Strategic Carbon Market Mechanisms and Foreign Investment Dynamics: Business Responses to Climate Policy in China

Abstract

This study examines whether China's Carbon Emissions Trading Policy (CETP) influences foreign direct investment (FDI) under staggered policy adoption. Using panel data for 260 cities from 2005 to 2021 and a two-way fixed-effects difference-in-differences (DID) approach supported by event-study pre-trend tests, the results show that CETP is associated with a statistically significant increase in FDI inflows. Treating carbon-market features as continuous treatments indicates that higher carbon-price levels and stronger market liquidity reinforce these effects. To clarify the underlying mechanisms, formal mediation using lagged R&D intensity and green patent applications demonstrates a significant innovation-driven transmission channel. Heterogeneity analysis further shows that the policy impact is stronger in eastern and first-/second-tier cities, consistent with higher institutional capacity and more developed market environments. Comparative insights with the EU ETS and K-ETS suggest that price credibility and market depth are important conditions for investment responses. Overall, the findings provide evidence that CETP can shape cross-border investment behavior and support the development of innovation-oriented, low-carbon growth pathways.