How climate policies can speed up manufacturing decarbonisation in the Western Balkans

Western Balkan firms are adopting measures to reduce environmental impacts, but smaller local firms need support to comply with EU regulations.

The European Union’s carbon border adjustment mechanism (CBAM) is designed to drive global industrial transformation by encouraging affected firms to adopt greener practices. CBAM introduces a carbon tax which firms can mitigate by cutting their emissions, thus maintaining their competitiveness in the EU market. CBAM was first announced in 2021, entered EU legislation in 2023 and was fully implemented in 2026. 

One way by which firms can reduce their carbon footprints is through ‘eco-innovation’: new, carbon-efficient production practices. This is particularly relevant for the Western Balkans’ economies, whose geographic proximity to, and economic integration with the EU has made the region highly economically dependent on the European single market. More than 60 percent of the region’s goods exports go to the EU, a figure that has remained relatively constant since 2016 (Barata da Rocha et al, 2026). Western Balkan manufacturing sectors, alongside Ukraine’s and Moldova’s, are among the twenty most exposed to CBAM in the world. 

Figure 1: Manufacturing exports exposed to CBAM as percent of total, top 50 percentile distribution

^{Source: Bruegel, based on CEPII dataset. Note: the graph design is inspired by Bahí et al (2026).}

CBAM can thus exert significant pressure on the export revenues of EU trading partners. For the Western Balkans striving to join the EU, EU accession criteria are a major driver of their national climate policies, which is ever more relevant given CBAM activation. The EU accession agenda requires the introduction of EU-equivalent climate policies, such as a national emissions trading system (ETS), in candidate countries. This allows a country to join the EU’s ETS and thus effectively avoid the taxes levied by CBAM. However, these environmental and climate reforms are among the most complex and costly aspects of the EU accession process (Ivanova and Esati, 2025). 

As part of these reforms, a country must introduce a monitoring, reporting, verification and accreditation (MRVA) system to credibly quantify carbon emissions, which can then be appropriately priced (ie ‘carbon price’), laying the foundation for an ETS. Polluting firms must then purchase ETS permits corresponding to their carbon footprint. 

Montenegro is the only Western Balkan country with an operational MRVA system and ETS, though it covers only one state-controlled company. Serbia, North Macedonia and Albania show a moderate level of preparedness in environmental and climate policy, while Kosovo and Bosnia and Herzegovina lag behind. 

This analysis examines how Serbia’s emerging climate-policy framework has prompted firms to transform their production processes and ultimately reduce their carbon footprints by introducing carbon-reducing innovations. Serbia is a particularly relevant case as the Western Balkans’ largest economy, accounting for around half of the region’s population and GDP. The analysis looks into the specific timeframe, following the adoption of the Law on Climate Change in Serbia, set to establish MRVA and the opening of EU accession negotiations on environment and climate change – both of which happened in 2021. Assessing firms’ responses to climate policies indicates how they may respond to a future emissions trading system (ETS) and other measures needed to align with the EU climate acquis and address CBAM-related pressures.

Climate policies support eco-innovation in the Western Balkans

We use firm-level Community Innovation Surveys (CIS) to examine eco-innovation among Serbian manufacturing firms between 2020 and 2024. The CIS is an anonymous, Eurostat-based survey that captures firms’ innovation activities, as well as their employment, revenue, industry and location, over a three-year period. Merging the 2020-2022 and 2022-2024 survey waves yields 5,985 cross-sectional observations, of which 2,023 are manufacturing firms. The main question of interest is the following: 

“During the 3-year period, did your enterprise introduce innovation that led to environmental benefit in the form of reduced energy use or CO₂ emissions (footprint) or replacement of fossil fuel energy with a renewable energy source” (Eurostat, 2023).

Among the firms that introduced eco-innovation, the survey distinguishes between firms that achieved significant environmental benefits and those that did not. Between 2020 and 2024, 36 percent of manufacturing firms pursued eco-innovations to cut CO₂ emissions or replace fossil fuel energy with renewables. One in five manufacturing firms achieved significant environmental benefits from these actions. 

Location data reveals that carbon-reducing innovations are equally present in urban and rural areas. They do not vary depending on whether a firm operates in a competitive or monopolistic market, either. Yet, some specificities are apparent (see Figure 2).

Figure 2: Serbian manufacturing firms undertaking carbon-reducing eco-innovation vs those successfully capturing benefits, 2020-2024

^{Source: Bruegel, based on Serbia CIS. Note: we identify CBAM manufacturing sectors by merging the HS code of the CBAM industry with NACE/CPA industry codes available in CIS. We used OECD guidelines for merging product (HS) and industry-level (NACE/CPA) data. Electricity-sensitive industries are defined as 4-digit manufacturing industries subject to EU state aid under EU (2020/C 317/04) state aid guidelines.} 

During 2020-2024, 42 percent of Serbian firms in CBAM-covered manufacturing sectors pursued eco-innovations and one-quarter did so successfully – marginally higher than the average for manufacturing firms in general. This may indicate an effect of the CBAM announcement but could also reflect temporarily heightened post-COVID environmental awareness (Matiiuk et al, 2023).

