Imperial researchers have won the Erik Kempe Award for a paper analysing incentives offered under the EU's emissions trading scheme (ETS).

Faced with environmental regulations and associated costs, companies can be tempted to relocate, both causing job losses and diminishing the positive impact of these regulations. To dissuade them, schemes such as the EU’s emissions trading scheme (ETS) offer incentives to the firms most at risk.

In their prize-winning paper, Ralf Martin and Laure de Preux from Imperial College Business School, Grantham Lecturer Mirabelle Muûls, and Ulrich Wagner (University of Carlos III de Madrid) analysed compensation under the ETS. They concluded that the EU’s compensation was overly generous but also failed to target firms in the most efficient way.

“We found that the EU ETS could have had the same impact at a much lower cost,” says Dr Muûls.

Allocating just the right amount of compensation is a delicate balancing act.  Give out too little and firms relocate, taking both carbon emissions and jobs outside the EU.  Distribute too many free permits and the scheme not only wastes money but rewards polluters for the harm they do to the environment.

In order to be as effective as possible, free permits should be offered first to those firms where they are most likely to help deliver the government’s objectives  (e.g. keeping jobs, taxable profits, or even emissions in the country). This is different from the current and widespread practices of compensating the firms with the highest propensity to relocate per se, or granting compensation in direct proportion to a firm's compliance costs in other policies. “You want to give permits to the firms to whom it will make the biggest difference,” explains Dr Muûls.

The team reached their conclusions through a theoretical model that they apply to the EU ETS after interviewing managers of 761 manufacturing firms across six countries, and combining this with economic performance data and official ETS carbon emissions data.

The Erik Kempe Award in Environmental and Resource Economics is awarded every other year by the  European Association of Environmental and Resource Economists (EAERE). It recognises the best paper in the field of environmental and resource economics, published in a refereed journal by an author affiliated to a European research institution.

“It’s very exciting,” says Dr Muûls. “The award will give our research greater recognition and therefore a greater impact.”

The paper has already attracted interest from EU and UK policymakers, and the researchers hope its influence will extend further afield since the EU’s ETS is regarded by many as a model for similar schemes across the world.

‘Everyone’s looking at the EU,’ says Dr Muûls, “These findings can inform policy makers globally when designing emissions trading schemes.”

Announced on Friday at the 21st EAERE Annual Conference, this year’s award will be presented in October at the University of Umeå in Finland.

The research team is now focussing on assessing the impact that the ETS has had on reducing emissions.

This type of research highlights the importance of economics and business expertise in shaping climate policy, a concept which Dr Muûls hopes to pass on to the next generation of business leaders through a new Masters course. The MSc in Climate Change, Management & Finance that will start in Autumn 2016 combines economics, finance and business insights from Imperial College Business School with scientific expertise from the Grantham Institute.