Picking Losers: Climate Change and Managed Decline in the European Union

Ergen, Timur; Schmitz, Luuk Article — Published Version Picking Losers: Climate Change and Managed Decline in the European Union Regulation & Governance Provided in Cooperation with: John Wiley & Sons Suggested Citation: Ergen, Timur; Schmitz, Luuk (2025) : Picking Losers: Climate Change and Managed Decline in the European Union, Regulation & Governance, ISSN 1748-5991, John Wiley & Sons Australia, Ltd, Melbourne, Vol. 19, Iss. 2, pp. 383-398, https://doi.org/10.1111/rego.70004 This Version is available at: https://hdl.handle.net/10419/319360 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. http://creativecommons.org/licenses/by/4.0/ Regulation & Governance, 2025; 19:383–398 https://doi.org/10.1111/rego.70004 383 Regulation & Governance ORIGINAL ARTICLE OPEN ACCESS Picking Losers: Climate Change and Managed Decline in the European Union TimurErgen | LuukSchmitz Max Planck Institute for the Study of Societies, Cologne,Germany Correspondence: Timur Ergen ([email protected]) Received: 15 November 2023 | Revised: 2 February 2025 | Accepted: 8 February 2025 Funding: The authors received no specific funding for this work. ABSTRACT Decarbonization forces societies to cope with the restructuring and outright unwinding of assets, firms, workers, industries, and regions. We argue that this problem has created legitimacy for industrial policies managing the reallocation of resources. We illustrate this dynamic by documenting incremental statebuilding in the European Union, an administration institutionally tilted toward regulatory statehood and the making of the Single Market in energy since the 1990s. European greening policies, we argue, have incrementally lessened the primacy of regulatory tools and have introduced a plethora of instruments to accelerate green restructuring and carbon unwinding. Best understood as a process of multisited institutional layering, the European Union increasingly appears to complement financial and regulatory instruments to effect green energy transitions with the management of decline in targeted regions and sectors, based on targeted funds and targeted transition planning. 1 | Introduction Recent studies examining the state's role in 21stcentury capitalism reveal that green transitions appear to compel governments to adopt interventionist approaches that diverge significantly from traditional models of the regulatory state. The governance challenges arising from climate change mitigation and adaptation can hence be understood as drivers of ongoing institutional change. This article adds to this perspective on the climate changerelated evolution of the regulatory state by documenting responses to an empirically underexplored dimension of green transitions—the state management of socioeconomic unwinding caused by greening policies. Complementing the growing literature on Just Transitions that highlights emerging compensatory logics in the political economy of climate change (Edenhofer and Genovese2024; Im2024; Schaffer2024), this article contributes to understanding how states raise political legitimacy for green structural change. The research question this article investigates is how the divestments and losses involved in decarbonization policies challenge the regulatory state. The two main answers our analysis provides are (a) that policyinduced divestments and losses push states into handson repertoires of managing decline and restructuring in affected regions and sectors and (b) that these repertoires may be layered on top of the regulatory state, rather than displacing it. The empirical case we rely on consists of the European Union's climate policies since the early 2000s. We demonstrate that the bloc has gradually expanded its decarbonization policy toolkits to include fiscal capacity building and economic planning, specifically targeting regions transitioning away from carbonintensive activities. By targeting transfers and transition policy aid to specific regions and sectors, the EU's greening policies have an overtly directional character, where administrative decisions aim to alter resource allocations on a granular regional and sectoral level. Importantly, such granular policy toolkits emerged as This is an open access article under the terms of the Creative Commons Attribution License, which permits use, distribution and reproduction in any medium, provided the original work is properly cited. © 2025 The Author(s). Regulation & Governance published by John Wiley & Sons Australia, Ltd. Timur Ergen and Luuk Schmitz authors contributed equally to this work. 384 Regulation & Governance, 2025 part of settlements meant to overcome political resistance to regulatory policies raising the price of emissions. They did not replace the European regulatory state in the climate arena but were layered on top of it. Green transitions are not just about phasing in green technologies or practices, but about the phasing out of polluting practices and structures (Albert etal.2021; Elliott2021; Thurbon etal.2023). As such, they are problems of socioeconomic reallocation, structural change, and restructuring. The restructuring problems associated with climate change policy confront states institutionally fashioned under very different political constraints, distributional coalitions, and ideational backdrops. As has been pointed out by an emerging political economy of the green state, one of the major dynamics of contemporary climate policymaking concerns the fault lines between institutional regimes built in times of regulatory statehood and pressures to accelerate climate change mitigation and adaptation. Core insights from this line of research concern attempts to mobilize (hidden) fiscal resources for green transitions (Lepont and Thiemann2024; Mertens and Thiemann2017), to stimulate industrial and technological innovation (Kupzok