This paper develops a model of trade with heterogenous firms, where firms invest in abatement technology and thereby have an impact on their level of emissions. The model shows how firm productivity and firm exports are both positively related to investments in abatement technology. Emission intensity is, however, negatively related to firms' productivity and exports. The basic reason for these results is that a larger production scale supports more fixed investments in abatement technology and, in turn, lower emissions per output. In contrast to the standard models of heterogeneous firms, firms' productivity, and thus export performance, is not exogenous, but endogeneously determined by firms' investment in abatement technology. We derive closed form solutions for firm-level abatement investments and emissions per output, and test the empirical implications of the model using detailed Swedish firm-level data. The empirical results strongly support the model.
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