Border Carbon Adjustments and Foreign Direct Investment with Technology Transfer

This study examines the effects of a unilateral carbon tax with a border carbon adjustment (BCA) policy by using a North-South duopoly model with endogenous plant locations and technology adoptions. If the North increases its carbon tax unilaterally, carbon leakage could arise; that is, effort to reduce carbon dioxide (CO₂) emissions can lead to an increase in emissions in the South that has a lower carbon tax. The North implements the BCA policy to reduce carbon leakage resulting from its firm's foreign direct investment (FDI) in the South. In carrying out FDI, the northern firm can choose to transfer "clean" or "dirty" technology, where technology's dirtiness is defined as CO₂ emissions per unit of the firm's output. Under the BCA policy, an increase in the carbon tax of the North induces northern firm's FDI that can lead to carbon leakage in the South. However, the resulting carbon leakage does not lead to an increase in global emissions because the northern firm transfers clean technology to the South. Under the BCA policy, an optimal carbon tax for the North exceeds its marginal damage and induces northern firm's FDI with clean technology