices for intermediate goods (especially steel and chemicals; import growth). However, this effect is more than compensated for by the aforementioned increase in demand. A shift would therefore not be observed from an economic perspective either.

Both from a climate protection perspective and in terms of EU27 economic development, joining forces in a climate club shows the most beneficial effects for CL protection, despite the low ambitions of the other member regions. The EU27 could do without going it alone with regard to climate protection and the negative consequences for its economy if it joined forces with other states and expanded the emissions trading system. Stricter climate targets are not necessary for the success of such a climate club in the non-European regions. At the same time, a common border adjustment mechanism as a compensation mechanism for the non-European states could act as an incentive to establish such a climate club. Overall, much higher CO₂ emission savings could be achieved and global prosperity (global GDP as a measure of prosperity) could benefit from this. In concrete terms, this would increase by around 0.7–0.8% in 2045 compared to the current situation with the EU Green Deal (“Ref_GreenDeal_ETS”) with and without the USA as a member of the climate club.

3.2. Extending Climate and Carbon Leakage Protection Beyond the Borders of the EU27 (Cluster 2)

In the following, it is assumed that a selection of regions outside the EU27 states also pursue ambitious climate targets (i.e., the WEO’s “Announced Pledges” pathway) via regional cap-and-trade systems that are independent of each other. As described in Chapter 2, the “EU_CBAM_high_Amb” and “EU_CBAM_high_Amb_noUSA” scenarios are used as a reference here. They are characterized by an emissions trading system limited to the EU27 as well as a border adjustment mechanism to protect energy-intensive sectors from carbon leakage and the specification of the Green Deal within the EU27. Selected countries outside the EU27 (potential climate club members with and without the USA) are also committed to climate protection, while the rest of the world remains on the “Stated Policies” path with regard to its targets.

Before the other scenarios are compared with the new reference scenario, it is worth noting that increasing the ambition of potential climate club member states outside the EU27 (such as the USA or Japan) already has a significant impact under the given assumptions on the current CBAM design of the European Council. If, based on the “EU_CBAM” scenario, countries potentially participating in climate protection raise their ambitions from pursuing the “Stated Policies” pathway to the stricter “Announced Pledges” pathway, with the scenario definition otherwise remaining unchanged, the EU27 can benefit significantly from this in macroeconomic terms. Although price increases within the EU will slightly reduce both investment and consumption, particularly in the long term, these GDP-reducing effects will be significantly offset by huge increases in exports. Products from the European Union will therefore become more competitive again compared to goods produced abroad that are also climate-friendly, and a large proportion of the observed increase in production in the energy-intensive sectors (steel, cement, and chemicals) in the EU27 will be directed to foreign trade.

Globally, on the other hand, there are clear negative macroeconomic effects compared to all previously considered scenarios. Under these conditions, global GDP would fall significantly as a result of the increase in ambition (by up to approx. −3% if the USA participates compared to “Ref_GreenDeal_ETS” in 2045). As Figure 3 shows, such an expansion in the ambitions of climate-protecting regions has significant CO₂ emission-reducing effects at a global level, whereby US participation can double this success. At the same time, however, it also shows that CO₂ emissions outside the “Announced Pledges” area increase significantly. This indicates that some of the potential savings in CO₂ emissions are prevented by relocating production to less ambitious regions, meaning that carbon leakage is occurring.

In order to prevent this effect to the greatest possible extent, various CL measures and their protective effect are now examined. As described above, the two scenarios “EU_CBAM_high_Amb_noUSA” and “EU_CBAM_high_Amb” are used below as a new comparison case for the further analyses. As in the first stage of the analysis, we start by examining the effects on CO₂ emissions.

If the additionally ambitious regions outside the EU27 now also protect themselves from cheaper competitors from less ambitious regions with regional border adjustment mechanisms (“Reg_CBAM_high_Amb_noUSA” and “Reg_CBAM_high_Amb”), the EU ETS trading system remains unaffected and, as Figure 4 shows, European prices also remain unchanged. In regions outside the EU27, on the other hand, CO₂ prices tend to rise (up to approx. +1.8% and 3.7% compared to “EU_CBAM_high_Amb_noUSA” and “EU_CBAM_high_Amb” in 2045, respectively), resulting in an overall decrease in global CO₂ emissions (approx. −0.8% and −1.6% compared to the new reference scenario in 2045). These effects do not change significantly if the regions continue to pursue their ambitious targets via regional cap-and-trade systems, but join forces with the EU27 states in a climate club and protect themselves across the club against imports from less ambitious regions by means of a joint border adjustment mechanism (“KC_COP36_noUSA” and “KC_COP36”).

