Different effects of carbon pricing and border adjustment in Germany and Spain

Abstract

This study examines the effects of carbon pricing in Germany, Spain, and the broader European context using the dynamic, three-region environmental multisector general equilibrium model, EMuSe. Our findings indicate that unilateral carbon pricing in Germany or Spain leads to a sustained negative output. The marginal increase in production costs outweighs modest reductions in emissions. However, when Europe collectively adopts carbon pricing, the long-term output effects become positive, although there are more significant transition costs due to close trade relations within Europe. We find evidence of carbon leakage, which is marginally mitigated by a border adjustment mechanism. However, this mechanism mainly protects domestic carbon-intensive sectors and produces inconsistent country outcomes; Germany gains, while Spain loses. Notably, Spain’s energy sector emerges as a long-term beneficiary due to its relatively lower emission intensity. The findings highlight the strategic importance for Europe to engage global partners in carbon pricing as it reduces the economic downturn phase and increases long-term gains.