Innovation under Cap-and-Trade: How emission trading systems propel decarbonization

This study investigates the direct and indirect effects of emission trading systems (ETSs) on carbon emission reductions across 81 countries from 2001 to 2021, with a particular focus on the mediating role of environment-related technological innovation (ETI). Drawing on the Porter hypothesis, this research hypothesizes that ETS directly reduces carbon emissions and fosters green technological innovation, further contributing to emission reductions. Using advanced econometric techniques, including fixed-effects regression models, system generalized method of moment, and mediation analysis via GSEM, the study finds that a 1% increase in ETS results in an approximately 0.02% direct reduction in carbon emissions, while a 1% increase in ETS indirectly reduces emissions by about 0.003% through ETI. Although the percentage seems modest, this impact translates into significant annual CO₂ reduction at national levels, underscoring the importance of ETS in practical, large-scale decarbonization efforts. The results underscore the dual pathways through which ETS contributes to decarbonization and highlight innovation's crucial role in achieving sustainable carbon emissions reductions. The study concludes with policy implications, advocating for the urgent need for strengthened international collaboration in ETS design and implementation, investments in green technological innovation, and enhanced cooperation among countries can further amplify the effectiveness of ETS, creating a collective momentum toward sustainable development and climate resilience. Nexus between emission trading systems, technological innovation, and carbon emissions. • Explore emission trading systems (ETSs) direct and indirect effects on carbon emissions across 81 countries via environmental technological innovation. • Mediation analysis shows that ETS, directly and indirectly, cuts emissions through technological innovation. • ETS policies drive innovation and sustainability, which is crucial for long-term carbon reduction.