Does the EU Emissions Trading System induce investment leakage? Evidence from German multinational firms

This study exploits the incomplete participation requirements of the European Union Emissions Trading System (EU ETS) to investigate the policy's causal effect on outward foreign direct investment (FDI) decisions of German multinational firms. Using a combination of difference-in-differences with bias-corrected matching, our baseline specification indicates that the sample average treatment effect is very small and levels out at -0.2%, but its standard error is large (0.16). Looking at a sub-sample of firms which can be considered as geographically more mobile because they are supposedly less capital-intensive, we find that a small number of EU ETS regulated firms have increased their FDI outside the EU by 52% +/- 47% compared to a counterfactual scenario. Paradoxically, relocating firms neither operate in the targeted energy-intensive sectors, nor are they emission-intensive. The small emissions share of these footloose firms indeed indicates a limited potential for policy-induced leakage of emissions. On the extensive margin, we find that all EU EIS firms on average have increased the number of their affiliates outside the EU by 28% +/- 24% relative to control firms. This causal change in network structures of multinational firms outside the EU is suggestive of endeavors undertaken by regulated firms to facilitate relocations in the future. (C) 2019 Elsevier B.V. All rights reserved.