Carbon Pricing and Fuel Switching by Firms: Theory and Evidence

What determines the effectiveness of carbon pricing in reducing CO2 emissions? Prior research points to the importance of firm-level technology adjustments but provides limited evidence on the specific technologies involved. We develop and estimate a model of heterogeneous firms' fuel choices to quantify the importance of fuel switching. The model explains three empirical findings from Swedish microdata: (1) fuel choices vary both across and within industries, (2) fuel switching accounts for a large share of the decline in manufacturing emissions between 2004 and 2020, and (3) higher carbon taxes have led firms to switch away from fossil fuels toward electricity and biofuels. Counterfactual analysis suggests that carbon pricing is effective in reducing manufacturing emissions, with fuel switching explaining roughly half of this effect. Market share reallocation toward cleaner firms further reduces emissions but increases the adverse impact on output. The cost of carbon pricing varies considerably across industries, due to differences in the firms' abilities to replace fossil fuels with efficient alternatives. 

Imports and the CO2 Emissions of Firms

We explore how importing of intermediate goods affects the carbon intensity of firms in the Swedish manufacturing sector. By exploiting exogenous shocks to foreign export supply of intermediate goods, we estimate that a 10 percent increase in imports causes a 5.6 percent reduction in carbon intensity. Average carbon intensity among the firms in our sample between 2004 and 2016 decreased by around 50 percent, and our results suggest that import growth accounted for about a third of this decline. Exploring the mechanisms, we find evidence for both a technique effect and a product composition effect. Importing has a positive impact on productivity, scale of production, and abatement investments. It also encourages firms to focus more on their core products. We find no evidence for a pollution haven effect.

Carbon Taxes and Offshoring

This paper explores how manufacturing firms' offshoring decisions respond to changes in the domestic price of carbon. Empirical studies find limited effects of carbon pricing policies on firms' offshoring levels, contrary to expectations. To explain this, I build and estimate a structural model of firms' offshoring behavior that decomposes the total offshoring response into different margins of adjustment. A higher carbon price increases offshoring through substitution toward foreign varieties and reduces offshoring through a negative scale effect. I quantify these margins using Swedish data and find that the negative scale effect slightly dominates for the average firm. The aggregate impact on manufacturing imports and production depends on whether carbon pricing is combined with border adjustments. Without border adjustments, the share of imports embedded in domestic production increases considerably. With border adjustments, this increase is reversed, but the negative impact on output is amplified. This result highlights a key policy tradeoff: while border adjustments protect against offshoring, they can also harm domestic production by increasing the cost of foreign inputs.