Why the effectiveness of ETSs on green innovation differs? The perspective from price stabilization mechanisms

Essential policy elements could affect the effectiveness of an ETS. A research team from the School of Economics at Huazhong University of Science and Technology and the Business School at Zhengzhou University finds that PSMs, which aim to support carbon price increases and maintain price stability, significantly affect the effectiveness of emissions trading systems in encouraging green innovation among covered firms. Only an ETS applying both the price-based (price limits) and quantity-based (updating cap) PSM, indicating a more complete policy design, would have a significant effect in inducing green innovation. PSMs help to do so by lifting certain levels of carbon prices and reducing the perceived uncertainties of covered firms. Firm-level features may yield heterogeneous effects. The impacts are stronger on firms with a lower rate of cost passthrough, a lower rate of asset reversibility, a higher ability of innovation, and state-owned enterprises.

The team published their review in Energy and Climate Management on October 30, 2025.

“Well-designed emissions trading schemes are expected to induce green innovation of covered entities. However, the empirical evidence has no consensus on such an effect. The effectiveness of ETSs largely relies on their institutional design. In this paper, we argue that whether ETSs have proper PSMs is crucial in determining their effectiveness on green innovation,” said Wenbo Zhu, corresponding author of the paper and associate researcher in the Business School at Zhengzhou University.

The team uses a sample of listed firms that belonged to sectors covered by China’s carbon market pilots and were located in both pilot and non-pilot regions, including the years before and after the pilots were launched (2010–19). They employed a staggered difference-in-differences (DID) approach to identify the effect of pilots that adopted specific PSMs on firms’ green patent applications.

The results have general policy implications. First, it is essential to introduce PSMs in ETS policy designs, especially when policymakers expect policy tools to encourage not only abatement but also green innovation. Second, a more complete design of PSMs could be more effective. A combination of price-based and quantity-based measures could play a positive role, while an application of a single type of PSM would be beneficial to certain firms, i.e., ones with a higher ability of innovation.

Other contributors include Banban Wang, associate professor in the School of Economics at Huazhong University of Science and Technology, and Deyong Song, professor in the School of Economics at Huazhong University of Science and Technology.

This work was supported by the General Project of National Natural Science Foundation of China (No. 72273047), National Social Science Fund of China (No.24&ZD103), Youth Project of National Natural Science Foundation of China (No. 72403228), Youth Project of Ministry of Education Humanities and Social Sciences Research of China (No.24YJC790251), and Huazhong University of Science and Technology Double First-Class Funds for Humanities and Social Sciences (2025ZKJD25).