and Nahm2024; Meckling2021), and to enlist financial markets for green investment (Gabor and Braun2023; van ’t Klooster2022). This article contributes to this line of inquiry by showing for the case of the European Union how problems of socioeconomic decline have conditioned a revival of industrial policy repertoires long thought dormant—if not dead. In a turn of phrase common in debates on industrial policy (Cowling 2003), we document the return of vertical repertoires in the climate arena. Reacting to the post1980s abandonment of policies supporting statepicked firms, sectors, regions, and technologies, industrial policy debates diagnosed a shift from vertical to horizontal policies—where the latter were designed to improve conditions for business activity without “picking winners” (see Ergen and Rademacher2023). While recent writings on the green state have documented a return of the state in the innovationoriented “picking of winners,” this article describes emerging policy repertoires around green states “picking losers.” Those repertoires revolve around the active state management of structural change—and particularly around the political easing of the phaseout of fossil fuelheavy activities. Hence, if green transitions involve a process of “institutional layering” (Thelen2004) of an innovation state, an investment state, and a green macrofinancial state on top of the established regulatory state, we argue that they have at the same time given rise to the growth of a decommissioning, liquidating, or stranding state. The main empirical case we rely on for illustration is the European Union since the late 1990s. We document an incremental process of layering through which regulatory instruments intended to make carbon emissions more costly are increasingly complemented with interventionist policy toolkits targeting transition losers. The European Union emissions trading system (ETS)—long heralded as an institutionally elegant and efficient way to phase out carbon emissions—has increasingly been supplemented with transfer programs targeted at the decarbonization of specific industries and regions. Since the mid2010s, the EU has actively built governance capacities to plan for decline in affected regions. Here, we are among the first to shed light on the role of the European Commission's DirectorateGeneral for Structural Reform Support (DG REFORM)—an institutional complex repurposed from working on Greece's structural reforms during the European sovereign debt crisis—to an agency active in greening the East by working to transition regions heavily dependent on fossil fuels. This article is structured in two major parts. Section2 reconstructs previous work on deviations from the regulatory state related to climate change policy and describes how the management of socioeconomic decline represents a distinctive added transition challenge. We aim to show how the literature in various fields has documented piecemeal but systematic deviations from classic patterns of regulatory statehood related to lowcarbon transitions. Laying the ground for our argument, we sketch scattered previous evidence that green transitions lead states towards granular transition governance. Section3 illustrates our argument based on a case study of European transition policies. We demonstrate how a process of institutional layering unfolded over the last 30 years. Since the early 2000s, a regulatory regime for emissions trading was incrementally punctured by industrial and regional policies seeking to organize and enable green restructuring in specific regions and sectors. In the conclusion, we lay out the main ways in which our argument can enrich ongoing debates in political economy. 2 | The Regulatory State, Climate Change, and the Question of Green Statehood Observations of a reemergence of a more activist, or “positive,” state in the early 21st century span multiple empirical fields of research. Thirty years after Majone's seminal paper on the decline of dirigisme in Europe (Majone1994), the regulatory state appears to be under siege on multiple interlocking fronts. One major issue area leading the charge relates to the reappearance of geopolitics and security as major concerns (LeviFaur2013; McNamara 2024; Seidl and Schmitz 2024). Other important issues concern problems of rapid technological change (Mügge 2024), as well as problems of inequality, structural change, and political legitimacy (Piore2019). In the original formulation by Majone(1994), the European regulatory state appeared as a poststatist polity focused on market regulation. This characterization reacted both to the increasing power of regulatory agencies after widespread privatization and deregulation and to the EU's institutional oddities, such as its fiscal limitations. After agricultural policy expenditure, Majone(1994, 87) observed that “remaining resources are insufficient to support largescale initiatives in areas such as industrial policy, energy, research, or technological innovation. Given this constraint, the only way for the Commission to increase its role was to expand the scope of its regulatory activities.” The primacy of regulatory statehood for Majone implied a narrowing down of state goals to “a single normative justification: improving the efficiency of the economy by correcting specific forms of market failure such as monopoly, imperfect information, and negative externalities” (Majone1994, 79). This meant a 385 stark deviation from the “positive state” of the postwar decades, whose policies where motivated by a plethora of political goals. While Majone's characterization has been amended, historically situated, and criticized for years, it can still serve as a valuable baseline to characterize state activity—particularly in the European Union where regulatory justifications of Union responsibility visàvis member states are still extremely common. In the