Environmental Policy and the CO2 Emissions Embodied in International Trade

As polices to curb carbon emissions are not implemented similarly across countries, a so-called "carbon leakage" may offset domestic carbon reductions at the global level by redirecting CO2-intensive production to places with less stringent environmental regulation. This article uses a standard gravity model with panel data to assess whether a tightening in environmental policy plays as an incentive to offshore highly polluting activities. Our results show no evidence of carbon leakage through international trade, as stringent environment policy leads generally to a reduction in CO2 emissions embodied in traded goods and services, both at aggregate and sectoral levels. However, we do find evidence of carbon leakage when considering imports from countries with the most stringent environmental policy, suggesting the need for economies committed to carbon neutrality targets to tackle the issue of global cooperation on climate policy.