An Analysis of The Distortive Effect of Environmental Policy Stringency on Physical Trade Balance for Fossil Fuels in China

Utilizing advanced econometric techniques such as quantile ARDL regression and time-varying Granger causality tests, we offer empirical evidence that China’s stricter environmental policies distort its physical trade balance for fossil fuels. Our findings indicate a clear trend: stricter environmental policies cause significant increases in the amount by which fossil fuel resources contained in Chinese imports exceed those contained in its exports. This suggests a form of carbon leakage, where firms involved in domestic production and exportation of fossil fuels to evade the heightened costs associated with stringent regulations reduce domestic production, which is then replaced by foreign production. Our findings underscore an imbalance in the regulatory approach between domestic production/exports of fossil fuels and its imports. While regulations on domestic production and exports are becoming tighter, those governing imports remain relatively lax.