Do carbon markets work?

In 2005, the European Union created the world's first and largest market-based carbon policy. Here, we look at the impact it has had, so far.

Ever since the EU created its market-based carbon policy, governments and businesses have been keen to see an impact. But analysing how effective policies can be on a noisy economic and global stage is complex – and hard proof that carbon markets can achieve what they set out to do is scarce.

What is the EU Emissions Trading Scheme?

The EU’s Emissions Trading System was launched to kindle innovation and give firms flexibility in how they could limit emissions – under the policy, firms buy a tradeable permit per tonne of carbon they emit.

By detailed examination of industrial data, we have reliably shown that creating a European carbon market prompted an overall 14 to 16 per cent fall in emissions over an eight year period, equivalent to 5.4 million tonnes of carbon each year – without any dent in firms’ profits or performance.

This is proof of success – carbon markets charge companies for the amount of carbon dioxide they emit – with a view to discouraging dirty and polluting industry and encouraging firms to invest in cleaner technology.

Emissions are not being transferred because global emissions have decreased

But how were we able to show the fall in emissions between 2005 to 2012 was a direct result of this market-based policy – and not down to other factors, such as fluctuating economic fortunes, outsourcing polluting production beyond Europe’s borders, or simply closing down emitting facilities?

We cross-referenced detailed information on French manufacturing firms gathered by French authorities since 1996 – long before this carbon market was conceived. We looked at a range of factors, from manufacturers’ use of fuel through to imports, staffing and economic performance, and were able to compare how firms within the carbon market performed compared to those outside, and observe differences as carbon markets kicked in.

Even though emissions have been declining in the manufacturing sector in every advanced economy regardless of carbon markets, we show that the 14 to 16 per cent reduction accounted for a third of the overall fall in emissions. Encouragingly, we found the emissions reduction hasn’t come at the expense of profits – production and turnover remained stable – nor do we observe any job losses. 

Carbon emissions beyond Europe

There was also no evidence of "carbon leakage" – that the firms had simply imported more polluting goods instead, shifting the emissions beyond their borders – eemissions are not being transferred because global emissions have decreased. 

And, although in this instance we haven’t measured whether firms were investing in new facilities beyond Europe, our separate study revealed last year that multinationals that belong to the European Trading System don’t increase their share of emissions beyond Europe. 

Perhaps most encouragingly, we discovered – where we had the relevant data – that companies were investing in cleaner production technologies. This is the ideal scenario: a carbon market that not only cuts emissions but also generates investment and paves the way for cleaner industry practices and systems.

We can’t ignore the impact of the global financial crash, which happened during the period we examined – could these energy-intensive firms have been hit by the fallout? Or were some regions hit harder than others, and did this skew results? We were able to identify that this wasn’t the case. The reductions we have seen in these results are real and verifiable. 

The best way to cut emissions from industry is through market-based policies rather than direct regulation

Our work raises new questions. Our investigation took place during a stretch when the price of carbon credits was relatively low – at around €15 between 2008 to 2012. Today the market has evolved: European prices peaked last year at around €100 and are still more than €70. Do these higher prices deter manufacturers from investing in new European facilities? Do they shift production beyond Europe when the price is too high at home? 

What will be the impact of the new mechanism to charge a carbon levy on imports from beyond Europe – the Carbon Border Adjustment Mechanism – on emissions within Europe? We’re now working with partners in the UK, Germany, France, the Netherlands, Italy and beyond on a pan-European data analysis of the impact of the carbon market upon emissions. We also want to understand more about the impact of carbon trading on supply chains which aren’t directly part of the scheme. What impact does the market have on wider innovation?

Climate change caused by greenhouse gas emissions is one of the greatest challenges the world must tackle. Economists around the world largely agree that the best way to cut emissions from industry is through market-based policies rather than direct regulation. Our work gives the message that if well designed and well implemented, carbon markets are an effective policy tool – they can deliver change. 

This article draws on findings from "Does Pricing Carbon Mitigate Climate Change? Firm-Level Evidence from the European Union Emissions Trading Scheme", by Jonathan Colmer (University of Virginia), Ralf Martin (Imperial College London), Mirabelle Muûls (Imperial College London) and Ulrich J. Wagner(University of Mannheim).