Market-based climate policies such as cap-and-trade aim to reduce carbon emissions while minimizing economic distortions. In the case of the European carbon market, i.e. the EU Emissions Trading System (EU ETS), several studies have confirmed its impact on reducing the aggregate emissions of affected entities (most recently, Colmer et al. (2024), Dechezleprêtre et al. (2023) ), while maintaining firm competitiveness (e.g. Joltreau & Sommerfeld (2019)). Clear as the EU ETS’s impact on carbon emissions may be, its implications for industry dynamics remain largely unexplored, even though they are central to European competitiveness policy (see Draghi Report (2024)).
Indeed, in settings that allow for creative destruction of producers, reductions in aggregate emissions do not necessarily mean “cleaning-up” of incumbent producers, but may also reflect changes in market composition. Intuitively, these changes may involve dirtier plants exiting, cleaner plants entering, multi-plant firms reallocating activity internally, or even production shifting across borders (e.g. Stilger (2025)). Understanding how these margins drive decarbonization is central to both welfare and policy design. Yet, it might be difficult to detect these patterns in empirical designs that focus on balanced panels of surviving regulated firms, or on simple comparisons between regulated and unregulated producers. If emissions fall mainly because the dirtiest units exit or because production is reshuffled within firms or across countries, the distributional, regional, and political economy consequences of climate policy look very different from a world in which all incumbents gradually adopt cleaner technologies.
To cut or to quit?
Marchioro (2025) asks whether the observed reduction in emissions under the EU ETS is due to a general emission decline across all plants, or whether it is primarily driven by a compositional effect of the surviving sample. The paper exploits variation generated by the 2013 reform of the EU ETS on free permit allocation rules, which in the case of France replaced the former national emission-based allocation system with harmonized EU-wide benchmark rules, thus linking free permit allocation to emission-intensity benchmarks rather than to plants’ historical emissions. Within a sample of incumbent French manufacturing plants covered by the EU ETS, treatment and control groups are defined based on relative allocation stringency, measured by the reduction in free permit allocations relative to peers producing within the same ETS activity. Using a difference-in-differences approach, the paper shows that ETS-covered plants subject to stricter permit cuts reduced emissions more than their activity peers, and that plants began adjusting their emissions levels right after the policy announcement. However, at least one third of these overall emission reductions are attributed to plant exits, implying that selection effects played a non-negligible role in shaping aggregate outcomes. A survival analysis confirms that plants facing higher relative cuts in free carbon permits, due to their inefficient baseline emission intensity, were more likely to exit the scheme and shut down operations. Finally, when decomposing the free permit allocation changes into a level component, capturing initial permit overallocation, and a relative efficiency component, capturing the plant’s distance from the newly-introduced EU product benchmarks, the latter is the main predictor of plant exits from the scheme and full shutdowns. Most of these exiting plants correspond to fuel generation units operating within the premises of industrial producers, which, at least in France, correspond to the low-hanging fruit of industrial decarbonization.
Reallocation inside firms
A natural next question is what happens inside multi-plant and multi-product companies. Studying European firms that experience a sharp withdrawal of free allowances, Alder, Franzmeyer, and Hattemer (2025) document declines in emissions accompanied by contractions in revenue, employment, and assets. They interpret these patterns as adjustment along an extensive margin within the firm, such as the closure of less productive product lines or business segments. Again in the context of heterogeneous multi-plant firms, Barrows et al. (2025) propose a structural estimation method that is explicitly designed to recover policy effects when treatment of some units affects outcomes of others, both across competing firms and within firm boundaries. They apply this estimator to study French ETS vs non-ETS producers, and show that being subject to carbon regulation can lead to within-firm reallocation of activity across plants. Indeed, when some plants are more exposed to regulatory pressure than others, multi-plant firms shift production and emissions internally rather than treating each plant in isolation.
The other side of the coin
If Marchioro highlights exit as a key adjustment margin, Pacelli (2026)’s paper “Being a New Entrant or an Incumbent Matters: Emissions Abatement and the EU ETS” studies the same institutional reform and its impact on entry. Using administrative plant-level data for Italy from 2008 to 2019, the author shows that sectors experiencing reductions in free allowances attracted cleaner entrants, whereas sectors with more generous allocations saw the entry of relatively dirtier plants. Incumbent firms, by contrast, show limited technological adjustment, indicating that the reform operated primarily through changes in market composition rather than within-plant abatement. To rationalize these empirical patterns, Pacelli develops a partial equilibrium model with heterogeneous incumbents and new entrants, where free allowances act as entry subsidies that lower the effective cost of operating dirtier technologies. The model demonstrates how differences in free allocation create variation in market entry and emission intensity, while incumbents’ responses are constrained by pre-existing technologies and investment costs.
Conclusions
These studies suggest that, in real-world carbon markets, aggregate emission reductions are rarely the result of a single, smooth “representative firm” response. Instead, they highlight how the distributional design of carbon markets can influence industry structure and environmental outcomes, even in the absence of changes in price-driven regulatory stringency. This offers novel insights for both economic research and carbon policy design. Indeed, the academic debate is increasingly moving beyond asking whether carbon markets work in reducing emissions, to measuring how strongly they affect different producers within regulated sectors. In this sense, reforms to free permit allocation provide one concrete source of within-ETS variation. In light of the introduction of the Carbon Border Adjustment Mechanism (CBAM), understanding how the gradual phasing-out of free carbon permits affects European firm competitiveness and industrial dynamics is essential for evaluating not only how much emissions fall, but what kind of economy emerges on the path to decarbonization.