Carbon leakage through supply chain adjustments
Hanyi Wang
Feb 4, 2026
#Environment and climate change
#Sustainability standards
Carbon pricing policies aim to reduce emissions by making carbon-intensive production more expensive, but they may inadvertently shift emissions to regions with laxer regulations – a phenomenon known as carbon leakage. "carbon leakage," threatens to undermine the effectiveness of unilateral climate policies (Copeland, Shapiro, and Taylor, 2021). European countries have been at the forefront of implementing ambitious climate policies, with the EU Emissions Trading System (ETS) serving as the cornerstone of these efforts. While these policies aim to reduce domestic carbon emissions, an important question remains: Do stringent carbon regulations simply push carbon-intensive production to countries with weaker environmental standards?
In this blog post, I discuss a potentially significant but understudied channel of carbon leakage – adjustments in international supply chains. Instead of focusing on facility relocation or multinational firms, which has been the emphasis of previous research on carbon leakage, I examine whether European sectors adjust their sourcing of carbon-intensive inputs from emerging economies in response to carbon policy changes (Wang, 2025).
This question is key in the context of ongoing debates about the EU's Carbon Border Adjustment Mechanism (CBAM). CBAM aims to level the playing field by placing a carbon price on certain imports, potentially reducing incentives to shift production abroad. But CBAM is controversial: some view it as essential for preventing leakage and supporting ambitious climate policy, while others worry about trade tensions, administrative complexity, and the burden it may impose on developing countries. Using sector-level input-output data, I find that European industries respond to carbon policy shocks by temporarily increasing their sourcing of carbon-intensive inputs from emerging economies following carbon policy shocks. The effect peaks after two years before dissipating, with stronger responses in smaller European economies and countries lacking national carbon taxes. These findings suggest carbon leakage through supply chains is real but modest and temporary, supporting approaches like the EU's CBAM while highlighting the need for targeted support to vulnerable economies during the green transition.
In this blog post, I discuss a potentially significant but understudied channel of carbon leakage – adjustments in international supply chains. Instead of focusing on facility relocation or multinational firms, which has been the emphasis of previous research on carbon leakage, I examine whether European sectors adjust their sourcing of carbon-intensive inputs from emerging economies in response to carbon policy changes (Wang, 2025).
This question is key in the context of ongoing debates about the EU's Carbon Border Adjustment Mechanism (CBAM). CBAM aims to level the playing field by placing a carbon price on certain imports, potentially reducing incentives to shift production abroad. But CBAM is controversial: some view it as essential for preventing leakage and supporting ambitious climate policy, while others worry about trade tensions, administrative complexity, and the burden it may impose on developing countries. Using sector-level input-output data, I find that European industries respond to carbon policy shocks by temporarily increasing their sourcing of carbon-intensive inputs from emerging economies following carbon policy shocks. The effect peaks after two years before dissipating, with stronger responses in smaller European economies and countries lacking national carbon taxes. These findings suggest carbon leakage through supply chains is real but modest and temporary, supporting approaches like the EU's CBAM while highlighting the need for targeted support to vulnerable economies during the green transition.
Supply Chain Adjustments as a Route for Carbon Leakage
When facing stricter environmental regulations, businesses have several potential responses. They might improve their production efficiency, invest in cleaner technologies, or pass costs to consumers. However, they might also shift their supply chains to source inputs from regions without comparable carbon pricing.
Most studies on carbon leakage either look at whether firms move abroad (Dechezleprêtre et al., 2022) or rely on heavy modelling. A few papers find only small effects. My work takes a different angle: I look at how entire industries adjust their supply chains, showing directly how carbon policies change Europe’s imports from emerging economies. I observe a correlation between EU carbon prices and carbon-intensive imports from emerging economies, suggesting that supply chain adjustments might be a more flexible and immediate response to carbon policies (Figure 1).
Most studies on carbon leakage either look at whether firms move abroad (Dechezleprêtre et al., 2022) or rely on heavy modelling. A few papers find only small effects. My work takes a different angle: I look at how entire industries adjust their supply chains, showing directly how carbon policies change Europe’s imports from emerging economies. I observe a correlation between EU carbon prices and carbon-intensive imports from emerging economies, suggesting that supply chain adjustments might be a more flexible and immediate response to carbon policies (Figure 1).
