Do Market-Based Mechanisms Reduce Carbon Emissions? Firm-Level Evidence from the European Union Emissions Trading Scheme

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Market-based regulatory instruments hold the promise of correcting market failures at least cost. However, evidence on their efficacy remains scarce. We evaluate the European Union Emissions Trading Scheme (EU ETS) – the world’s first and largest market-based climate policy. Using administrative data on almost 4,000 French manufacturing firms, we estimate that the EU ETS induced regulated firms to reduce carbon dioxide emissions by 8% compared to unregulated firms, with no detectable negative effects on their economic performance. We find no evidence that firms evaded the consequences of the new regulatory environment by outsourcing production, suggesting that these emissions reductions were global rather than local. Consistent with this claim, we also provide evidence that firms made targeted investments to reduce emissions. Our estimates imply that the EU ETS reduced French industrial emissions by an average of 5.6 million tonnes each year between 2008 and 2012, accounting for 30% of the aggregate industrial emission reductions that occurred during this period. Extrapolating our findings to the rest of the EU suggests that the policy reduced industrial emissions by an average of 50 million tonnes per year between 2008 and 2012. Back-of-the-envelope calculations reveal that the same reductions could be achieved by planting 5 billion trees at a cost of $1.5 billion, at least twice the estimated cost associated with the estimated reductions delivered by the EU ETS.

Jonathan is an Assistant Professor in the Department of Economics at the University of Virginia. His research explores topics in environmental and development economics, with a view to understanding how we can design environmental regulations and manage environmental quality in a way that maximizes global economic potential. He is a Visiting Professor in the Department of Economics at the University of Oxford and a Visiting Fellow at Brasenose College.