Conference Agenda

How effective are climate policies in reducing emissions? Although this issue is becoming more pressing, standard models largely ignore the role of heterogeneity in firms’ responses. Using administrative German firm data, I show that two determinants of carbon leakage, the emission intensity of production and the import intensity of intermediates, vary significantly across firms. I incorporate this heterogeneity into a model of heterogeneous firms to introduce two new adjustment channels to carbon pricing: the reallocation of production towards firms with a lower emission intensity or a higher import intensity. I calibrate the model to the German manufacturing sector and simulate an increase in the domestic carbon price. A model with firm heterogeneity predicts greater emission reductions, smaller welfare losses, and a higher leakage rate. Production reallocation towards less emission-intensive firms offsets increased emissions from offshoring. Combining a domestic carbon price with a carbon tariff would further reduce leakage and welfare losses. However, it would not yield additional emission reductions since it limits the reallocation of domestic production towards clean firms. These results suggest that optimal carbon taxes and tariffs derived from models without firm heterogeneity may be set at an excessively high level to achieve a specified emission target.

Carbon tariffs are a widely discussed mitigation instrument for carbon leakage --- the relocation of emissions to other countries in response to more stringent unilateral environmental policies. This paper examines unilateral carbon pricing, specifically firm-specific carbon tariffs combined with a domestic emission tax, in a theoretical two-country, two-sector trade model. With increasing returns to scale, firm heterogeneity, and an optional fixed-cost investment to upgrade to an emission-free technology, the carbon tariff is found to reduce emissions in two ways other than leakage mitigation. First, exporters in the unregulated foreign country are incentivized to adopt the clean technology, thereby decarbonizing their domestic supply as well. Second, the carbon tariff enables a negative leakage effect: raising the carbon tax in the regulating home country expands the profits of foreign exporters. As a result, resources are reallocated from less productive, dirty non-exporters to highly productive exporting firms. If a large share of foreign exporters is clean due to the existence of the carbon tariff, an increase in the carbon tax may lead to a decrease in emissions from foreign consumption. However, the foreign gain in competitiveness also increases the number of active foreign firms, which might offset the emission decline. Finally, I show that the negative leakage effect is likely to be more pronounced in the later or `final' stages of the environmental policy, when the carbon price is high.

As trade wars resurface on the global stage, climate policy enters new terrain.

While coordinated global action is widely recognized as the most effective solution to curb emissions and avoid trade conflicts, political realities often lead to fragmented national policies. In response, firms can exploit regulatory differences by shifting production to regions with laxer environmental standards and more protected markets - a phenomenon that not only alters domestic industry size but also involves carbon leakage, where pollution is displaced rather than reduced.

Our primary objective is to investigate the interplay between climate policy and trade protectionism, with a particular focus on the carbon leakage that arises from production relocation driven by both climate and trade policy.

We develop a framework in which government objectives are shaped by two competing factions: a materialistic faction, which prioritizes protecting domestic industries from foreign competition, and a green faction, which is committed to reducing global carbon emissions. By incorporating the influence of competing political interests into our framework, we offer new insights essential for crafting effective climate policy in an era of growing geopolitical and economic fragmentation.

Border carbon adjustments are pivotal for addressing carbon leakage in emissions-intensive and trade-exposed sectors like steel. This paper evaluates the economic and environmental impacts of different border carbon adjustment designs, including mass-based approaches, such as those tied to carbon pricing, and rate-based approaches, which levy fees based on carbon intensity. Additionally, we analyze the interplay of these designs when implemented unilaterally or jointly. Using a novel structural equilibrium model of the global steel market with plant-level detail, we simulate four policy scenarios involving the European Union and the United States. Our findings reveal that rate-based policies achieve minimal global emissions reductions at high welfare costs, while mass-based policies achieve significantly greater reductions at comparable costs. The interplay between policies highlights the risks of uncoordinated actions, which create trade distortions and reduce policy effectiveness, underscoring the need for coordinated, sector-sensitive climate strategies.