Figure 1: This figure plots average EU ETS carbon prices across covered sectors (dashed red line, right axis, €/tCO2) and the ratio of carbon-intensive imports from emerging economies to total inputs (solid blue line, left axis, per cent) over the period 1999-2019, averaged across the 29 European countries in our sample.
Measuring the Impact of Carbon Policy Shocks
I study how carbon policy shocks affect Europe’s supply chains by looking at moments when carbon policy news caught markets off guard. These “surprises”—for example, the EU’s unexpected vote against the back-loading proposal in 2013 or sudden decisions about the carbon-leakage list—come from Känzig’s (2023) carbon-policy shock series. I then examine how these shocks change the share of carbon-intensive inputs that European sectors source from emerging economies such as China, India, Brazil, and Russia.
Key Finding: A Temporary Increase in Overseas Sourcing
Using these surprise policy changes, I examine what happens to import patterns in the years that follow. Figure 2 shows the main result: European industries temporarily increase the share of carbon-intensive inputs they buy from emerging economies after a carbon policy shock. The effect is small but noticeable: imports rise by around 0.2 percentage points, peaking two years after the shock, before gradually returning to normal. In other words, supply chains do adjust. But the response is temporary—not a permanent shift.
Figure 2: Impulse responses showing changes in carbon-intensive import shares from emerging economies following carbon policy shocks. The top, middle, and bottom panels show different measures of import shares relative to total imported inputs, all inputs, and domestic supply, respectively. Grey shaded area displays the confidence interval.
What Does This Mean for Climate Policy?
These findings show that supply-chain-based carbon leakage does occur, but it is modest and temporary. When carbon prices rise unexpectedly, European industries initially import slightly more carbon-intensive inputs from countries with weaker environmental rules. Over time, however, this effect fades. This pattern suggests that firms use international sourcing as a short-term way to manage cost pressures, not as a long-term escape from regulation.
The impacts are not evenly distributed. Lower-income European economies show larger increases in carbon-intensive imports after policy shocks. Countries that combine the EU ETS with their own national carbon taxes experience much smaller changes. This hints that more comprehensive policy packages can help contain leakage, while economies with fewer resources to invest in cleaner technologies may feel greater pressure to rely on imports when carbon prices rise.
These insights matter for the ongoing debate around the EU’s CBAM. My results suggest that CBAM could help limit the short-term leakage that occurs through supply chains, but it should not be seen as a stand-alone solution. Because the leakage effects I document are modest and temporary, CBAM’s potential benefits need to be weighed carefully against its costs and international implications. A successful green transition will almost certainly require a mix of approaches—coordinated carbon pricing, investment in cleaner technologies, and targeted support for countries and industries facing the greatest adjustment pressures. Future research could examine the longer-term effects of CBAM as firms adjust production technologies and sourcing decisions, as well as its interaction with alternative carbon policies in trading partners.
This blog is based on the research paper "Carbon Leakage Through Supply Chain Adjustments" (Wang, 2025, IDOS Discussion Paper) https://doi.org/10.23661/idp10.2025
The impacts are not evenly distributed. Lower-income European economies show larger increases in carbon-intensive imports after policy shocks. Countries that combine the EU ETS with their own national carbon taxes experience much smaller changes. This hints that more comprehensive policy packages can help contain leakage, while economies with fewer resources to invest in cleaner technologies may feel greater pressure to rely on imports when carbon prices rise.
These insights matter for the ongoing debate around the EU’s CBAM. My results suggest that CBAM could help limit the short-term leakage that occurs through supply chains, but it should not be seen as a stand-alone solution. Because the leakage effects I document are modest and temporary, CBAM’s potential benefits need to be weighed carefully against its costs and international implications. A successful green transition will almost certainly require a mix of approaches—coordinated carbon pricing, investment in cleaner technologies, and targeted support for countries and industries facing the greatest adjustment pressures. Future research could examine the longer-term effects of CBAM as firms adjust production technologies and sourcing decisions, as well as its interaction with alternative carbon policies in trading partners.
This blog is based on the research paper "Carbon Leakage Through Supply Chain Adjustments" (Wang, 2025, IDOS Discussion Paper) https://doi.org/10.23661/idp10.2025
References
Carbone, J. C., & Rivers, N. (2017). The impacts of unilateral climate policy on competitiveness: Evidence from computable general equilibrium models. Review of Environmental Economics and Policy, 11(1), 24-42.