literature on the European Union, the idealtypical regulatory state has increasingly been described as coming under siege from multiple fronts (among many: Genschel and Jachtenfuchs 2018; Di Carlo and Schmitz 2023). This article builds on this perspective by highlighting a front related to the management of climate policyinduced decline. We want to highlight that we do not consider this front dominant or overall characteristic of the European Union. One of the major tenets of the debate on the regulatory state since Majone has been a cautionary take against monomorphic notions of state intervention (LeviFaur2013; Morgan and Orloff2019). Instead, large parts of the literature on the siege of the regulatory state describe processes of partial and issuespecific bricolage and institutional layering, rather than unidirectional change. This is particularly true for research uncovering institutional change in climate policy. As laid out in the following, influential research on the return of the activist state as a greening state describes localized experiments with nonconventional policy instruments, niche developments, the presence of conflicting logics, and forms of “hidden” policies that do not openly challenge formalized notions of the regulatory state. There currently exist three major takes on how the green state punctures the regulatory state in the European Union: the investment state, the derisking state, and the rise of green industrial policy. To situate the original contribution of our article, we briefly reconstruct the basic tenets of each perspective before pointing to an emerging additional view stressing how states deal with transition losers. 2.1 | The European Green State as an Investment State Particularly for the European case, recent research has documented the rise of a wide range of unconventional forms of fiscal statehood aimed at decarbonization. Most of the institutional foundations of the European investment state have existed for a long time but have grown significantly in the aftermath of the European sovereign debt crisis. Institutions such as the European Investment Bank and member states' development banks have become largescale de facto providers of investment assistance across Europe in a situation of institutionalized austerity in member states and the lack of fiscal capacity of the European Union itself (Mertens and Thiemann 2017; Lepont and Thiemann2024). Given the centrality of fiscal underdevelopment in Majone's original scheme, the development of central fiscal powers implies a major deviation. The literature on the European investment state has stressed that the expansion of fiscal capacity is partially unfolding in a politically “hidden” way—without overt challenges to institutionalized notions of fiscal policy in the EU. Nonetheless, the remodeling of institutions to serve green policy ends has been underwritten by official acknowledgments that climate change mitigation as an infrastructural problem requires massively rising levels of public investment (Mertens and Thiemann2023). Given the hardcoded institutional constraints of European fiscal policy, however, the public provision of investment has largely relied on offbalancesheet vehicles and the public underwriting of private investment (Alayrac and Thyrard 2024; Endrejat2024). 2.2 | The European Green State as a Derisking State The European tendency to favor publicprivate cofinancing over actual public investment has been at the center of work on the rise of the derisking state. In particular, Gabor(2021) has argued that 21stcentury macrofinancial regimes push states to rely on private investment for transition financing by creating attractive assets in the green economy. Shadowing her earlier work on the structural dominance of financial interests in development policy, Gabor argues that the European “small” green state primarily derisks investments to create profitable assets for large financial pools (Gabor2022; Gabor and Braun2023). Critical macrofinance places the locus of state action at the level of institutions seeking to carve pathways for finance to flow in strategic directions. As a theory of changing forms of statehood under conditions of climate change, Gabor's analyses point toward the odd forms in which developmental ambitions in the green economy are channeled into states underwriting marketled transition policies. In recent comparative extensions of the macrofinancial approach to green transitions, Gabor and Braun(2023) point to how institutional, ideological, and international power dynamics shape the extent to which states seek investment through financial markets, rather than through public means. The derisking state stands in an odd relationship to Majone's notion of the regulatory state. It highlights the return of nonregulatory goals of policy but describes (in parts selfinflicted) limitations of policy capacity that induce states to seek public policy goals by incentivizing private service provision. 2.3 | The European Green State as a Green Developmental State A third core strand of research on greening states emphasizes the return of developmental policies for green industries and technologies. Green industrial policies have been emerging around the world as governments seek to develop technologies to combat climate change and vie for position in emerging industries (Allan etal.2021; Meckling2021; Rodrik2014). Compared to the “old” East Asian developmental state of the 1980s, recent green industrial policies in rich countries have deployed a range of more lighttouch policies, such as startup assistance, R&D support, consortia, grants and loans, and consulting services (Block2008; Nahm2021). “Winning coalitions” of businesses, investors, social movements, workers, and political beneficiaries may form around growing green industries, which may then increasingly marginalize transition losers (Meckling etal.2015). Through