External Costs of Agriculture: Market-based Instruments and Trade Policy Measures to Support a Reform of the Common Agricultural Policy

2. The agricultural sector causes environmental damage with global impacts. The EU's Common Agricultural Policy (CAP), which relies on regulatory measures and subsidies, fails to meet environmental targets in many cases. This paper analyses how market-based instruments based on the polluter-pays principle – agri-environmental levies and tradable permits – can internalise the external costs of agriculture. As a unilateral EU measure without accompanying trade policy would lead to production and emission shifts to third countries (leakage), three options for carbon border adjustment in the agricultural sector are examined: an extension of the existing Carbon Border Adjustment Mechanism (CBAM) to agricultural goods, a Leakage Border Adjustment Mechanism (LBAM), and a consumption-based levy. Combining market-based instruments with appropriate trade policy safeguards could strengthen incentives for innovation, reduce administrative burdens and achieve environmental goals in a predictable manner – without destabilising the international trading system.