The Impact of the European Union Emissions Trading System on Carbon Dioxide Emissions: A Matrix Completion Analysis

Abstract

Despite the negative externalities on the environment and human health, today’s economies still produce excessive carbon dioxide emissions. As a result, governments are trying to shift production and consumption to more sustainable models that reduce the impact of carbon dioxide emissions. The European Union, in particular, has implemented an innovative policy to reduce carbon dioxide emissions by creating a market for emission rights, the emissions trading system. The objective of this paper is to perform a counterfactual analysis to measure the impact of the emissions trading system on the reduction of carbon dioxide emissions. For this purpose, a recently-developed statistical machine learning method called matrix completion with fixed effects estimation is used and compared to traditional econometric techniques. We apply matrix completion with fixed effects estimation to the prediction of missing counterfactual entries of a carbon dioxide emissions matrix whose elements (indexed row-wise by country and column-wise by year) represent emissions without the emissions trading system for country-year pairs. The results obtained, confirmed by robust diagnostic tests, show a significant effect of the emissions trading system on the reduction of carbon dioxide emissions: the majority of European Union countries included in our analysis reduced their total carbon dioxide emissions by about 20% during the emissions trading system treatment period 2005–2016, compared to the total carbon dioxide emissions that would have been achieved in the absence of the emissions trading system policy. Finally, several managerial/practical implications of the study are discussed, together with its possible extensions.