Research and analysis

Methodology note: assessing the preliminary economic impacts of linking the UK-EU Emission Trading Schemes

Published 19 May 2025

1. Introduction

Government modelling suggests linking the UK and EU Emissions Trading Schemes (ETS) will provide a +0.1% GDP gain relative to the baseline. This employed a Computable General Equilibrium (CGE) model that captures the global economy moving between steady states, so should be interpreted as the long-run effects of the policy against a baseline of no ETS linking. There are potential sensitivities with this analysis, particularly around the interaction with Carbon Border Adjustment Mechanism (CBAM)  – where exemption from the EU CBAM would have further growth benefits.

2. Data and baseline

The modelling uses the GTAP-E model specification and is based upon the associated GTAP11 database (reference year of 2017). We compare the results to a baseline for the year 2035 in which the UK and EU operate independent ETS markets, with no joint price and the requirement to meet climate targets unilaterally. 

3. Modelling inputs and trade cost reductions

To simulate the effects of linking UK ETS with the EU, the scenario we model has two stages:

1. Alignment: the UK’s ETS price adjusts as it joins the EU’s larger market. The upper bound on this increase would be if the UK’s price rose to meet the EU’s price exactly. We implement this as a shock to the UK’s ETS price to show the change in output and emissions.
2. Bloc-level decarbonisation: Once the ETS markets are linked, decarbonisation targets are shared across the combined market for ETS permits, allowing for decarbonisation to take place in the most cost-effective place. We implement a 5% decarbonisation target to the combined market as an arbitrary, illustrative shock to show the pattern of decarbonisation across the different regions. Our model calculates the ETS price required to achieve the set target, which is not based on government policy.

4. Results – long-run GDP impacts

Comparing the impact on real GDP when the UK achieves the same decarbonisation from alignment and a unilateral 5% target through its own ETS price, the ‘linking scenario’ has a cumulative +0.1% GDP (£2.7bn based on 2023 prices) against the baseline, or £3.8bn using  government GDP forecasts for 2040 (at 2024 prices). This is driven by the EU’s marginal cost of decarbonisation being lower once the markets are linked. These results give us evidence on the scale and direction of the potential effect, but not the transition path and are dependent on the underlying data.  

In the linked scenario, alignment with the EU’s ETS price produces a 2.5% reduction in greenhouse gas emissions (GHG). The decarbonisation target of 5% applies at the UK and EU bloc level, producing a cumulative impact on UK real GDP of 0.7%, composed of 0.2% from alignment with the EU’s price, and 0.5% to achieve the further 5% emissions target.

In our unlinked baseline, both the UK and EU achieve 5% separately, so to calculate the equivalent decarbonisation shock for the policy scenario we combine the decarbonisation achieved by the UK in alignment (2.5%) with the 5% target in the linking scenario’s second stage (total of 7.3%). Taking the difference between the scenario and the baseline gives a cumulative +0.1% benefit to real GDP in the linked case over the period of alignment and the time taken to reach 5% decarbonisation from the ETS.

The mechanism driving this result is that UK firms become net purchasers of ETS permits under linking. These transactions between firms would be net welfare enhancing, as the amount paid by UK firms to EU firms would be greater than the EU firms’ cost of marginal decarbonisation, but less than the UK firms’ decarbonisation costs.

5. Caveats of the analysis

The modelled impacts are based upon current policy assumptions. This means that they may change in future as the detail and scope of the agreement are finalised.

Key caveats and uncertainties include:

• GDP impacts are sensitive to carbon price assumptions: traded carbon values are taken from 2035, with a carbon price differential between the UK and EU that was proportional to the one present at the time of modelling.
• The results are relative to the 5% decarbonisation target: the economic impact of linking ETS is permanent and continuous throughout the UK’s decarbonisation. We have also modelled a 10% climate target, which shows the same pattern of results but with proportionally higher impacts.
• There are policy interactions not captured: this modelling does not capture the potential interactions with Carbon Border Adjustment Mechanisms, which may provide further economic benefit to aligning with the EU. There is ongoing work to quantify this.
• Permit sale revenue is not well-defined: the model does not capture revenue flows from the sale of permits between regions, the recycling effects of which could further impact GDP.
• Model data is benchmarked to 2017: compiling a consistent, global economic model is data and labour intensive, creating a significant lag to the observations in the database which is the latest available.