Adverse Selection in Carbon Offset Markets: Evidence from the Clean Development Mechanism in China

Carbon offsets could reduce the global costs of carbon abatement but there is little evidence on how much they truly reduce emissions. We study carbon offsets sold by firms under the Clean Development Mechanism (CDM) in China by matching offset projects proposed to the United Nations to panel data on emissions and output for manufacturing firms. We have two main findings. First, the CDM attempts to screen out projects that would be profitable without offset payments by rejecting proposed projects with higher stated returns. Second, offset-selling firms steeply increase emissions after registering an offset project, relative to similar firms that proposed a project but did not follow-through. We explain this increase in emissions by jointly modeling the firm decision to propose an offset project and the Board’s decision of whether to approve. In the model, CDM firms increase emissions due to a combination of the selection of higher-growth firms into abatement project investment and the causal effect of higher productivity, post investment, on firm scale and therefore emissions.