the logic of positive policy feedback (Béland etal.2022), green industrial development may 386 Regulation & Governance, 2025 subsequently buy political room for maneuvering to scale down polluting industries (Meckling etal.2017). In the European case, many historical green industrial and technology policies have been devised by member states—sometimes using carveouts, sometimes in open conflict with the bloc's regime to limit state aid to industry. Recently a number of studies have documented green developmentalist initiatives originating at the European level (Cooiman 2023; Mocanu and Thiemann2024; Di Carlo and Schmitz2023; Prontera and Quitzow2021). As compared to perspectives on investment and derisking states, descriptions of a green neodevelopmental state deviate strongly from Majone's characterization of the EU. In the green industrial policy space, states appear to not just return to nonregulatory policy goals but to develop positive state capacities enabling them to actively pick (green) winners. 2.4 | The European Green State and the Problem of Decline There are scattered observations in the literature on green transitions that suggest that contemporary deviations from the regulatory state relate to a distinct additional challenge. Policies appear to play an active role in managing the unwinding of emissionintensive activities and the restructuring of affected communities. We discuss exemplary evidence on problems of governing greeningrelated decline before formulating a systematic take on decline as a green transition challenge. In political economy, Breetz etal. (2018) have suggested that efforts to introduce commercialized green technologies into energy systems shift the politics of transitions toward conflicts over administrative and institutional reform and the redesign of large technological systems. Similar arguments about a distinct “latestage” politics of green transitions have been developed in the specialized transition literature (Geels 2014; Isoaho and Markard2020; Koretsky etal.2023; Turnheim and Sovacool2020). A major problem is that climate policyrelated losses are heavily concentrated in specific regions and industries (Jakob etal.2020). Brauers etal.(2020) have documented the political challenges of phasing out coal in Germany and the United Kingdom. Like any attempt at forced largescale societal change, climate policymaking as a deep socioeconomic transformation tends to turn “noisy” even after initial advances (Patterson 2022). Highlighting sequencing and potential misalignment between the “creative” and “destructive” aspects of transition policy, Thurbon etal.(2023) have shown for the cases of Korea and China how the state has recently taken up the phasing out of fossil infrastructures as a distinctive task beyond green industrial policies. Concerns about the climate changerelated unwinding of socioeconomic structures have risen markedly in recent years—particularly after the Paris Agreement of 2015. In rich Western nations, this is especially true for clusters related to coal mining, processing, and use. There are transnational as well as national aspects to debates about the organized winding down of coal power generation. In the realm of transnational climate change governance, a major concern is how to compensate poorer and mediumincome nations for forgoing the developmental potential of continued (if not expanded) fossil fuel usage and how to rewire exporting nations' growth models (Edwards2019). Across countries, the relationship between assets deemed as “stranded” due to climate change and states is anything but uniform, as states can be major direct and indirect owners of fossil assets and infrastructures (Babic etal.2022; Semieniuk etal.2020). For the case of the European Union, an emerging research literature investigates notions and practices of Just Transition. While hitherto largely a normative debate about the need for redistributive logics in green transitions (Newell and Mulvaney2013), a range of recent policy initiatives picks up the language and compensatory focus of the debate for policymaking. Bradlow and Swamidurai (2024) show how the recent proliferation of “Just Energy Transition Partnerships” between Global North and South countries is heavily tilted toward phaseout policies. Compensatory transfers are effectively tied to decommissioning commitments, rather than to developmental projects. Volintiru and Nicola(2024) have documented how European institutions have inserted themselves into the Romanian policy process to restructure the miningintensive Jiu Valley through the EU Just Transition Mechanism. They show how European compensatory resource flows are tied to local investment projects with high technical planning requirements and highly uncertain restructuring outcomes. The systematic problem research on restructuring in energy transitions points to is that common notions of green transitions emphasizing the stateled manipulation of relative prices operate with a reductive notion of socioeconomic change. Notions of green transitions in which societies fluidly and proactively adapt to predicted futures of cheap green and expensive carbonheavy energy vastly underestimate the inertia of socioeconomic structures. This is all the truer as green transition policies target the unwinding of socioeconomic structures that are viable, provide for economic livelihoods, and sustain community life on an ongoing basis—not to speak of the hitherto extremely prosperous and profitable sections of the global fossil fuel economy (Christophers2022). In this sense, we suggest understanding policies easing, managing, and planning greeningrelated decline as forms of the incremental coping of policymakers with the fact that greening policies aim to transition complex societies, rather than systems of economic stocks, flows, and price signals. In a process reminiscent of Polanyi's(2001, 