How Does the European Union’s Carbon Market Impact Firm Productivity?

2023-02-14T00:00:00+01:00

The European Union Emissions Trading System (EU ETS) was introduced in 2005 to reduce greenhouse gas (GHG) emissions from the electricity and heat generation sectors, energy-intensive industry sectors (e.g. refineries, metals, cement, chemicals, glass, polymers, paper, cardboard) and intra-EU commercial aviation. It lowers GHG emissions in a cost-effective manner, without favouring a particular technology. Installations regulated by the EU ETS are required to obtain allowances (either purchased on the market or allocated for free) that match their actual emissions, incentivising them to invest in decarbonising their production processes.

Our paper seeks to examine the effect of the EU ETS on the productivity of firms regulated by the system. In the short term, it is reasonable to expect a negative effect, with the carbon price signal increasing costs, particularly for the production of emissions-intensive goods. However, the EU ETS also changes firms’ investment plans by encouraging investment in low-carbon technologies. In the medium- to long-term, emissions costs can thus ultimately be reduced and firms’ performance improved.

The empirical literature on the subject offers inconclusive results which vary depending on the phases examined (e.g. the pilot phase of the EU ETS, which was relatively unrestrictive in terms of the price of the allowances compared with the most recent, more ambitious phase, see Chart to the right) and from country to country. An examination of manufacturing firms in France, Italy and Spain shows that the EU ETS was not detrimental (insignificant aggregate effect) to average productivity over the 2005 to 2017 period.

Nevertheless, the system’s effects are heterogeneous. Among the EU ETS-regulated firms we examined, its effects on productivity were more positive overall for firms close to the technology frontier or financially unconstrained firms, i.e. those best positioned to invest in decarbonisation.

European Union's Emissions Trading System and Productivity: Firm-Level Evidence for France, Italy and Spain

2022-09-21T00:00:00+02:00

The Working Paper series presents work carried out within DG Treasury, disseminated with the aim of enlightening and stimulating public debate. The authors are solely responsible for their work.

The European Union Emissions Trading System (EU ETS) was introduced in 2005 in order to incentivize a reduction in carbon emissions in industrial firms in the most efficient way. Despite a low carbon price during the initial phases of the scheme, the EU ETS did foster a reduction in industrial emissions. A key question, though, is whether these reductions came together with lower productivity, as the scheme has constrained production processes. We study the effect of the EU ETS on total factor productivity (TFP) for manufacturing firms in France, Italy and Spain, from 2000 to 2017. The EU ETS is here considered as a quasi-natural experiment and we apply a difference-in-difference framework. We study whether firms reacted differently depending on their initial efficiency, size, financial constraints, sector, and country; or across the different phases of the implementation. The results suggest that the instrument overall was not detrimental to firms' productivity, except for smaller firms, firms initially far from the technological frontier, and financially-constrained ones. The reform had a positive impact on TFP for larger firms and more efficient or less financially-constrained ones. The impact of the EU ETS is found to be very heterogeneous across sectors, the major beneficiaries being the food, chemicals and metallurgy industries. It is also more positive in France than in Italy and Spain.

Trésor-Info - Publications de la direction générale du Trésor - Difference-in-differences-method

How Does the European Union’s Carbon Market Impact Firm Productivity?

European Union's Emissions Trading System and Productivity: Firm-Level Evidence for France, Italy and Spain