Market Structure and Green Innovation Response to Carbon Pricing: Evidence from the EU Electricity Market

This study examines how national electricity market structures condition the impact of carbon pricing on green innovation within the European Union. Using two-way fixed-effects panel models, we uncover a central paradox: although liberalized, price-signal markets exhibit the highest baseline levels of green innovation, the marginal effect of carbon pricing in these markets is weakest and often negative. This pattern points to an innovation-substitution effect, whereby market flexibility facilitates short-term compliance strategies, such as fuel switching, that crowd out investment in fundamental research and development (R&D) when carbon prices remain moderate. By identifying this mechanism, the study establishes electricity market structure as a pivotal moderating factor in the carbon pricing–innovation nexus and highlights a critical boundary condition for the Porter Hypothesis. The findings provide important insights for the design of sustainability policy mixes, demonstrating that institutional context plays a decisive role in translating economic instruments into sustained technological change. Effective climate policy therefore cannot be context-blind; instead, it must combine carbon pricing with tailored market design and direct support for long-term R&D to coherently advance the sustainability transition.