The European Commission plans to tighten the greenhouse gas emissions targets in the Emissions Trading System. Ralf Martin and colleagues examine the likely impact on affected businesses, and conclude that industry is exploiting concerns about competitiveness to obtain free emission permits according to criteria that are too lax.industry, R&D, carbon policy, carbon trading

Mirabelle Muûls

Ralf Martin

Ulrich J. Wagner

English

Research Papers in Economics

CentrePiece Summer 2010
T
he European Commission is
currently finalising the design
of the third trading phase of
the European Union’s (EU)
Emissions Trading System (ETS), which will
begin in January 2013 and last until 2020.
A key concern will be any potentially
negative effects on the competitiveness 
of affected businesses. But the
Commission’s stated objective is to
increase the share of emission permits that
are auctioned rather than allocated for
free to ‘vulnerable’ industries.
Without doubt, increasing the amount
of auctioned permits would improve 
the system’s fairness. The current practice
of allocating free permits on the basis of
past emissions effectively rewards
businesses that have been lagging behind
in reducing emissions.
Auctioning permits also provides
additional revenue for governments to pay
for research and development (R&D) and
infrastructure investments required for the
transition to a low-carbon economy. The
auction revenue could further be used to
compensate people on low incomes in the
event that carbon pricing has regressive
distributional effects or simply to help
balance strained government budgets. 
The European Commission plans to tighten the
greenhouse gas emissions targets in the Emissions
Trading System. Ralf Martin and colleagues examine
the likely impact on affected businesses, and conclude
that industry is exploiting concerns about
competitiveness to obtain free emission permits
according to criteria that are too lax.
Europe’s emissions
trading scheme:
taxpayers versus the industry lobbyCentrePiece Summer 2010
11
Where the Emission Trading
System is going wrong
The proposed design of the third phase of
the ETS includes criteria to determine
which industrial sectors should continue to
receive free permits. Under these criteria,
147 sectors – more than half of the 
258 manufacturing sectors under
consideration – will be eligible for free
permits, despite the fact that not all of
these sectors include firms that are
regulated by the ETS.
This follows pressure from industry
groups claiming that more stringent carbon
pricing will provoke job losses and cause
carbon-intensive production to relocate
outside the EU – a process referred to as
‘carbon leakage’. 
Our research asks whether the
proposed criteria for exemption from
auctioning are appropriate. Do they
capture the risk of downsizing or plant
closure? And what are the implications in
terms of job losses, carbon leakage and
emissions?
Our analysis is based on data from
almost 800 interviews with managers in
manufacturing plants – both members and
non-members of the ETS – in six EU
countries (Belgium, France, Germany,
Hungary, Poland and the UK).
Each firm is rated on a scale from 1 to
5 as to the likelihood and degree of
downsizing in response to future climate
policy, with a score of 1 corresponding to
no expected response and a score of 5
indicating a high likelihood that the firm
will close down or relocate. The results of
the analysis are as follows:
First, a complete relocation in response
to carbon pricing is highly unlikely.
Among the principal manufacturing
industries we sampled, none of the
‘average’ firms are at risk of relocation or
closure (see Figure 1). There is only one
sector (Other Minerals) out of 14 where
the average score is slightly above 3,
implying downsizing by at least 10% of
employment or output. In no case does the
95% confidence band include the
maximum score of 5 (closure). 
5
4
3
2
1
- 101234
Notes: Each three-digit industry is represented by one green and one red
point.The horizontal axis measures for red points normalised carbon
intensity (VaS) and for green points normalised trade intensity (TI).The
vertical axis measures the downsizing risk score derived from the interviews
with managers.The two lines represent the fitted values for each set of points.
Figure 2:
Correlation between downsizing risk and intensity measures 
D
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Fitted values
Trade intensity
Fitted values
Downsizing of 10%
Closure or relocation
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No impact
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Notes: The bars show the sector-level average score measuring the risk of
downsizing as a consequence of climate policy.The lines represent the
confidence bands, calculated at the 95% level.
Figure 1:
Average risk of downsizing due to more stringent 
carbon policy’ 
The Emissions Trading
System is accommodating
the interests of the
industry lobby too
generously at the expense
of European taxpayersCentrePiece Summer 2010
12
Second, the Commission’s 
assessment criteria are flawed. 
The Commission bases its assessment of
sectors at risk of carbon leakage on two
statistics – the carbon intensity (which is
measured as the amount of carbon a
sector emits divided by its value added;
what is usually referred to as Value at
Stake, VaS); and the trade intensity (TI),
which the Commission defines as the
value of imports and exports to non-EU
countries over the total market size of the
sector within the EU.
We examine how well these statistics
capture downsizing risk by correlating
them with our score. Plotting sectoral
carbon and trade intensities against
downsizing risk scores reveals that carbon
intensity is strongly correlated with
downsizing risk, but trade intensity is not
(see Figure 2).
Using the trade intensity criterion to
determine which sectors should be exempt
from auctioning is therefore likely to result
in exemptions for firms that are not at all
at risk of downsizing or carbon leakage.
Free permit allocation in this instance is
simply a transfer of taxpayers’ money to
industry without any additional social
benefit – this money should be reclaimed.