Chen, Q., Chen, Z., Liu, Z., Suárez Serrato, J. C., & Xu, D. (2021). Regulating conglomerates in China: Evidence from an energy conservation program (NBER Working Paper 29066). National Bureau of Economic Research (NBER).
Copeland, B. R., Shapiro, J. S., & Taylor, M. S. (2022). Globalization and the environment. In G. Gopinath & K. Rogoff (Eds.), Handbook of International Economics (Vol. 5, pp. 61-146). Elsevier. https://doi.org/10.1016/bs.hesint.2022.02.002
Cui, J., Wang, C., Wang, Z., Zhang, J., & Zheng, Y. (2023). Carbon leakage within firm ownership networks (SSRN Paper 4514971). https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4514971
Dechezleprêtre, A., Gennaioli, C., Martin, R., Muûls, M., & Stoerk, T. (2022). Searching for carbon leaks in multinational companies. Journal of Environmental Economics and Management, 112, 102601.
Ederington, J., Levinson, A. & Minier, J. (2005). Footloose and pollution-free. Review of Economics and Statistics, 87(1), 92-99.
Fowlie, M. L., & Reguant, M. (2022). Mitigating emissions leakage in incomplete carbon markets. Journal of the Association of Environmental and Resource Economists, 9(2), 307-343.
Jordà, Ò. (2005). Estimation and inference of impulse responses by local projections. American Economic Review, 95(1), 161-182.
Känzig , D. R. (2023). The unequal economic consequences of carbon pricing (NBER Working Paper 31221). National Bureau of Economic Research (NBER).
Naegele, H., & Zaklan, A. (2019). Does the EU ETS cause carbon leakage in European manufacturing? Journal of Environmental Economics and Management, 93, 125-147.
Wang, H. (2025). Carbon leakage through supply chain adjustments (IDOS Discussion Paper 10/2025). Bonn: German Institute of Development and Sustainability (IDOS). https://doi.org/10.23661/idp10.2025
Carbone, J. C., & Rivers, N. (2017). The impacts of unilateral climate policy on competitiveness: Evidence from computable general equilibrium models. Review of Environmental Economics and Policy, 11(1), 24-42.
Chen, Q., Chen, Z., Liu, Z., Suárez Serrato, J. C., & Xu, D. (2021). Regulating conglomerates in China: Evidence from an energy conservation program (NBER Working Paper 29066). National Bureau of Economic Research (NBER).
Copeland, B. R., Shapiro, J. S., & Taylor, M. S. (2022). Globalization and the environment. In G. Gopinath & K. Rogoff (Eds.), Handbook of International Economics (Vol. 5, pp. 61-146). Elsevier. https://doi.org/10.1016/bs.hesint.2022.02.002
Cui, J., Wang, C., Wang, Z., Zhang, J., & Zheng, Y. (2023). Carbon leakage within firm ownership networks (SSRN Paper 4514971). https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4514971
Dechezleprêtre, A., Gennaioli, C., Martin, R., Muûls, M., & Stoerk, T. (2022). Searching for carbon leaks in multinational companies. Journal of Environmental Economics and Management, 112, 102601.
Ederington, J., Levinson, A. & Minier, J. (2005). Footloose and pollution-free. Review of Economics and Statistics, 87(1), 92-99.
Fowlie, M. L., & Reguant, M. (2022). Mitigating emissions leakage in incomplete carbon markets. Journal of the Association of Environmental and Resource Economists, 9(2), 307-343.
Jordà, Ò. (2005). Estimation and inference of impulse responses by local projections. American Economic Review, 95(1), 161-182.
Känzig , D. R. (2023). The unequal economic consequences of carbon pricing (NBER Working Paper 31221). National Bureau of Economic Research (NBER).
Naegele, H., & Zaklan, A. (2019). Does the EU ETS cause carbon leakage in European manufacturing? Journal of Environmental Economics and Management, 93, 125-147.
Wang, H. (2025). Carbon leakage through supply chain adjustments (IDOS Discussion Paper 10/2025). Bonn: German Institute of Development and Sustainability (IDOS). https://doi.org/10.23661/idp10.2025
