A GVAR analysis of the macroeconomic effects of the Carbon Border Adjustment Mechanism in the Global South

The Carbon Border Adjustment Mechanism (CBAM) is a market-based approach to carbon pricing designed to accelerate the EU’s 2050 energy transition by mitigating carbon leakage and enhancing sectoral competitiveness. We assess the associated costs of CBAM by simulating the macroeconomic impacts of the policy using the latest global VAR framework (1979Q2-2023Q3) of 33 advanced and emerging economies. While modelling the international trade linkages between the EU and its Global South and Global North trade partners, we trace the direct and indirect impacts of the CBAM policy to real output, real exchange rate and inflation of the Global South countries. We find that the indirect effects through the worldwide supply pressure index & global economic conditions index and the direct impact through the disaggregated EU industry and manufacturing import prices present potential welfare losses to the Global South countries regarding the decline in real GDP and real exchange rate depreciation. The most striking implication of the results is that the policy could have far-reaching negative welfare consequences without proper mitigation measuressuch as: ploughing back proceeds from the CBAM scheme to support climate action internationally and exemption of poor and low-emission countries from the program as ways to moderate the impacts on the economies.