Outward Foreign Direct Investment Patterns of Italian Firms in the European Union's Emission Trading Scheme*

• DOI: http://doi.org/10.1111/sjoe.12323
• Published date: 01 January 2020
• Date: 01 January 2020

Scand. J. of Economics 122(1), 219–256, 2020

DOI: 10.1111/sjoe.12323

Outward Foreign Direct Investment Patterns

of Italian Firms in the European Union’s

Emission Trading Scheme*

Simone Borghesi†

University of Siena, 53100 Siena, Italy

simone.borghesi@unisi.it

Chiara Franco

University of Pisa, 56126 Pisa, Italy

chiara.franco@unipi.it

Giovanni Marin

University of Urbino “Carlo Bo”, 61029 Urbino, Italy

giovanni.marin@uniurb.it

Abstract

We consider the role played by the European Union’sEmissions Trading System (EU ETS) as a

possible driverof outward foreign direct investment (FDI) for Italian manufacturing firms. Using

a panel dataset of about 22,000 firms covering the first two phases of the EU ETS and the period

before the EU ETS, we measure the patterns of FDI towards countries not covered by the EU

ETS. The results show that the EU ETS had a weak effect on the number of new subsidiaries

abroad (extensive margin), while it had a larger impact on production taking place in foreign

subsidiaries (intensive margin), especially in trade-intensivesectors.

Keywords: Carbonleakage; EU ETS; foreign direct investment

JEL classification:F23; L23; Q50

I. Introduction

In the last few years, the European Union’s Emissions Trading System (EU

ETS) has attracted much attention among scholars and policymakers as

it represents the central policy instrument adopted by the EU to mitigate

climate change. The capacity of the EU to unilaterally develop the first

transboundary system of emissions trading has made the EU ETS a

*Wewould like to thank three anonymous reviewers and participants at the GCET15 Conference

(2014, Copenhagen), DEGIT XX Conference (2015, Geneva), 21st EAERE Conference (2015,

Helsinki), SIE Conference (2015, Naples) and EUI ClimateAnnual Conference (2015, Florence)

for valuable comments and suggestions on previous versions.Any remaining errors are our own.

†Also affiliated with the European University Institute, Florence.

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The editors of The Scandinavian Journal of Economics 2018.

220 Outward FDI patterns of Italian firms in the EU ETS

prototype for several other emissions trading schemes that are rapidly

spreading around the world (Ellerman, 2010; International Carbon Action

Partnership, 2016).

However, the lack of an internationally coordinated environmental policy

has raised increasing concerns about the potential losses in competitiveness

that might derive from such a stringent unilateral environmental regulation.

It has been argued that in the presence of global externalities, such as

those generated by CO2emissions, unilateral environmental interventions

might end up being not environmentally effective while generating negative

socio-economic consequences in terms of job losses.

Some European production sectors are regarded as particularly

vulnerable to the risk of carbon leakage – that is, the delocalization of

production (and corresponding carbon emissions) of involved industries

towards geographical areas with laxer environmental regulations. This issue

has been recognized by the European Commission, which exempted from

the auctioning of emission allowances those sectors more exposed to the

risk of leakage, at least for the second commitment period of the EU ETS

(2013–2020).

Surprisingly enough, however, this debate about the risks of carbon

leakage lacks empirical evidence so far on whether the EU ETS can actually

induce European firms to change their location, moving their production

towards countries that are not subject to the EU ETS in order to avoid the

need to comply with the regulation and the related costs. Our paper aims

at closing this gap by providing empirical evidence on this relevant issue.

The relocation risks caused by unilateral environmental regulation are

the object of a long-standing and extensive body of theoretical and empirical

literature (e.g., Hoel, 1991; Dean, 1992; Lucas et al., 1992; Motta and

Thisse, 1994). We can distinguish two main research strands in this field:

one on the so-called pollution haven hypothesis (PHH) and the other on

the pollution haven effect (PHE). The PPH argues that domestic regulatory

stringency might trigger outward flows of FDI, while the PHE claims that

regulatory stringency “at home” can negatively affect exports or inward

flows of FDI. Both hypotheses have been investigated by several authors,

mainly with respect to outward FDI from developed to developing countries,

reaching contrasting results (see, among others, Hanna, 2010; Wagner and

Timmins, 2009; Eskeland and Harrison, 2003). Although different types of

environmental policies have been considered to assess the validity of the

PHH, the role played by the EU ETS as a firm-level driver of outward

FDI has not been examined so far, mainly because of the lack of available

data.

To overcome this limitation of the existing studies, the present paper

contributes to the literature by providing an empirical investigation about

the potential carbon leakage effects of the EU ETS for firms operating in

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The editors of The Scandinavian Journal of Economics 2018.

S. Borghesi, C. Franco, and G. Marin 221

Fig. 1. Outward FDI flows for selected EU countries (2000 = 1)

Source: OECD.

Italy, one of the major countries subject to this regulation.1In our opinion,

the Italian case is particularly interesting for several reasons. (i) Italy is one

of the main emitters within the EU ETS, showing an active role within the

EU ETS trade network (Borghesi and Flori, 2018). (ii) Italy has shown a fast

increase in outward FDI in the last few years, particularly towards non-ETS

non-OECD countries, above the average increase of other EU ETS countries

(see Figure 1). (iii) Italy lags behind in terms of eco-innovation with respect

to the other main EU economies, as confirmed by the comparison reported

in Figure 2. Therefore, the implementation of the EU ETS might induce

those Italian firms that are “at the margin” to relocate their production to

regions not subject to the EU ETS rather than to change their production

activities (as in more technologically advanced countries).

In this paper, we use administrative data on Italian manufacturing firms

to identify the impact of the EU ETS on outward FDI, employing matching

techniques based on propensity score to construct a proper counterfactual.

From the analysis performed in the paper, the first two phases of the

EU ETS turn out to have a twofold effect on the FDI of Italian firms:

1During the period 2005–2012, Italian EU ETS plants accounted for 9.5 percent of total EU ETS

plants, received 10 percent of overall emission allowances, and contributed to 10.3 percent of

total CO2emissions.

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The editors of The Scandinavian Journal of Economics 2018.