Production Leakage: Evidence from Uncoordinated Environmental Policies

This paper documents that international trade can cause uneven distribution of production opportunities to countries in face of uncoordinated environmental policies. Specifically, we use exogenous introductions of national carbon policy to study how local firms react to such shocks, especially when they make sourcing decisions on carbon inputs. Results show that regulatory carbon taxes lead domestic firms to import more carbon products, such as cement, iron and steel, from foreign producers. Micro evidence further shows that firms will increase their trade shares to foreign suppliers located in pollution haven. Exploiting global supply chain information, we further find that domestic regulatory carbon taxes do benefit foreign carbon suppliers, helping them to, for example, increase fixed investment, expand production scales and improve financial performance. These findings highlight the importance to take into account international trade when forming environmental policies in order to fulfill the growth, welfare and emission reduction goals of such policies.