Key aspects of policy design are crucial to determining whether an emissions trading system can effectively stimulate green innovation. A recent study by researchers from the School of Economics at Huazhong University of Science and Technology and the Business School at Zhengzhou University shows that price stabilisation mechanisms are central to this process. These mechanisms, which are intended to support rising carbon prices while limiting excessive volatility, significantly influence whether emissions trading systems succeed in encouraging innovation among regulated firms. The findings suggest that carbon markets do not automatically generate innovation; rather, their effectiveness depends heavily on how they are institutionally designed.

The study finds that only emissions trading systems that combine both price-based and quantity-based price stabilisation mechanisms have a statistically significant effect on firms’ green innovation. Price-based tools, such as price floors or ceilings, work together with quantity-based measures, such as adjustments to the emissions cap, to form a more complete and credible policy framework. Systems that rely on a single stabilisation mechanism tend to be less effective, suggesting that partial designs fail to provide sufficiently strong or reliable incentives for innovation. In contrast, a comprehensive combination of mechanisms creates clearer signals and a more predictable environment for long-term investment in green technologies.

According to the authors, price stabilisation mechanisms promote innovation through two main channels. First, they help sustain carbon prices at levels high enough to make investing in low-carbon technologies economically attractive. Second, they reduce uncertainty about future carbon prices, which firms often view as a significant risk when making costly, potentially irreversible innovation decisions. By limiting price volatility and improving policy predictability, these mechanisms increase firms’ confidence that investments in green innovation will generate returns over time.

The effects of price stabilisation mechanisms are not uniform across firms, however. The study identifies significant heterogeneity linked to firm-level characteristics. Firms with a lower ability to pass compliance costs on to consumers respond more strongly, as they face greater incentives to reduce emissions through innovation rather than pricing strategies. Similarly, firms with less reversible assets show stronger responses, since stable carbon pricing reduces the risks associated with long-term capital commitments. The innovation effects are also more pronounced among firms with stronger existing innovation capabilities and among state-owned enterprises, which may be better aligned with long-term policy objectives or have greater access to resources.

The research, published in Energy and Climate Management on 30 October 2025, uses data on listed firms in sectors covered by China’s carbon market pilots between 2010 and 2019. By comparing firms in pilot and non-pilot regions before and after the schemes were introduced, and applying a staggered difference-in-differences approach, the authors identify the causal impact of different stabilisation designs on green patent applications. Overall, the findings underline the importance of embedding well-designed price stabilisation mechanisms within emissions trading systems, primarily when policymakers aim not only to reduce emissions but also to foster sustained green innovation.

More information: Banban Wang et al, Why the effectiveness of ETSs on green innovation differs? The perspective from price stabilization mechanisms, Energy and Climate Management. DOI: 10.26599/ECM.2025.9400020

Journal information: Energy and Climate Management Provided by Tsinghua University Press