The EU ETS and Hard-to-abate Manufacturing Industries

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Abstract

A cornerstone of green transition policies is the EU Emission Trading Scheme (EU ETS). The policy instrument increases the costs of CO2, thereby exerting a push effect to lower emissions. We empirically study key aspects of the directed technological change literature against the backdrop of the EU ETS and hard-to-abate (HTA) manufacturing industries. These are characterised by scale intensive, continuous production processes and considerable sunk costs related to capital investments. The technologies used are determined by established trajectories that determine the knowledge base and production networks of these companies. This causes substantial path dependence and lock-in situations. The research draws on a multitude of datasets, such as EU ETS data at the plant level, firm performance and patenting information, foreign direct investments, and recipient level information of EU regional funds. The research is highly policy relevant, and addresses questions about the regional distribution of HTA industries in the EU, the breaking-up of technological path dependence, stick (EU ETS) and carrot (co-funding) mechanisms, carbon leakage, and firm performance.

Work Packages

WP1: The spatial distribution of hard-to-abate industries and aspects of the structural transformation across EU regions

The energy transition involves not only transforming current industrial frameworks but also potentially phasing out firms that rely on "dirty technologies." Consequently, the demand for workers in these sectors is expected to decrease to some degree. Recent studies in the U.S. have shown that such changes can mirror the decline of the coal industry, which had a significant, localized impact on labor markets. Therefore, this work package will initially create a "status quo and exposure map" to depict the regional distribution of industries that are difficult to transition away from and related sectors. This map will serve as the foundation for an exploratory analysis of transformation efforts and their outcomes.

WP2: Path dependence and technological change

Hard-to-abate industries are characterised by enduring technological foundations and limited alternatives for their energy-intensive production processes. This work package examines technological development and the effectiveness of policy measures in driving directed technical change. Decarbonisation technologies in hard-to-abate industries face dual externalities: knowledge externalities reduce firms' incentives to invest in technology due to the risk of imitation, while these innovations address environmental externalities. Without equitable public measures, firms that innovate may be disadvantaged, thereby reducing investment incentives. It is suggested that combining research funding with environmental regulations or taxes can create appropriate incentives and induce innovation in specific technological directions. This analysis will explore how the EU Emissions Trading System (ETS) and targeted research and development subsidies influence the technological direction of European firms in hard-to-abate industries.

WP3: Foreign direct investments and carbon leakage

Policy makers and industry representatives have expressed concerns about the potential negative impacts on the competitiveness of regulated industries under the EU Emissions Trading System (ETS). Unilateral regulations could impose significant costs on regulated firms, divert resources from production activities, and potentially shift production to areas outside the regulated zone. Such a relocation of emission-intensive production capacities might result in "carbon leakage," in accordance with the pollution haven hypothesis. Using an extensive firm-level database, matched with project-level cross-border investment information and EU ETS data, this work package systematically analyses the risk of carbon leakage from the EU ETS. Specifically, it examines cross-border investments and the relocation of European production sites outside carbon-regulated areas at the firm level. Additionally, we investigate whether the allocation of allowances influences the risk of carbon leakage.

WP4: CO2-Emissions and firm performance in the EU

The EU Emissions Trading System (ETS) aims to reduce emissions through economic incentives, inherently linking it to firm performance. This aligns with the "weak Porter hypothesis," which posits that environmental regulations spur innovation. The "strong Porter hypothesis" further suggests that such regulations can enhance firm performance (Porter & Linde, 1995). Several studies have explored the EU ETS's impact on firm performance. For example, an OECD Working Paper (Dechezleprêtre et al., 2018) found that during 2005-2012, the EU ETS significantly increased revenue and fixed assets of regulated firms, though it did not significantly affect employment or profit. This indicates higher investments, such as in carbon-saving technologies, but the effect on productivity remains unclear. Similar findings have been reported in studies focusing on individual countries. This work package uses state-of-the-art identification methods and considers both ETS and EU funding information as determinants of firm performance and behaviour.

Project Team

Dr. Klaus Friesenbichler

Principal Investigator, WIFO

Julia Bachtrögler-Unger, PhD

WIFO

Mag. Dr. Agnes Kügler, MSc.

WIFO

Dr. Birgit Meyer, MSc.

WIFO

Mag. Dr. Claudia Kettner-Marx, MSc.

WIFO

Philipp Piribauer, PhD

WIFO

Anja Sebbesen, PhD

WIFO