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The deployment of cleaner production technologies is crucial to mitigate the effect of climate change. The diffusion of technology from developed to developing countries can be done through different channels. It can be a business decision such as firms' relocation, creation of a subsidiary or the adoption of technology by southern firms, or it may be decided at government level. This paper investigates in a two-country model (North and South) the relationship between the firms' relocation and diffusion of mitigation technologies. We assume that both countries implement a carbon tax and there are two kinds of production technology used: a relatively clean technology and a dirty one. This paper theoretically shows that the diffusion technology by technology adoption, public transfer or subsidiary creation induces a decrease in relocation, while technology diffusion via purchasing dirty southern firms may increase the number of relocated firms. The paper also demonstrates that technology diffusion may have perverse effects in the long run. Indeed, total emissions may increase with technology diffusion since southern firms are more competitive.

The issue of how to allocate pollution permits is critical for the political sustainability of any cap-and-trade system. Under the objective of offsetting firms' losses resulting from the environmental regulation, we argue that the criteria for allocating free allowances must account for the type of abatement technology: industries that use process integrated technologies should receive some free allowances, whereas those using end-of-pipe abatement should not. In the long run, we analyze the interaction between the environmental policy and the evolution of the market structure. In particular, a reserve of pollution permits for new entrants may be justified when the industry uses a process integrated abatement technology.