If the climate club were to be implemented via a joint ETS system in addition to carbon leakage protection, European companies would have the opportunity to purchase additional CO₂ emission allowances from the increased trading volume resulting from the system expansion in the design analyzed here (“KC_COP36_ETS_noUSA” and “KC_COP36_ETS”). Competition for CO₂ emission allowances within Europe will thus be loosened and the CO₂ price within the EU27 will fall significantly. At the same time, the pressure on the member states outside the EU tends to increase and thus further raises CO₂ prices there in particular, even compared to the previously considered system without a common ETS (“KC_COP36_noUSA” or “KC_COP36”). This leads to further CO₂ emission savings globally.

Even outside the ambitious regions, as Figure 5 shows, the implementation of all carbon leakage instruments reduces CO₂ emissions compared to the situation without protection. This indicates that some of the relocation of production resulting from the increase in ambition can be successfully prevented with the help of the specified measures (especially in the steel sector, for example). While the effects do not differ significantly between regional and a joint CBAM system, the implemented version of the climate club with a cross-member ETS system in particular shows the highest protective effect under the framework conditions specified here.

The analysis of the economic effects illustrated in Figure 6 shows that regional individual CBAM protection of potential climate club member regions outside the EU27 (“Reg_CBAM_high_Amb_noUSA” and “Reg_CBAM_high_Amb”) tends to have a negative impact on the Union’s GDP (up to approx. −0.6% or −1% in 2045), which is expressed as an increasing loss in the balance of trade (exports lose profitability due to taxation). With regard to the CO₂ emission effects, a merger (of all ambitious regions) in the climate club and the joint levying of a border tax (without a joint emissions trading system; “KC_COP36_noUSA” and “KC_COP36”) result in similar EU27 GDP changes. In both scenarios, the other ambitious countries (outside the EU27) in the aggregate tend to benefit from their CL protection compared to the reference. These positive effects are somewhat more pronounced with the participation of the USA, but are not significant (≤+1%). The rest of the world tends to show negative GDP trends in the two CBAM variants considered here (without a joint ETS system), although these remain negligible (<−0.4%) until 2045. Overall, this also results in negligible negative macroeconomic effects at the global level up to approx. −0.1% in 2045.

Tightening the design of the climate club through the implementation of a common ETS system would have a consumption and investment-promoting effect, at least in the short to medium term (up to 2035), due to lower aggregate consumer prices within the EU27 compared to the reference. Consumption as well as industrial production and investment develop better in all calculation years than in the reference scenario (“EU_CBAM_High_Amb”) due to lower CO₂ and consumer prices within the EU27 under the scenarios considered here (“KC_COP35_ETS_noUSA” and “KC_COP36_ETS”). At the same time, entry into the climate club worsens the international competitive position of the EU27. As a result, the trade balance is continuously negative compared to the reference.

Over the period up to 2045, these negative developments are outweighed by the positive effects from the price reductions, resulting in overall beneficial macroeconomic effects within the EU27.

US participation in the climate club (and thus a tightening of its ambitions) tends to weaken the positive economic effects for the EU27 and reverses them in the long term. US membership worsens the EU’s trade position and therefore has a particular impact on its export and import volumes.

4. Conclusions and Outlook

Table 4. Overall overview of the effects of the 1st scenario cluster on average between 2025 and 2045 (as a deviation from Ref_noGreenDeal_ETS).

		Ref_GreenDeal_ETS	EU_Free Allocation		EU_CBAM_ FrAllocSec		EU_CBAM		KC_COP35 _ETS_low _Amb_noUSA		KC_COP36 _ETS_low_Amb
Climate Protection	Emissions reduction effect (global)	−0.8%	−1.1%		−1.2%		−1.3%		−1.5%		−1.8%
Carbon Leakage	Emission reduction effect (outside the EU27)—carbon leakage extent	0.9%	0.5%		0.5%		0.4%		−2.9%		−4.0%
	Deviation of emissions outside the EU27 compared to Ref_no GreenDeal_ETS		−0.3%		−0.4%		−0.5%		−3.8%		−4.9%
	Emission-reduction effect (outside potential climate club regions)—carbon leakage extent	0.9%	0.5%		0.4%		0.3%		−0.3%		−0.6%
	Deviation of emissions outside potential climate club regions compared to Ref_no GreenDeal_ETS		−0.4%		−0.5%		−0.5%		−1.1%		−1.5%
Overall economic development	EU27 GDP Development	−1.1%	−1.3%		−0.8%		−0.9%		−0.1%		−0.1%
	Global GDP Development	−0.5%	−0.6%		−0.5%		−0.6%		−0.1%		−0.1%
		Legend:		significant negative effects		negative effects		negligible effects		positive effects		significant positive effects

