Does the EU ETS cause carbon leakage? A global supply-chain perspective

This paper provides causal evidence that carbon leakage under the EU Emissions Trading System (EU ETS) operates through global supply-chain linkages. Exploiting the phased implementation of the EU ETS as a natural experiment, we construct a granular country–sector–year panel combining bilateral trade data with multi-regional input–output tables to estimate the effect of carbon regulation on trade in intermediate goods and embodied emissions. We find that in sectors covered by the ETS, imports of intermediate goods from non-ETS countries are around 8% higher, and the carbon content of those imports is 11% higher in manufacturing, the sector group in which the scheme’s coverage and traded intermediate inputs overlap. The main results are based on Poisson pseudomaximumlikelihood estimates, complemented with a log-linear specification that provides an exact additive decomposition of the effect. On the export side, the carbon content of regulated sectors’ shipments falls in manufacturing, and the decomposition attributes that decline to a reduction in the volume exported rather than to cleaner production. Our analysis also shows the existence of sectoral heterogeneity. Sectors with stronger upstream and downstream supply-chain integration import less additional embodied carbon, whereas sectors with weaker linkages show larger leakage effects. The composition result is corroborated by a staggered difference-in-differences specification on the intensive margin. The results identify embodied emissions in intermediate inputs as a key channel of carbon leakage and suggest that effective climate policy requires well designed carbon border adjustments with supply-chain-sensitive allowance allocation mechanisms, and stronger international policy coordination.