Reviewing the evidence on the innovation impact of the EU Emission Trading System

Abstract

The Paris Climate Agreement calls for decarbonization of the economy in the second half of this century. This requires a radical redirection and acceleration of technological change towards low- and particularly zero-carbon solutions. Global carbon pricing is seen as a key enabler for such decarbonization, with the European Union’s Emission Trading System (EU ETS) serving as an important pillar. This chapter reviews the evidence on the innovation impact of the EU ETS. The review shows a very limited effect of the scheme on technological innovation, but there are clear signs of it having stimulated organizational innovation, with the impact being more pronounced for the electricity sector than for industry. The initially high expectations of the EU ETS regarding technological innovation largely dissipated once the scheme’s lack of stringency became apparent and prices collapsed accordingly. Also, for many of the rather incremental innovations that have taken place, the EU ETS was shown to be only one contributing factor among others, with the broader policy mix and long-term targets playing a particularly pivotal role in stimulating innovation. In contrast, there is clear evidence that the EU ETS has been a key driver of various organizational innovations, including making climate change a top management issue. However, so far, these organizational innovations have only had limited effects on shifting corporate strategies towards low-carbon solutions because of low carbon prices, the relatively high share of free allocations in industry, and more pressing business concerns. Despite this, the scheme’s positive impact on organizational innovations should not be underestimated, as these constitute a necessary precondition for future technological innovations. The findings suggest that the Commission’s proposal for the fourth trading period of the EU ETS points in the right direction, but further efforts will be needed to significantly increase the scarcity of EU allowances and the share of auctioning in order to fully unleash the scheme’s transformative power. If the identified shortcomings are not addressed, the EU ETS cannot play its intended role in guiding the decarbonization of the European economy, for which innovations in low-carbon solutions are a fundamental requirement.