What are the economic and environmental effects of the European Union Emissions Trading Scheme?

The European Union (EU) put forward an ambitious climate mitigation target of reducing greenhouse gas (GHG) emissions by at least 55% below 1990 levels by 2030. How will the EU deliver? Carbon pricing – through the European Union Emissions Trading System (EU ETS) – is expected to deliver a large part of the emissions reductions. Under an ETS, installation operators can trade GHG emission permits with each other, ensuring that emissions are reduced cost-effectively. Launched in 2005, the EU ETS is the world’s first international ETS, covering over 14,000 energy-intensive plants across 30 European countries, accounting for around 40% of the EU’s total GHG emissions. From the outset the EU ETS raised concerns about its environmental effectiveness and potential negative economic effects for the European industry by putting regulated firms at a disadvantage vis-a-vis their foreign competitors.

A recent paper ‘The joint impact of the European Union emissions trading system on carbon emissions and economic performance’ published by OECD authors in the leading Journal of Environmental Economics and Management sheds light on this concern. Based on an earlier OECD working paper, the study is the first comprehensive, European-wide analysis of the impact of the EU ETS on both carbon emissions and economic performance of regulated companies during the first two phases of the system’s existence, from 2005 to 2012.

The study uses data for carbon emissions of installations from the national Pollutant Release and Transfer Registers (PRTR) of France, Netherlands, Norway and the United Kingdom, complemented with data from the European PRTR. It also includes economic data of firms for all European countries to investigate the impact of EU ETS on various economic dimensions, including employment, fixed assets, profits, and revenues. The study makes use of the EU ETS inclusion criteria, according to which installations below a certain capacity threshold do not need to participate in the carbon market. It compares installations or firms operating in the same country and the same sector and of similar characteristics, but which fall under different regulatory regimes since the launch of the EU ETS.

So what does the study tell us?

The EU ETS led to a reduction of carbon emissions of around 10% between 2005 and 2012 but has not had any adverse impact on employment (see Figure 1). Most of the emissions reductions were observed in the second trading phase of the EU ETS and were primarily driven by larger installations. This is in line with the observation that pollution control technologies are capital-intensive and involve relatively high fixed costs. There is also evidence that a more generous allocation of free allowances results in a weaker reduction of emissions.

Figure 1. The impact of the EU ETS on jobs and CO₂ emissions

Note: The graph shows the percentage change on CO₂ emissions and number of employees by year of firms participating in the EU ETS versus those not participating.

Source: Based on Dechezleprêtre et al. (2018) and Dechezleprêtre et al. (2023)

The study also finds that the EU ETS has not had a negative effect on regulated firms’ revenue, profits, fixed assets and jobs. In fact, the EU ETS seemed to have led to an increase of revenues and fixed assets of regulated firms – contrary to what could have been expected. One explanation  could be that the EU ETS induced regulated firms to increase investment – likely in carbon-saving technologies – which, in turn, may have increased productivity.

In its first eight years of existence, the EU ETS effectively reduced carbon emissions without negatively affecting the economic performance and competitiveness of European regulated firms. This is in line with recent literature reviews on the effects of carbon pricing on environmental and economic outcomes. While these results demonstrate that concerns about negative effects of the EU ETS on the competitiveness of the European industry have been vastly overplayed, more research is needed to assess these findings against new realities. In fact, the period between 2005-2012 was characterised by relatively low permit prices of EUR 20/tCO₂ on average and a generous allocation of free allowances. From mid-2020, permit prices were fluctuating around EUR 80t/CO₂, so it remains to be seen whether these findings hold true in a high price environment.