clearly summarizes the results of the first scenario strand. It can be seen that an increase in climate protection ambitions within the EU27 leads to an overall global reduction in emissions (but outside the significant range, i.e., >−1% but <0%, light green coloring). Each design of the carbon leakage protection instruments examined can increase this effect up to the significant range (between −1 and −2%) (dark green coloring).

Emissions outside the EU27, on the other hand, increase due to the implementation of the Green Deal (<1%, light red coloring) and indicate carbon leakage to a non-significant extent (i.e., <1%). The implementation of various CL protection instruments can mitigate this effect. While the protective effect is not significant if the measures are limited to the EU27, an extension of the emissions trading system to potential climate club regions leads to significantly lower emissions outside the EU27, but also outside the climate club. From a macroeconomic perspective, an increase in Europe’s climate protection ambitions is accompanied by significant losses in economic growth, which are exacerbated by the additional costs for the free provision of emission certificates, while they could be somewhat reduced by a CBAM limited to the EU27. However, abandoning the Green Deal while simultaneously expanding the emissions trading system to potential climate club member regions would have almost no economic impact for the EU27 and would be the most efficient instrument for climate protection under the scenarios here. While the KC_COP scenarios, especially with the participation of the USA, are associated with the highest global emissions reductions, emissions also tend to decrease outside of the climate club. At the same time, the framework conditions of these scenarios have no negative macroeconomic effects either at the EU27 level or globally.

The analysis of the second cluster of scenarios shows, as summarized in

Table 5. Overall overview of the effects of the 2nd scenario strand on average between 2025 and 2045 (as a deviation from EU_CBAM_high_Amb or EU_CBAM_high_Amb_noUSA).

		Reg_CBAM_Amb_noUSA	KC_COP35 _noUSA		KC_COP35_ ETS _noUSA		Reg_CBAM_ high_Amb		KC_COP36		KC_COP36_ETS
Climate Protection	Emissions reduction effect (global)	−0.3%	−0.3%		−0.5%		−0.7%		−0.7%		−0.8%
Carbon Leakage	Emissions-reducing effect (outside potential climate club regions)—carbon leakage extent	−0.3%	−0.3%		−0.6%		−0.8%		−0.8%		−1.0%
Overall economic development	EU27-GDP Development	−0.3%	−0.3%		0.2%		−0.5%		−0.5%		−0.1%
	global GDP Development	0.0%	0.0%		0.3%		0.0%		0.0%		0.3%
		Legend:		sign. negative Effects		negative Effects		negligible Effects		positive Effects		sign. positive Effects

, that an increase in climate protection ambitions outside the EU27 generally leads to more advantageous effects than Europe going it alone, both in terms of climate protection and the economic impacts. Under these adapted conditions and the variants of possible carbon leakage protection instruments analyzed in this study, a climate club based on the COP proposal (from a total of 36 countries) with a common emissions trading system and a CBAM will produce the best results compared to competitors from less ambitious regions. From a global climate protection perspective, this case shows the highest potential for saving CO₂ emissions. If the USA participates in the climate club with a joint emissions trading system, the CBAM could have a significant protective effect. From an economic perspective in the EU27, this scenario is also associated with the lowest GDP losses on average (between 2025 and 2045).

Overall, the analysis of the two scenario clusters shows that a European solo effort does not lead to the optimal solution from both a climate protection and economic perspective. Supra-regional participation generally leads to better solutions and can be maximized through an overarching ETS system and a climate club solution with a common CBAM protection mechanism against imports from less ambitious regions. The more regions that actively participate, the more likely it is that as many SDGs as possible will be achieved at the same time.

Further research should also devote its analyses to other regional compositions of the climate club. For example, adjusting China’s climate policy in a variety of ways (increasing ambition, implementing regional CL protection measures, participating in the climate club, etc.) could significantly influence the results. In addition, the selection of protected sectors and the consideration of process-related CO₂ emissions could have an impact on the emission balances.