Does Pricing Carbon Mitigate Climate Change? Firm-Level Evidence from the European Union Emissions Trading System

Can carbon markets cut emissions without harming industry?

Jonathan Colmer, Ralf Martin, Mirabelle Muûls, and Ulrich J. Wagner study the environmental and economic effects of the European Union Emissions Trading System in their paper "Does Pricing Carbon Mitigate Climate Change? Firm-Level Evidence from the European Union Emissions Trading System".

They rely on administrative firm-level data on French manufacturing emissions, energy use, financial accounts, trade flows, and pollution-control investments from 1996 to 2012 to compare regulated firms with similar unregulated firms.

Their main conclusions include:

• Regulated firms cut carbon dioxide emissions by 14% during phase I of the EU ETS and by 16% during phase II, with no detectable contraction in employment, value added, or output.
• Aggregated up, the policy reduced French industrial emissions by roughly 5.4 million tonnes per year, accounting for between 28% and 47% of the 2005-2012 industrial emissions decline.
• Carbon leakage appears negligible, since regulated firms did not significantly increase imports, shift toward purchased electricity, or change the fuel mix of their direct emissions.
• Regulated firms increased capital investment by 8% to 11% and roughly doubled their environmental investments, to upgrade their production processes rather than buy allowances or ration output.
• The authors model these results as fixed-cost adoption of cleaner production technologies that simultaneously lower emissions intensity and marginal variable costs.
• Using the highest phase II permit price of around 53 dollars per tonne as a ceiling, the EU ETS ranks among the most cost-effective climate policies, well below most renewable subsidy schemes.

This paper shows a credible carbon price can deliver real abatement without the competitiveness losses that have historically slowed political adoption, with total factor productivity even moving weakly upward rather than downward under regulation.

The case for granting free allowances to industries deemed at risk of leakage looks weaker than at the launch of the EU ETS.

These results also reframe the long-running debate about carbon leakage that has shaped both the Carbon Border Adjustment Mechanism and the allocation rules under phase IV of the EU ETS.

The analysis however only covers French manufacturing in phases I and II, when permit prices were low and free allocation was the rule for most industrial organisations.