88) take on 19thcentury British social reforms, policymakers can be thought to “discover society” through problems of social resistance to (green) socioeconomic change. The process of institutional layering we describe in our case study below represents a sequence of piecemeal attempts to establish socioeconomic and political room to maneuver in order to decarbonize. Transition measures targeting decline often overlap with the policies described in the literature on the investment, derisking, and entrepreneurial state, but have distinct politicaleconomic logics. In terms of social coalitions, as compared to notions of the green entrepreneurial or innovation state, a decommissioning state aims at providing societal legitimacy for structural change, rather than at the development of new technologies or the growth of green profits—and thereby the creation of “winning coalitions” (for a similar take on industrial policy, see Katzenstein1985). In 387 this sense, the decommissioning state we are describing is “picking losers,” rather than “winners.” As compared to the derisking state, a decommissioning state becomes administratively active in regional and sectoral restructuring, rather than through financial incentives. And as compared to the investment state, policies aimed at decline have distinct compensatory and restructuring logics and involve direct government planning. In the following section, we build on this notion of decline as a transition challenge by showing how the European regulatory approach to climate policy has been incrementally perforated by measures for green restructuring. Important examples are transfers to declining regions and a planning repertoire targeting specific regions and industries, developing roadmaps for resource and workforce shifts, and establishing local expertise in the management of green transitions. As we show in the following section, fiscal and administrative capacity for decommissioning, as it has emerged since the mid2010s, has been instrumental in reforming the EU's emissions trading system and has become a key part of the bloc's climate policy toolkit. 3 | Case Selection: The EU as a Green State Situating the EU in the universe of 21stcentury greening states is not straightforward. It requires situating the EU in both the climate policy and the industrial policy universes of cases. In the early 2010s, the European Union would undoubtedly have qualified as one of the “most advanced cases” of climate mitigation policy due to early participation in transnational climate accords and attempts to implement an emission trading scheme. It would hence constitute a primary target to study the latestage political economy of green transitions. By the mid2020s, the bloc's slow and troubled response to U.S. and Chinese green industrial policies appears to make it more of a laggard. We contend, however, that the EU's unique position in rolling out the “sticks” in conjunction with the “carrots” of climate change mitigation policy has given rise to another set of policies aimed at managing the decline of regions and sectors of a carbonbased economy. Across the world, we increasingly see that the political viability of climate policies depends on the state capacity to manage the politics of green transitions. Here, the early European experience is arguably important for the transitions states elsewhere face in the future. The problems of situating the EU as a climate policymaker are compounded by its distinct role in economic and industrial policy. The analysis of the EU as a statelike structure has recently given rise to debates in political science (Kelemen and McNamara2022). Particularly in fiscal and administrative terms, the EU remains uniquely weak given the breadth of its policy mandates. Furthermore, the bloc represents a major exception in industrial policy terms in that it formally abandoned vertical industrial policies as distortionary of the Single Market during the 1990s (Thomas2000). Nevertheless, the bloc has had extensive policy experience with declining industries and regional restructuring and hence with industrial policies seeking to manage the reallocation of resources (Warlouzet2019). While the EU can hence hardly be seen as “representative” of green states around the world, its policies respond to structural problems of green transitions facing polities all around the world. In this problemcentered sense, we discuss the EU as an illustrative case of a regulatory state resorting to more interventionist, granular toolkits to phase out the carbon economy. The systematic contribution of this article is to document and situate the rise of policies aimed at green structural change. Methodologically, then, it provides a “formation story” (Hirschman and Reed2014)—an account of the emergence of a policy repertoire—of what we argue is a distinctive set of instruments aimed at managing decline. Our data consists of primary material from hearings, public consultations, speeches, and reports published by DG REFORM and other parts of the European Union. Our reconstruction of the earlier phases in the ETS draws from secondary literature and selected Commissionlevel policy documents. 