Firms’ Supply Chain Adaptation to Carbon Taxes

The paper presented in this Mannheim Applied Seminar studies how firms adjust input sourcing in response to climate policy. Using the EU Emissions Trading System (ETS) as a natural experiment and French product-level import and production data, the authors show that firms increasingly shifted imports of ETS-regulated inputs to non-EU countries over the 2010s as the policy became more stringent, indicating carbon leakage. This leakage is economically significant: the share of ETS-regulated products sourced from outside the EU rose by 4.3 percentage points after the ETS was implemented. Motivated by these empirical findings, they estimate a heterogeneous firm model using pre-ETS data. Simulating the model under a e100 carbon tax reproduces observed leakage, raises domestic prices and modestly reduces French emissions. Adding a carbon tariff similar to the EU’s Carbon Border Adjustment Mechanism (CBAM) reverses the leakage but further increases prices. The combined ETS+CBAM regime is seven times more effective than the ETS alone in reducing emissions.