Abstract
In this article, we explain why the current climate policy mix of the European Union (EU), consisting of the EU Emissions Trading System (ETS) and overlapping policies, is incoherent with respect to emission abatement and cost-effectiveness. The concept of policy coherence guides our analysis in identifying the EU ETS’ current dynamic supply adjustment mechanism, the Market Stability Reserve (MSR), to be at the heart of the shortcomings of current market design. Incoherence emerges due to the MSR’s quantity-based indicator for scarcity. It only works well for current and past demand fluctuations, but not for anticipated changes in demand, e.g., caused by a member state’s fossil-fuel phase-out. As a result, instead of fostering synergies as intended, the MSR undermines coherence by creating backfiring interactions and making precise predictions of overlapping policies’ impacts close to impossible. Considering the European Commission’s reform proposal of July 2021, we argue that a change in the MSR’s parametrisation leaves the fundamental cause of incoherence unaddressed. Based on recent findings in the economics literature, we propose introducing a price-based indicator for scarcity as a solution to substantially reduce the current incoherence of the policy mix.
Highlights
Following the United Nations Conference on Environ‐ ment and Development in Rio de Janeiro in 1992 and the Kyoto Protocol of 1997, the need arose for the European Union (EU) to create a policy infrastructure to achieve its greenhouse gas (GHG) abatement targets
It is important to note the dual role of the EU Emissions Trading System (ETS): As an instrument for putting a price on carbon and regulating emissions, it is an element of the policy mix in its own right
We investigate the current design of the European Union Emissions Trading System (EU ETS) with the Market Stability Reserve (MSR) and how the latter impacts the coherence of the EU’s climate policy mix within the ETS sectors
Summary
Following the United Nations Conference on Environ‐ ment and Development in Rio de Janeiro in 1992 and the Kyoto Protocol of 1997, the need arose for the European Union (EU) to create a policy infrastructure to achieve its greenhouse gas (GHG) abatement targets. It is important to note the dual role of the EU ETS: As an instrument for putting a price on carbon and regulating emissions, it is an element of the policy mix in its own right It connects all market participants by the shared cap, which implies that any other climate policy affecting any regulated partici‐ pant changes the availability of allowances for all others as well. As other policies continued to target emission reductions, the waterbed has been perceived as an obstacle rather than a facilita‐ tor of coherence because it prevented said climate poli‐ cies from reducing total emissions To address this perceived downside, the EU ETS has been complemented by a dynamic supply adjustment mechanism, the Market Stability Reserve (MSR). By focusing on the concept of policy coherence, we offer a new perspec‐ tive towards the current EU climate policy infrastructure and make the key findings of the past three years of eco‐ nomic research on this matter accessible
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