4 | Planning Like a Regulatory State: The Case of the ETS Reform Since the mid2010s, the EU's climate policies have increasingly strayed away from a predominantly regulatory approach and adopted industrial and regional policy repertoires. Many of the EU's earlier climate policies aimed for single marketwide harmonization and the primacy of horizontal, regulatory policy instruments. The crucial instrument with which the Union sought to harmonize green energy transition efforts across the continent was (and is) the European Union ETS—a capandtrade system formally devised in 2003 and operational since 2005. This section traces how the politicaleconomic logic behind the push for regulatory harmonization through the ETS ran into political roadblocks. Over time, the focus on regulatory priceshifting through the ETS has gradually been complemented by more interventionist green policy initiatives. These have partially been described as the rise of a green investment, derisking, and innovation state. What gets overlooked in such accounts are efforts deploying significant administrative and fiscal facilities to dissociate European societies from carbonintensive economic activities. This section describes the importance of capacity building to manage decline as a critical building block of the EU's transition governance. To illustrate the incremental nature of policy change, our analysis is structured in a chronological way, documenting the gradual layering of programs onto the original regulatory regime. 4.1 | The ETS and the Regulatory State in European Climate Policy The dominance of the regulatory state in EU climate action rests on three pillars: the European Commission's longstanding concern about cost efficiency and harmonization in the environmental field, the complex and extensive system of European emissions trading, and the bloc's legacy of rolling back member state interference in the energy sector. We provide a very cursory account of the ideas tied to the ETS to lay the groundwork for situating the novel characteristics of the EU's recent transition policies. The European Union has been a key actor in international initiatives to mitigate climate change (Bäckstrand and Elgström2013). At the same time, blocwide policies to meet international 388 Regulation & Governance, 2025 commitments seemed for many years to fail. The European Commission had been pushing for a European carbon tax since the early 1990s (called an “energy tax” in 1997). Besides the goals of expanding the EU's reach in environmental and fiscal terms, the early proposals for a carbon tax were motivated by the idea of establishing “efficient” and “coherent” instruments to combat climate change (van Eijndthoven2011). Historiographies of the 1990s push for European carbon taxes share the assessment that the proposal failed politically due to business lobbying and reservations among member states (Newell and Paterson1998; Skjaerseth1994). Notwithstanding the defeat of taxbased proposals, the concerns about efficiency and harmonization strongly shaped future policy rounds in the climate field. The major followup project to the European carbon tax was the European system for emissions trading. In the EU context, emissions trading got its first mention in a 1992 report on environmental degradation, which identified it as a line of action to “[i]ntroduce [c]arbon emission trading permits to set up a global market” (European Commission1992). Commission support for the instrument picked up in the late 1990s, originally as an escape route from carbon tax proposals (Dreger2014, 30; Skjaerseth and Wettestad2016). Crucial for our case study, emissions trading proved highly complementary to the EU's focus on “horizontal” and “nondistortionary” policies, in which climate change mitigation would not open the door to renewed discretionary member state interference with the Single Market. As described in a Commission green paper in 2000: … a coherent and coordinated framework for implementing emissions trading covering all Member States would provide the best guarantee for a smooth functioning internal emissions market as compared to a set of uncoordinated national emissions trading schemes … [A] Community approach is necessary to ensure competition is not distorted within the internal market … [while it] should also be ensured that Member State initiatives do not also create undue barriers to the freedom of establishment within the internal market (European Commission2000, 4–5). Since its initiation in 2005, the European Union ETS has grown into the global frontrunner experiment with capandtrade to combat climate change, and it remains one of the world's largest artificial markets for trading rights to pollute. As an evolving policy, the ETS has been devised in multiple “phases” through which the EU has tried to expand, adjust, and reorient the regime over time. We discuss major milestones of ETS development to demonstrate how resistance to the administrative pricing of emissions created the political space for experiments with vertical policies and the creative repurposing of existing institutions for managing decline. 4.2 | The Regulatory Spirit and the Initiation of the ETS Phase 1 of the ETS, from 2005 to 2007, has been called the pilot or experimental phase. The ETS was the first major EUled intervention in European energy systems after the coordinated deregulation of the electricity and gas sectors that began in 1996. A crucial starting point for understanding the spirit of the ETS as an energy policy is the liberalization process. Indeed, liberalization and emerging centralized emissions allocation have been discussed as the major successive landmarks of European statebuilding in the energy domain (Jegen and Mérand2014). Still in the 1990s, energy generation and distribution were among the major fields of state intervention and nonmarket coordination in EU member states. National and regional monopolies, extensive state ownership, deeply interwoven crossownership across the sector, and routine interestgroup bargaining were the norm across much of the continent (Matláry1997). Historical accounts of energy market liberalization have usually portrayed it as the result of memberstate bargaining—particularly between France, Germany, and the United Kingdom (Matláry 1997; McGowan1993). As illustrated by Eising and Jabko(2001), EU electricity market liberalization was embedded in a larger normative shift across the continent, which redefined common notions of good governance toward transnational market organization and horizontal industrial policy. This did not rule out attempts by