When cost efficiency is ignored, carbon market success is overstated

<h2>Abstract</h2> Understanding the true cost effectiveness of emissions trading schemes (ETSs) is essential for advancing climate policy. In this study, we contribute by introducing the trade effect—the mechanism through which ETSs promote convergence in marginal abatement costs (MACs)—and by developing a novel empirical framework to quantify this trade effect using firm-level data. Our empirical findings suggest that conventional assessments, which focus primarily on emissions reduction (the cap effect), may overstate the effectiveness of carbon markets by neglecting cost efficiency. Unlike earlier studies, our results reveal that China's ETS, in its current form, has not consistently performed better than administrative measures in terms of cost effectiveness, indicating an insignificant trade effect. This divergence highlights a potential gap in current ETS evaluations and underscores the need for critical adjustments in China's ETS, including stricter emissions caps, fewer free allowances, and a long-term strategic roadmap. Our approach provides a new lens for ETS performance evaluation, offering policymakers actionable insights to refine carbon market designs globally.