Carbon leakage limits the effectiveness of unilateral climate policy. This paper develops a quantitative general equilibrium trade model with global value chains,  carbon emissions, and heterogeneous firms to study the effect of carbon pricing and leakage mitigation tools. I show that the selection of heterogeneous firms generates first-order consumption effects of carbon pricing by affecting firm entry across sectors. An application to EU climate policy highlights that these selection effects increase the consumption loss of carbon pricing. At the same time, they create scope for recycling carbon revenues toward industrial policy, which limits these losses. The results further indicate a trade-off across common leakage mitigation tools. Border adjustments more effectively reduce leakage, while output-based rebates attenuate consumption losses.

This paper investigates the role of firm heterogeneity in environmentally extended new trade models, contrasting Eaton-Kortum and Melitz models to Armington and Krugman models. We show that when emissions per sales are constant across firms -- a standard assumption in the literature -- all four models predict identical emission responses. However, when emissions per quantity are constant across firms, this equivalence breaks. We propose a generalized framework that nests both assumptions. Calibrating the model with multiple industries and estimating the key elasticity between emission intensity and productivity using German firm-level data, we find that firm heterogeneity considerably raises emissions from trade liberalization.

This paper revisits the exporter’s environmental premium (EEP) by incorporating emissions embodied in domestically and internationally sourced intermediate inputs. Combining administrative firm-level data and customs records for German manufacturers with an environmentally extended input-output table and fuel specific emission factors, we document three stylized facts: (i) embodied emissions account for over half of firms’ total emissions; (ii) exporters’ production involves disproportionately more embodied emissions, particularly through international sourcing; and (iii) once embodied emissions are considered, the EEP reverses: exporters appear cleaner based on production-related emissions alone, but dirtier in total emissions. We rationalize these patterns in a sourcing model and test its predictions using a shift-share IV strategy based on foreign demand shocks. Export expansion lowers the production-related emission intensity without affecting total emissions, underscoring the role of sourcing in shaping firm-level environmental outcomes. These findings highlight the importance of accounting for embodied emissions when evaluating the welfare and environmental consequences of trade liberalization. 

Carbon pricing policies are usually combined with compensation for exposed firms to prevent adverse competitiveness effects. In cap-and-trade systems, this carbon cost compensation mostly occurs through free allocation of emission permits. Using an administrative panel of German manufacturing firms, this paper investigates how free allocation in the European Union Emissions Trading System affects firms’ competitiveness and their incentives to reduce emissions. Leveraging a reform of free allocation rules in a continuous difference-in-differences design, we find that that a reduction of freely allocated emission permits decreased firms’ emission intensity. Our results suggest that this decrease is driven by energy efficiency improvements instead of outsourcing of emission intensive production. On the other hand, we do not find statistically significant effects on firms’ employment, sales, value added, investments and exports – indicating that the reduction in free permits did not reduce firms’ competitiveness.