member states and dominant firms to use deregulatory tools as a basis for hidden industrial policy measures, particularly through national champion policies and forms of formal privatization with continued state influence (Bulfone2019). Notwithstanding such hidden deviations, public utility notions of energy provision, as well as the plethora of traditional member state interventions in the sector, were redefined as “barriers” to a single market for energy enabled by transnational regulatory frameworks. As in other domains, European statebuilding in the energy sector had a dominant “negative” tilt (Scharpf1999), in that it consisted of the institutionalization of regulatory powers with the explicit purpose of rolling back member state interference in energy. This tilt has also influenced the EU's policy styles in the climate arena. The bloc's translation of international climate accords into EU directives (such as the Kyoto 2020 goals into Directive 2001/77/EC) expressly left space for member states to implement their own instruments in pursuit of decarbonizing the energy sector. The European innovation or neodevelopmental state in support of green energy technologies had for years been growing in parallel to the ETS as the centralized regulatory tool. “27 Member States operate 27 different national support schemes,” a 2008 summary report stated, raising concerns over potential market fragmentation and inefficiencies (European Commission2008). While accepting in principle member states' pursuit of green technology development, the Commission for years expressed concerns that decentralized subsidy schemes for renewable energy sources could shield sections of European electricity production and use from market mechanisms and thereby undermine the single market (Leiren and Reimer2018). Aligning with the spirit of the 1990s plans for the institutionalization of a single market for energy, selective benefits for renewable sources, for example, were routinely framed as “distortions” in European public policy debates (Gawel and Strunz 2014; Lehmann and Gawel2014). Accompanying a 2008 push to expand “marketbased instruments” to further environmental policy domains, the Commission stressed their twosided benefits for regulatory statehood: 389 “[b]esides their merits in helping achieving specific policy goals, the EU has used marketbased instruments to avoid distortions within the internal market caused by differing approaches in individual Member States, to ensure that a similar burden falls on the same sector across the EU and to overcome potential adverse competitiveness effects within the EU” (European Commission2007, 3–4). While there has arguably been further accommodation with regard to member state greening schemes throughout the years, DG Competition and DG Energy continued to advocate that member states limit vertical policies in favor of EUwide carbon pricing (good insight into the spirit of regulatory concern with decentralized greening policy repertoires can be found in the 2014 Commission state aid guidelines for green energy support, 2014/C 200/01). To summarize, core parts of European statebuilding in the energy arena were based on the paradigm of single marketenabling regulatory harmonization and, above all, on the idea of centrally orchestrated priceshifting. European green technology policies—the European green innovation state—grew in a fragmented fashion in member states. From the perspective of the European regulatory state, vertical policy measures, such as green technology policies, public ownership, sectoral subsidization, regional policies, and industrial targeting, were often treated as temporary matters of member states and potential obstacles to a functioning single market as well as to costeffective climate policy. 4.3 | Gradualism, Leakage, and Overallocation As a “single marketcompatible” approach to European greening policies, the ETS was meant to achieve compliance with transnational greenhouse gas reduction commitments by raising the cost of carbon throughout the EU. While the ETS would in theory bring immediate cost pressure to the EU's carbon economy, phases 1 and 2 of the regime were kept decidedly unencompassing. The ETS traditionally excluded important sectors such as aviation, issued extensive free emission allowances based on historical levels of pollution (and hence historical levels of technology), and was for a long time very slow in making good on the “cap aspect” of capandtrade systems (Skjaerseth and Wettestad2016). At times, the “economic growthcompatible” implementation of the ETS was decried as a form of hidden industrial policy, particularly for energyintensive sectors. At a minimum, the ETS's early evolution was characterized by high levels of gradualism in that it had a certain sectoral or politicaleconomic logic of only incrementally including societal emitters deemed politically more difficult to decarbonize (Genovese and Tvinnereim2018). A similar gradualist logic appeared in 2008 stipulations that granted free allowances to the power sectors of 10 eastern European member states for emitting facilities initiated before 2009 (Müller and Slominski2013, 1436). In a similar vein, the Commission responded to concerns about “carbon leakage” in globally competitive markets as a justification for the overallocation of allowances in the late 2000s (Rehn 2008). Based on extensive stakeholder consultations, the ETS has spared sectors “deemed to be exposed to a significant risk of carbon leakage” from having to purchase emissions allowances since 2009 (European Commission2009). The associated list of sheltered sectors has been amended multiple times since 2009 and still comprises 63 industries for the period of 2021–2030. By some estimates, the overallocation of EU allowances to industry between 2008 and 2020 amounted to around 1.1 billion allowances, representing a potential transfer of up