The EU and the UK both control domestic greenhouse gas emissions through cap-and-trade systems – their Emission Trading Systems. To reduce ‘carbon leakage’ they propose to charge imports for emissions at the same price as domestic producers through Carbon Border Adjustment Mechanisms, which take the domestic price and apply it to imports, without limits. We show that this approach could result in a technological improvement that reduces demand for domestic emissions, increasing global emissions. We propose alternatively that domestic producers and importers should bid in the same capped market for emissions permits. We show that such an arrangement avoids the possible perversity just noted and implies lower global emissions for any given technological improvement.

Revised: September 2025