These findings reveal that carbon leakage could contribute to the efforts of manufacturing firms to clean up their operations, in addition to technological advancements and productivity growth. However, all firms do not respond equally: the reduction in emissions of firms in polluting industries is smaller compared to those in cleaner sectors. Moreover, the effect on the carbon footprints of large multinational corporations is larger, as these firms are able to employ strategies such as importing goods and shifting operations overseas.
Production in manufacturing firms in high income countries is generally becoming cleaner. Some of this trend has been shown to be due to the adoption of new technologies, but carbon offshoring – i.e. when dirty production at home is replaced with imports of carbon-intensive products from abroad – may be an additional factor. If so, this is concerning, because it risks undermining climate policies by simply moving emissions to countries with laxer regulations. However, assessing the extent to which high-income countries reduce domestic pollution by importing goods whose production generates foreign pollution is methodologically challenging because it requires an extensive data at the micro level, including product level decisions, imports and emissions and some exogenous variation in offshoring. As a result, there is a lack of knowledge on the causal mechanisms at play.
Carbon offshoring behavior
In one of the chapters of my doctoral thesis, I examine the carbon offshoring behavior of Swedish manufacturing firms from 2006 to 2014 using detailed data on production, trade, and emissions. For my empirical purpose, I use firm-specific instruments measuring their imports of emission-intensive goods from countries with less stringent environmental policies. Changes in these countries' export composition are then used to predict shifts in the intermediate and final goods imports of Swedish firms.
The main conclusions of the study are threefold. First, in a year where the carbon content of input import of a firm is 10% higher than what it normally is, we would expect production-based CO2 emission intensity to fall by 5.3%. While there is a reduction of average production-based emissions, my findings indicate that this is somewhat offset by an increase in transportation emissions. Therefore, it remains uncertain what the net effect on emissions will be. My second set of results show that environmental policy arbitrage may play a role this effect. Offshoring to countries with weaker environmental regulations led to a relatively larger reduction in emissions intensities, with this effect being particularly pronounced in low-income countries. Thirdly, I find that cleanups are larger for multi-product firms, cleaner industries and multinational companies.
Policy perspective
From a policy perspective, these findings suggest that harmonised environmental policies are the first and best approach to curb the rise in global and local emissions, consequently helping to combat the looming danger of climate change. However, since this is mostly impracticable, an efficient carbon border adjustment mechanism (which involves imposing taxes on imports based on their carbon content) could serve as an effective strategy for tackling carbon leakage. This would encourage firms to innovate more to keep their total emissions lower than the home country's regulatory threshold, thus helping to mitigate the need to pay abatement costs and high environmental penalties. The effectiveness of border adjustments may vary depending on the stage at which carbon is taxed. Some authors have highlighted that border taxes can replicate, at most, 1% of the CO2 reduction achievable through global climate cooperation. Therefore, careful consideration of when and how carbon taxes are applied is essential. Border adjustments shift the tax downstream, transitioning from a tax on domestic extraction to one on domestic production and, subsequently, to domestic consumption.
As environmental policymakers consider these implications, attention must also be directed towards climate financing for low-income countries. Balancing these policy considerations is vital for the development of effective, globally coordinated strategies aimed at achieving meaningful and sustainable reductions in carbon emissions.
About the author
Albert Duodu is a PhD Candidate in Economics at Lund University School of Economics and Management.
Albert’s primary research interests revolve around International Trade, and Environmental Economics, with a particular focus on applied microeconometrics and spatial analysis. In his research, he explores the drivers of green manufacturing transition and the implications of asymmetric implementation and enforcement of environmental policies on firms and consumers.
This research was undertaken as part of the author’s PhD studies at the Department of Economics at Lund University School of Economics and Management. Read more about the dissertation:
Carbon Footprints in a Global Marketplace : Firm-Level Insights on Trade and the Environment
