The impact of emissions trading systems on manufacturing installation productivity: Evidence from Japan

Emissions trading systems have been widely studied globally, but less attention has been paid to their impacts on the productivity of the regulated facilities. This column examines the impact of Japan’s regional emissions trading systems on productivity during both the pre-compliance transition period and the compliance period. The findings indicate that although no evidence supports total factor productivity increases during the transitional period, installations improve their productivity during the initial compliance period.

Emissions trading systems (ETSs) have emerged as a pivotal mechanism aimed at fostering carbon mitigation by creating a market for trading emissions allowances and offering economic incentives for installations to reduce their emissions. To achieve these objectives, installations are mandated to adopt various methods to bring their operations into compliance – such as investing in green technologies, replacing equipment, and modifying operational processes – which in turn, may improve their economic performance, and particularly total factor productivity (TFP), in the long term. While ETSs generally aim to achieve reduction targets in a cost-efficient manner through innovation and productivity gains, they can also impose financial and operational burdens on regulated firms (Baier et al. 2006), reducing TFP (Mo et al. 2023). The inconsistency of impacts underscores the necessity of investigating the influence of ETSs on productivity, an issue that is further complicated by regulatory strategies designed to mitigate adverse effects during the initial compliance stage.

Pre-compliance transition periods

Recognising the potential adverse effects of these compliance burdens in the initial stage, policymakers may announce the regulation in advance to provide installations with a transitional period to bring their operations into compliance with the forthcoming reduction targets, including investment in cleaner technologies (Xu et al. 2022), upgrading equipment to meet targets, and personnel training, which could potentially affect TFP before full implementation of regulations. These additional costs could also limit investment in research and development activities (Dechezleprêtre and Sato 2017). Conversely, during the middle and later compliance stages, these regulations can transform environmental costs into economic incentives to implement productivity improvements, meaning that initial losses in productivity shift to enhanced productivity (Benatti et al. 2024). Despite the significance of these dynamics, the existing literature has not thoroughly examined how ETSs affect TFP across different compliance stages, particularly during the transitional period within Japan’s manufacturing industry.

Japan’s regional ETSs

In 2007, the Tokyo government announced the introduction of Japan’s first regional ETS, which was scheduled to commence operations within two years of the announcement. Facing similar economic and environmental challenges as Tokyo, Saitama, with its substantial manufacturing base in the Kanto area, began preparing analogous regulatory frameworks around the same period. The Saitama Prefectural government confirmed that the earliest verified operator-facing explanatory meeting on the planned target-setting emissions trading scheme was held in 2008 and included information on the planned FY2011 start. Therefore, the announcement period of Saitama ETS was dated from 2008 instead of 2007, because this is the earliest confirmed point at which potential regulated operators were officially informed of the forthcoming system and its implementation schedule. Moreover, both the Tokyo and the Saitama ETSs introduced phased emissions reduction targets calculated based on the baseline emissions derived from CO2 emissions over any consecutive three-year period from 2002 to 2006. Installations were notified of their specific emissions reduction targets starting from the transitional period.

The Tokyo ETS covers approximately 1,200 installations across all industries, whereas the Saitama ETS regulates approximately 600 installations. Both systems regulate installations with annual energy consumption exceeding 1,500 kilolitres of crude oil equivalent (approximately 2,800 tons of CO2). An installation exceeding this threshold for three consecutive years, on average, is included in the regulated installation list of Japan’s regional ETSs. The Tokyo and Saitama ETSs offer free allowances allocated to installations. The Tokyo system primarily focuses on commercial and service industries, whereas the Saitama system mainly covers manufacturing installations. Regulated installations under the Tokyo ETS are subject to penalties, including monetary fines and public notification of non-compliance, if they fail to meet their emissions reduction targets. By contrast, although non-complying installations under the Saitama ETS do not face monetary fines, their names are published, meaning they can face public pressure.

The initial compliance period for manufacturing installations under the Tokyo ETS extended from 2010 to 2014, whereas for the Saitama ETS, it spanned from 2011 to 2014. Both ETSs established an initial emission reduction target of 6% for this period. The subsequent compliance period for both regions covered 2015 to 2019, during which the Tokyo ETS increased its reduction target to 15%, while the Saitama ETS set a target of 13% (see Table 1). Installations that exceed their reduction targets are eligible to earn credits that are equivalent to the excess reductions. These allowances can be banked for use in the following compliance period. Conversely, installations that face challenges in meeting their targets can utilise emissions allowances and various alternative credits to achieve compliance.

Table 1 Information on the Tokyo and Saitama ETSs

Stage-dynamic impacts of ETSs on TFP

Installations may require time to adjust before taking actions, such as investing in or adopting new technologies, which ultimately lead to increases in TFP. Clò et al. (2024) highlight this aspect, examining the dynamic impacts of environmental shocks and finding that their effects can vary between the short and long term. In the context of Japan’s regional ETSs, installations might initially face uncertainties and higher compliance costs. Over time, as they adapt their operational strategies and invest in energy-efficient technologies, productivity gains may become more pronounced. However, such improvements may only appear during specific compliance periods. To capture these time-dependent impacts, this study investigates how ETSs influence TFP at different regulatory stages, enabling the identification of periods when installations achieve the greatest productivity improvements. Specifically, this study distinguishes the period into the transition stage, the period from the announcement to the first compliance stage, and from the announcement to the early second compliance stage. 

Figure 1 summarises the stage-specific effects of Japan’s regional ETSs on installation-level TFP, with point estimates and 95% confidence intervals. The estimate for the announcement year (transition start) implies that regulated installations had approximately 0.7% higher TFP than non-regulated installations. However, this estimate is not statistically significant, indicating that installations do not immediately enhance their TFP. In other words, although installations may start to conduct activities to comply with upcoming regulations or make early investments, such efforts do not translate into gains in productive efficiency at this initial stage. However, when the window extends through the first compliance period, the estimated effect becomes statistically significant and implies that regulated installations experienced approximately 1.7% higher TFP. Combined with the results on announcement year (transition start), these findings suggest that, while installation do not exhibit immediate TFP improvements, they are able to implement effective operational changes during the first compliance period, resulting in measurable productivity gains. This result also agrees with the finding from Benatti et al. (2024) who mentioned that while the productivity growth might fall initially, it tends to be enhanced following the initial adjustment period.

Figure 1 Stage-specific result of ETSs

Nevertheless, the effect remains positive in the early second compliance stage, implying approximately 1.6% higher TFP. However, the magnitude is slightly smaller than during the first compliance period. One potential explanation, as reported by the Tokyo and Saitama governments, is that installations achieved substantial emissions reductions and productivity gains during the first compliance period, and as the new reduction targets for the second compliance period are relatively low, it may not sufficiently incentivise further investments or technological advancements. In summary, the stage-dynamic analysis underscores the importance of considering temporal dynamics in assessing the impact of ETS implementation.

Source : VOXeu