Production Leakage: Evidence from Uncoordinated Environmental Policies

This paper documents that international trade may cause uneven distribution of opportunities and costs to countries in face of uncoordinated environmental policies. Specifically, we use exogenous introductions of national carbon taxes to study how local firms react to such shocks, especially when they make outsourcing 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. Firm-level data additionally show that firms will increase their trade shares to foreign suppliers headquartered in pollution haven. Exploiting buyer-supplier relation information, we further find that domestic regulatory carbon taxes do benefit foreign carbon suppliers, helping them to, for example, expand production scales and relax financial constraints. These findings highlight the critical role that international trade play in fulfilling growth, welfare and emission reduction goals of environmental policies.