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Externalities and Climate Policy: The European Union Emissions Trading System (EU ETS)
Externalities are the costs and benefits of economic activity that influence people who are not directly involved. Such externalities can be a controversial issue in climate policy because pollution and carbon emissions affect more people than the consumers and producers of goods. When a crop perishes due to climate change or health problems that are related to emissions, it affects all of us.
So, the European Union has sought to implement a climate policy that alleviates those negative externalities. It's called the European Union Emissions Trading System (EU ETS).
The EU Emissions Trading System, also known as the EU ETS, has been highlighted as a front-runner. During the 2005 and 2021 sessions, greenhouse gas emissions in the EU, as one can see in the table below, fell 47 percent, according to Europa.eu, 2023 stats. Their goal to cut down on the amount of carbon dioxide produced looks like it will be attained in several years. How have such overshadowing emission reductions been possible?
Let's look at how the policy works and how it compares to other options.
How the EU ETS Works
The EU ETS is a system aimed at reducing greenhouse gas emissions in the EU member states. It is also applied in Lichtenstein, Norway, and Iceland. The main goal of the EU ETS is to have fewer emissions from Power plants, Industrial plants, large ships, and airlines.
It is similar to a cap-and-trade setup. Each year, the cap is set for the emissions produced in the operations of a company. If they surpass the cap, they would have to pay fines. The best is reduced annually to ensure the gradual process of achieving emission reduction is implemented in the EU countries.
This system's favorable feature is that emission allowances can be vented and interchanged with businesses all over the place. As a result, businesses planning to use the allowance can sell it to the company they are dealing with if they do not use the allowance.
The Negative Externalities the EU ETS is Helping Reduce
Carbon emissions have undue negative impacts on climate change and health. This includes the following:
1- Global warming is making strong progress: Numerous studies are showing that carbon dioxide (CO2) released due to the burning of carbon-based fuels is quite significant for climate change. NASA says 50% of world human-generated CO2 emissions occurred over the last 200 years. On the contrary, climatic conditions could lead to causes things such as altered climate patterns, disrupted ecosystems, and high tides.
2- Health risks: Carbon emissions are closely associated with a number of health problems. The United States Environmental Protection Agency states that air pollution associated with carbon emissions increases the chance of heart and lung diseases.
3- Economic costs: The impacts of these alterations can generate different kinds of economic costs. For example, floods due to abnormal weather conditions might spoil crops and public infrastructure and result in the loss of tourists.
Although pollution-creating production processes are a necessity for manufacturing, the consequences are massive. This is the reason why regulations like the EU Emissions Trading Scheme (ETS) encourage the deployment of more environmentally friendly manufacturing and also lead to the reduction of pollution, which is advantageous to all the stakeholders involved.
Economic Impact on Industries
The EU ETS seems to help some, but it also hurts others in different sectors. The changes produced are both good and bad. Perfectness is not the feature of any invention, even of the complex systems functioning within the EU. Therefore, it is necessary to analyze and compare the different aspects that the system can bring to the surface.
The Constructive Outcomes
The EU ETS, similar to most regulations, has been a mixed blessing to varied industries. Existence does not suffice to enjoy happiness; thus, it is a must to comprehend as well as to give account to the entire spectrum of events it may bring. The positive effects come from certain industries that profit from the EU ETS. Most noticeable are those companies working on the development of innovative green energy production strategies for their clients.
In addition, some initial data points out that companies that sell their emission reductions can make more profits. But, when allowances are left, the profits of the companies will decrease.
Lastly, companies that switch to green energy that is both energy and cost-efficient may be able to diminish their operational costs, which in the long term will eventually give them the opportunity to experience an increase in their profits.
The Negative Effects
Some sectors have met challenges related to the EU ETS. The policy was aimed at quite a few power-intensive industries, such as airlines, large ships, and industrial & power plants. Currently, these industries have to put a lot of effort into becoming environmentally friendly through the costs of investing in new technologies and paying fines if they surpass the emission caps. Notwithstanding the implementation of the EU ETS, research which was published in the Journal of Environmental Economics and Management. This announced that no significant effects had been experienced on the profits or employment of the affected industries.
As per the findings of the research, this is mostly the case due to the cooperation of the companies with the emissions caps, which guided the companies to take small steps to change their production methods gradually rather than all at once. For this reason, the plan is seemingly working out as expected.
How the EU ETS Compares to Other Options
Now, you may still wonder if any alternative climate policies to the EU ETS exist. A couple of others have been discussed or used, so let's look at how they compare.
Carbon Taxes
Carbon taxes are a price that is specifically set, which emitters have to pay for each ton of greenhouse gas their operations emit. This policy has been implemented in Canada, certain European Countries, South Africa, and some U.S cities.
Some of the early US studies on carbon taxation in different sectors demonstrate that it has helped, to some extent, in reducing greenhouse gas emissions. The effects are, however, far less promising than those of the EU ETS.
The downside of this project is that it does not contain any emission limit sections. Thus, the factories that pollute the environment are not allocated a concrete number of tons of CO2 gases they are allowed to release, which is the basic concept of the system of emissions trading and emissions reduction, not just the tax exemption costs.
Command and Control Regulations
The command-and-control procedure is based on the fact that the organization that represents the government forces the firms to comply with the amount of greenhouse gases they can emit in a certain period. One of the most useful methods of a system like this is that it limits carbon usage during the production process through the fact that it is carved in stone on a legal basis.
Yet, on the other hand, it has the potential to be very restrictive. If the main sector is too hardly hit by the limit that they cannot comply with in the beginning, the necessary adjustment can lead to a reduction in production, and the economic condition can worsen. Thus, a cost and cap system like the one in the EU ETS, which is flexible, would appear to be the most suitable one for most industries to comply with.
Conclusion
Issues such as environmental change and health risks due to greenhouse gas emissions are part of the circumstances that should be taken into account in climate policy for the well-being of the people. And that is why the results of the EU ETS are so important. It is a method, which is a combination of a cap-and-trade plan and a carbon tax, that is based on the market approach to the policy change. Thus, the new policy will be seamlessly adopted and managed with the support of the people.
It's a very engaging story that should be a lookout for us to see how it affects its own continent in the future. In the event that the plan is successful on a continuous basis, we might expect that its adoption will be seen in other areas where greener operations exist.
