Carbon leakage traditionally refers to the relocation of production to less-regulated regions to reduce carbon costs, which has prompted the adoption of additional carbon regulations such as carbon tariffs and carbon allowances. However, this policy portfolio may also trigger reverse carbon leakage, a relocation behavior in which firms move production to regulated regions to exploit policy arbitrage. We develop a game-theoretic model with dynamic carbon allowances to analyze the interaction among firms location choices, technology improvement, and regulatory policies. The results show that although a high carbon tariff induces reverse carbon leakage, total emission increases because production expansion outweighs the reduction in unit emission. Furthermore, technology improvement unexpectedly intensifies the increase in total emission through a free-ride effect under the dynamic allowance mechanism, which lowers the tariff threshold for reverse leakage. Additionally, although reverse carbon leakage improves consumer surplus, it may reduce overall social welfare when environmental damage exceeds economic gains. Therefore, regulators should mitigate reverse carbon leakage by setting relatively low carbon tariffs and carbon allowances simultaneously, particularly in industries where technology improvement is possible.
Yang et al. (Sun,) studied this question.