Round 1 2023

Two projects were awarded funding in the first round of the Centre for Inclusive Trade Policy's Innovation Fund.

Designing Credible Leakage Border Adjustments To Promote Compliance. Theory and Empirics
PI: Chiara Forlati (University of Southampton)

By 2022, the EU should approve the Carbon Border Adjustment Mechanism (CBAM). Many countries, including the UK, are considering similar measures. CBAM is designed to prevent carbon leakage due to the Emission Trading System (ETS) by taxing imports according to their carbon content. However, since estimating import carbon content is very complex, CBAM will be applied only to a few sectors, and it is likely not to be effective in eliminating leakage.

This project proposes an alternative route towards leakage prevention: the Leakage Border Adjustment Mechanism (LBAM). LBAM offsets ETS-induced cost disadvantages of domestic producers relative to foreign competitors and requires knowledge only about product-specific import demand, export supply and output-to-emissions elasticities. This approach will enable computation of Leakage Border Adjustment Taxes that prevent leakage induced by ETS and then comparison of these with CBAMs in terms of welfare and emissions.

Key Findings

The traditional border carbon adjustment, of which the EU’s carbon border adjustment mechanism (CBAM) is a prominent example, requires information on the carbon content of imports, which is very hard to obtain. This limits the practical application of CBAM to a small number of products. In contrast, this project proposes a new leakage border adjustment mechanism (LBAM) with minimal information requirements which can therefore be easily applied to all tradable sectors without creating an excessive administrative burden.

The main idea behind LBAM is to set import tariffs and potentially export subsidies,
that sterilise any effects on imports (and potentially exports) induced by the domestic carbon price change. Using a detailed quantitative trade model with 57 countries and 131 manufacturing sectors, the researchers show that a broad implementation of border adjustment is key to effectively avoid leakage: As the EU’s CBAM applies to only a few carbon-intensive sectors, it hardly improves welfare and emissions compared to a situation without border adjustment because the vast majority of sectors, many of which are carbon-intensive, are not covered by the EU’s CBAM.

Because LBAM targets all leakage-prone industries, it increases the effectiveness of unilateral carbon pricing at reducing global emissions by up to 50%. This is accomplished by a tariff designed to exactly offset any displacement of domestic production by imports due to carbon pricing. The researchers show that a leakage border adjustment via export subsidies is particularly effective in avoiding carbon leakage that arises from consumers in third countries substituting goods produced in the EU with goods from other origin countries where production is more carbon- intensive.

Furthermore, in contrast to carbon border adjustment, LBAM is likely compatible with WTO rules. LBAM does not discriminate between trade partners, and it does not make them worse off. It merely offsets any changes in imports and exports due to the unilateral introduction of carbon pricing, thereby sterilizing market access effects (larger imports, less exports) that would otherwise occur.


A proposal to refocus the EU Carbon Border Adjustment Mechanism on preventing carbon leakage (Vox EU)

Read the paper

Designing Effective Carbon Border Adjustment with Minimal Information Requirements. Theory and Empirics (CITP WP)

Read the Working Paper

Treaty Scrutiny: The Role of Parliament for UK Trade Agreements
PI: Holger Hestermeyer (Kings College, London)

Parliaments play an important role in the democratic legitimation of international agreements, including trade agreements. In many jurisdictions they possess an up-or-down vote on trade agreements and their norm-creating and -legitimating functions are used for developing trade policy through collaboration between government and parliament.

In the UK, Parliament’s role in treaty-making is limited to scrutinizing treaties under CRAG 2010. The need to replace the EU’s trade agreements has incentivised a reform of internal parliamentary procedures. However, scrutiny is still found badly wanting, as a House of Commons International Trade Committee report dated 27 October 2022 concluded.

This project sets out to describe the development and current state of affairs of UK treaty scrutiny and from there develop realistic proposals for improvement, allowing for a greater involvement of parliament in treaty-making and thus for a more inclusive policy.