In contrast, electricity-price-sensitive firms were substantially more active than the manufacturing average: 55 percent undertook eco-innovation, while 38 percent successfully reduced their carbon footprint or shifted towards renewable energy. These patterns may reflect region-specific industrial conditions: the day-ahead electricity markets in the Western Balkans have some of the highest prices in Europe, despite substantial state subsidies (Vujanović et al, 2025), though this may have been amplified by the energy crisis triggered by Russia’s invasion of Ukraine in 2022.

The high incidence of eco-innovation may also reflect a broader sectoral pattern: manufacturing firms are generally energy-intensive and therefore have a strong incentive to reduce energy costs. For many firms in the region, eco-innovation may be as much a cost-saving and energy-efficiency strategy as an environmental one.

The high- and medium-level drivers behind these eco-innovations bear this out (Figure 3): over 70 percent of firms conduct carbon-reducing eco-innovations to reduce high energy costs, suggesting that this structural issue in the region is a main driver of eco-innovation. The second most prominent driver is improving reputation, accounting for two thirds of eco-innovation. 

Figure 3: Factors driving eco-innovation in Serbian manufacturing firms, 2020-2024

^{Source: Bruegel, based on Serbia Community Innovation Surveys. Note: a firm may select more than one answer.}

The set of factors shaded blue in Figure 3 concerns different state regulatory pressures. Among these incentives, environmental regulation appears most influential: 65 percent of manufacturing firms pursue eco-innovation in response to environmental regulations, 54 percent in response to taxes, charges or fees and 57 percent in anticipation of future regulations.

This regulatory dynamic contrasts sharply with research showing that, in eastern European countries, rules and laws often hinder innovation, which is primarily competition-driven (Stojčić et al, 2025). This suggests that eco-innovation differs from ‘standard’ innovation in being more strongly regulatory-driven. Grants and subsidies play a modest role in encouraging firms to introduce carbon-reducing innovations – less so than among EU firms covered by the ETS (Revoltella and Kalantzis, 2026). Public-procurement requirements similarly play only a limited incentivising role.

Other factors, though sizable, play a lesser role: 46.6 percent of firms conduct innovation on a voluntary basis, while 42.2 percent innovate due to existing market demand.

Large and technically advanced firms are better positioned to reduce their carbon footprint

Firms’ adoption of eco-innovations is shaped not only by regulatory requirements and energy efficiency needs, but also by technological capabilities and firm size (see Figure 4). Exporters, foreign-owned firms with better technologies (Vujanović et al, 2022; Ghodsi et al, 2025), firms that invested in R&D and large firms introduced carbon-reducing innovations significantly more than the manufacturing average (dashed line). 

Figure 4: Carbon-reducing innovations success rate across technology and firm-size levels in Serbia

^{Source: Bruegel, based on Serbia Community Innovation Surveys.} 

Of Western Balkan firms focused on exports to the European Economic Area (EEA), 43 percent undertook eco-innovations, while only 23 percent of firms serving the Western Balkans region did the same. This suggests that firms serving markets where environmental regulations are in place are more likely to green their production. 

Foreign-owned firms are especially innovative, with one in two undertaking eco-innovations to reduce their carbon footprint or switch to renewable energy sources. Firms investing in R&D are also more prone to eco-innovate: 64 percent engage in eco-innovation, and more than two thirds of these firms report subsequently reducing emissions or greening their energy use. This is 30 percentage points higher than non-innovating firms.

Firm size, which often defines access to finance in this region and general financial strength (Vujanović et al, 2022), also matters. Around 60 percent of large firms pursue carbon-reducing innovation, roughly 20 percentage points more than small firms. This may reflect the greater financial and organisational resources available to larger firms (Vujanović et al, 2021).

Climate policies need to be coupled with support for smaller and local firms

This analysis shows that climate policies in the Western Balkans, which are largely driven by EU accession-related reforms and aspirations, can be an important impetus for adopting carbon-reducing manufacturing practices. This is now particularly relevant with CBAM in place: EU candidate countries need to step up and introduce a national ETS.

The capacity to adopt carbon-reducing innovation is uneven. Small firms recorded limited uptake of such innovations in 2020-2024, largely reflecting more constrained access to finance. Firms that neither innovate nor serve markets beyond the Western Balkans are less likely to adopt carbon-reducing practices. 

Better-targeted local and EU-funded grants are needed to help smaller and less technologically advanced firms invest in greener production as climate policies tighten. Since CIS data show that not all eco-innovation brings successful environmental benefits, funding schemes should also include monitoring to assess whether recipients translate support into carbon-reducing outcomes. Future measures should build on existing frameworks¹² to target smaller, locally oriented, less technologically advanced firms by financing their green practices.

Currently, a national ETS has been implemented only in a highly imperfect form in the smallest Balkan country, illustrating that this climate policy tool needs effective implementation support. Effective support for gradually increasing carbon pricing should be considered, alongside stronger incentives for decarbonisation investment. Future climate regulation will need to be designed and implemented in a way that facilitates carbon-reducing eco-innovations, while accounting for the specific circumstances of technologically disadvantaged firms, whose main market is the Western Balkans, so that they are not left behind.

Source : Bruegel