Carbon Markets Work – But Not As Effectively Everywhere

Why It Matters
As more countries roll out emissions trading systems (ETS), it is tempting to assume that these carbon markets will deliver deep cuts in emissions. This research shows a more complex picture: ETS outcomes vary widely across the world. Without understanding such variation, policymakers may be prone to overestimating how quickly carbon markets can deliver decarbonisation on a global scale.

Key Takeaways

• After an ETS is rolled out, emissions drop significantly only after several years, and not uniformly across regions.
• Economic structure matters; particularly, country dependence on rents from natural resources presents a barrier.
• Market design, complementary policies and political commitment all play a role in shaping the extent to which an ETS drives decarbonisation.
  

A Growing Global Patchwork

Emissions trading systems are now a central part of the global climate policy toolkit. Dozens of national and regional ETSs are in place, and more are under discussion. But they do not all look alike. Despite their popularity, countries have adopted ETSs at different speeds and in different ways.

The researchers track the timing, scope and stringency of ETS rollout across countries from 2005 to 2022. They find substantial global heterogeneity. Some regions implemented carbon markets rapidly with wide geographic and sectoral coverage, while others introduced them gradually or in limited form. These rollout paths matter: countries that adopted ETSs nationwide achieved larger emissions reductions, while those that adopted partially did not witness substantial emissions reductions.

Why Timing and Design Matter

A key finding is that emissions reductions do not occur immediately after a carbon market launches. Most ETSs display a multi-year lag before substantive decarbonisation begins. The researchers identify three reasons for this delay.

First, firms take time to adjust investment plans and abatement strategies. The first years often involve compliance learning rather than genuine emissions cuts. Second, permit prices tend to start low as markets stabilise, providing weaker early incentives. Third, regulatory adjustments in the initial years, such as tightening caps or improving monitoring systems, significantly influence long-term effectiveness.

Importantly, the study shows that the design of an ETS matters as much as the timing. Systems with broader sectoral coverage, stronger caps and well-defined enforcement mechanisms are far more likely to deliver sustained emissions reductions. Where ETS design is weak or politically constrained, early gains remain modest, even after the market has matured.

Where are ETSs more Impactful?

The research uncovers large differences in decarbonisation outcomes across regions. The European Union’s ETS, the world’s largest, shows strong and consistent emissions reductions after its major reforms. In contrast, several smaller or newer systems display slow progress, especially where allowance prices remain low or where firms receive generous free allocations.

Political commitment is a critical factor. Countries that treat ETSs as core climate policy tools introduce stronger annual tightening of emissions caps and maintain more stable regulatory environments. Those that treat ETSs more symbolically, often to signal climate ambition, tend to implement weaker rules, leading to smaller or delayed emissions reductions.

Moreover, ETSs paired with renewable energy incentives or energy efficiency schemes could produce faster decarbonisation than ETSs operating alone.

Overall, carbon markets are likely to be most effective when they are part of a broader and coordinated climate policy portfolio.

Lessons for firms engaging with carbon markets

Expect carbon prices to rise over time.
Because most ETSs tighten their emissions caps slowly but steadily, firms should expect rising carbon costs. Early compliance planning, low-carbon investment and efficiency improvements will deliver growing competitive advantages.

Monitor policy shifts.
The study shows differences across countries in ETS effectiveness are driven in part by design choices and broader political economy. Companies should monitor regulatory reforms closely, as changes to cap trajectories, free allocations or offset rules can significantly affect compliance costs.

Move early.
Given the multi-year adjustment period identified in the research, companies that act early could face smoother transitions and lower long-run costs. Those that delay abatement until carbon prices spike risk operational disruptions and expensive last-minute compliance investments.

 

Authors & Sources

Authors: Arzi Adbi (National University of Singapore), Sumit Agarwal (National University of Singapore), Siddharth Natarajan (Nanyang Technological University)
Original article: Energy Economics

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