Third, up to 88% of manufacturing 
sector emissions are exempt from
regulation under the proposed
thresholds for the ETS. 
The thresholds proposed by the
Commission implicitly define three groups
of exempted sectors, depicted as the
rectangles A, B and C in Figure 3.
Strikingly, group B contains a particularly
heterogeneous group of industries. 
80
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0 2 04 06 08 0 1 0 0
Figure 3:
Value at stake and trade intensity of sectors 
in the interview sample   
V
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Notes: The figure plots the position of the sectors included in our interview sample in
terms of the two criteria proposed for exempting sectors from auctioning of permits.
The size of the circles is proportional to the number of firms in a given four-digit
industry (NACE 1.1 classification). The rectangles A, B and C represent the three sets
of eligible sectors defined by the Commission’s thresholds for the two criteria. The
solid lines show mean trade and carbon intensities, and the dotted lines represent the
respective employment-weighted means.
Trade intensity
Downsizing of 10%
Closure or relocation
Some impact
No impact
N
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Figure 4:
Impact measures across ‘at risk’ groups 
Notes: The bars represent, for each set of firms as described on the horizontal axis,
the average score measuring the risk of downsizing as a consequence of climate
policy. The lines represent the confidence bands, calculated at the 95% level.
Most industry sectors
entitled to free emission
permits would not close
or relocate outside of
the EU if they had to
pay for permitsCentrePiece Summer 2010
13
There are a large number of industries
with very low carbon intensity as well as a
few sectors with moderate carbon
intensity. We thus further subdivide this
group by carbon intensity and analyse the
following four subgroups:
  Group A with carbon intensity (VaS)
greater than 30%.
  Group B with moderate carbon
intensity, depicted as Group B & VaS>5%.
This group has trade intensity (TI) greater
than 30% and carbon intensity between
5% and 30%.
  Group B with high trade intensity
(>30%) but low carbon intensity (<5%),
depicted by Group B & VaS<5%. 
  Group C with moderate trade and
carbon intensity (5%<VaS<30% and
10%<TI<30%).
Figure 4 plots the average downsizing risk
and associated 95% confidence bands for
these groups. Only carbon-intensive firms
(Group A) and the more carbon-intensive
among the trade-intensive firms (Group B
& VaS>5%) are at high risk of outsourcing
a significant part of their production – 
but even then the downsizing is only
around 10%.
How to save €7 billion 
If the Commission’s exemption criteria
were to exclude only these two groups 
(A and B & VaS>5%) from permit
auctioning, the amount of permits
auctioned would increase considerably
without aggravating the overall risk of job
losses and carbon leakage. 
This could be achieved by modifying
the thresholds for the third phase of EU
emissions trading as follows. Only sectors
with a carbon intensity higher than 30%
or sectors with both trade intensity greater
than 10% and carbon intensity of more
than 5% should be granted an exemption.
This modification would revoke the
exemptions currently envisaged for Groups
C and B & VaS<5%. By a conservative
estimate, this would provide additional
revenue for European governments of at
least €7 billion annually.
Changing criteria moving
forward
We find no evidence that the trade
intensity criterion reliably measures the risk
of downsizing or closure across sectors.
The Commission should therefore replace
this criterion in the longer run with one
that more accurately reflects a sector’s
vulnerability to carbon leakage.
The trade intensity measure potentially
misses an important aspect that
determines vulnerability – namely
‘locational specificity’. The more strongly a
firm benefits from factors that are specific
to the EU – such as the skill set of the
workforce, agglomeration economies, the
stability of institutions, etc. – the less likely
it is to shift production abroad in response
to EU climate change policy. Nevertheless,
more research into the measurement of
locational specificity is needed before this
concept can be implemented. 
Conclusion 
Despite many design improvements, there
is a concern that even in the third phase
of the ETS, the Commission is
accommodating the interests of the
industry lobby too generously – at the
expense of European taxpayers. 
But there is still a window of
opportunity for European governments to
improve the design of the ETS while
raising additional income of €7 billion
annually. 
Rather than providing an unspecific
subsidy for industry, this money could be
earmarked to finance investments and
R&D crucial for the transition to a low-
carbon economy. It could equally be used
to mitigate the possibly regressive effects
of higher carbon prices on low-income
groups. Finally, it could help to balance
strained government budgets in the wake
of the financial crisis.
Further reading
Barry Anderson, Jörg Leib, Ralf Martin, Marty
McGuigan, Mirabelle Muûls, Laure de Preux
and Ulrich Wagner (2010) ’Climate Change
Policy and Business in Europe — Evidence
from Interviewing Managers’, forthcoming
CEP Discussion Paper.
Removing the exemptions in 
the Emissions Trading System
would raise €7 billion annually
This article summarises ‘Still Time to Reclaim
the European Union Emissions Trading
System for the Taxpayer’, a CEP policy
briefing by Ralf Martin, Mirabelle Muûls and
Ulrich Wagner (http://cep.lse.ac.uk/pubs/
download/pa010.pdf).
Ralf Martin is a research economist at CEP .
Mirabelle Muûls is a research associate in
CEP’s globalisation programme and at the
Grantham Institute for Climate Change at
Imperial College London. Ulrich Wagner is at
Universidad Carlos III de Madrid and is a
research associate in CEP’s productivity and
innovation programme.

Europe's emissions trading scheme: taxpayers versus sthe industry lobby

http://cep.lse.ac.uk/pubs/download/cp311.pdf

Europe's emissions trading scheme: taxpayers versus sthe industry lobby

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