Carbon Trading

This chapter examines carbon trading as a core market-based instrument for climate governance and the net-zero transition. Building on the broader discussion of carbon finance in the previous chapter, it focuses more directly on emissions trading systems (ETSs) and related carbon markets as mechanisms for allocating emissions rights, revealing carbon prices, and incentivizing abatement where it is least costly. The chapter reviews the development of major carbon trading systems across jurisdictions, with particular attention to the EU, China, and subnational programs in the US, and synthesizes the growing empirical literature on their effects on emissions reduction, innovation, firm performance, competitiveness, and market behavior. It also considers the interaction between compliance markets and voluntary carbon markets, highlighting the importance of allowance allocation, market liquidity, price volatility, and regulatory credibility for system effectiveness. The chapter then evaluates the main theoretical perspectives used to interpret carbon trading, including welfare economics, innovation-based arguments, institutional political economy, and financialization perspectives. Taken together, the evidence suggests that carbon trading can support cost-effective emissions reduction and long-run technological change, but its performance depends critically on cap stringency, monitoring and enforcement, stable policy expectations, and safeguards against low-integrity market expansion. The chapter concludes that carbon trading is neither a self-executing solution nor merely a financial overlay, but a governance-dependent policy instrument whose effectiveness rests on credible institutions and sustained political commitment.