Abstract

In this paper, I exploit detailed product-level data on production, trade, and emissions of Swedish manufacturing firms to examine how firms adjust their production decisions in response to supply shocks in trading partner markets. First, I show that firms increase import of carbon content of inputs and own-produced goods in response to world export supply shocks affecting these products. Next, using a shift-share instrument, I show that carbon offshoring activities lead to a substantial reduction in firms' emission intensity. Latter results show that the role of environmental policy arbitrage in this effect is nontrivial, and clean-ups are highly unevenly distributed among sectors.  These findings suggest that the harmonization of environmental policies could serve as an effective strategy to tackle climate change and carbon leakage.