to around €90 billion at current ETS prices (PellerinCarlin etal.2022). While these and other early perforations of the ETS as a regulatory tool implied a certain sectoral logic, we would caution against understanding them as vertical instruments in the early ETS. They represented “common strategies of grandfathering, postponed implementation, and phased or graduated implementation” visible in all kinds of policy fields to appease policy losers (Trebilcock2014, 156). The process of layering of vertical repertoires we aim to highlight by contrast consists of active transition work in losing regions and sectors. Particularly in the years after the Global Financial Crisis and the Eurozone crisis, the ETS slid into a deep crisis. Initial overallocation paired with the decrease in demand for emission allowances due to the recession led to a collapse in prices for emission allowances (see Figure1). The result was that the Commission feared that the logic of priceshifting to accelerate green transitions was increasingly undermined, as carbon prices at the turn of the decade were not “painful” enough to incentivize reallocation: the lowcarbon transformation and innovation effect has been compromised. New but not yet fully commercial technologies … are not progressing toward the market as anticipated or may require more direct support, just as budgetary constraints make this more difficult for governments to provide. By depressing the carbon price, the fall in emissions in the ETS has paradoxically increased the risk of Europe getting locked into too highcarbon investments. This is particularly inopportune considering the size of the capital stock still to be replaced this decade (European Commission2012, 5–6). FIGURE 1 | The development of EU ETS spot market prices, 2005–2021. Source: International Carbon Action Partnership (2023). 390 Regulation & Governance, 2025 While most of the EU's policy initiatives at the time continued to advocate the ratcheting up of carbon prices and expansion to excluded sectors, attempts to revive the ETS met massive political resistance in the aftermath of the crises and austerity measures after 2008. Observers repeatedly pronounced the ETS dead when a Commission proposal to temporarily reduce the number of allowances failed to pass the European Parliament in early 2013, not even reaching the Council for deliberation (Wettestad2014). At its lowest level, the price of emission allowances hit €2.50. It was arguably this state of blocked reform, coupled with a changing international environment, that gradually gave way to more vertical transition policy repertoires—European transition policies aimed at the restructuring of specific regions and economic sectors—as well as an incremental tightening of the ETS. 4.4 | Post2014: ETS Reform and the Political Problem of Decline This section traces the development of EU climate policy from the stasis around 2014 through the creation of the Just Transition Fund and DG REFORM, illustrating how the EU has incrementally layered new policy instruments and administrative capacities onto its existing regulatory framework to deal with the management of declining industries and the phaseout of fossil fuels. The 2014 European Council conclusions on the 2030 climate and energy policy framework set the political guidelines for the ensuing ETS reform. While reaffirming the centrality of the ETS as the primary instrument for reducing greenhouse gas emissions, the European Council also laid the groundwork for new mechanisms that would later evolve into more interventionist and sectoral policies (European Council2014, 1–3). The European Council conclusions outlined three key elements that would shape future policy developments: A Market Stability Reserve (MSR) as suggested a few months earlier by the Commission to reduce the surplus of emission allowances; a new fund aimed at upgrading energy systems in lowerincome member states using ETS revenues; and an expansion of the use of ETS revenue focused on supporting innovative lowcarbon technologies through projectbased financing. Building upon the European Council's framework, the Market Stability Reserve (MSR) was introduced as a mechanism to address the longstanding issue of allowance surplus in the ETS. The MSR was initially proposed in 2014 and negotiated over the following years, with the legal basis established in 2015. However, a significant reform of the MSR was adopted in early 2018 and formally approved later that year. The MSR began operating in January 2019, with its key features fundamentally altering the nature of the capandtrade system by endogenizing the emissions cap (Beck and KruseAndersen 2020). Prior to this reform, the EU ETS operated with a fixed, politically determined cap on emissions. The MSR changed this by making the cap responsive to market conditions, specifically the allowance surplus. Under the new system, when the allowance surplus exceeds 833 million, a percentage of allowances are absorbed into the MSR, effectively reducing the available supply. Conversely, if the surplus falls below 400 million, allowances are released from the MSR. This dynamic adjustment mechanism aims to stabilize allowance prices and improve the system's resilience to supply and demand imbalances. Crucially, the 2018 reform introduced a cap on the MSR itself, stipulating that from 2023 onward, any allowances in the MSR exceeding the previous year's auction volume would be permanently revoked. This endogenized the cap and effectively severed the link between policy interventions and the number of allowances. The consequence was that through these interventions the ETS actually started to bite (see Figure1). As a result, the problem was no longer that the ETS did not work, but rather that it promised to work, prompting activity to actively plan transitions. The legislative process around the ETS reform, unfolding since 2014, reveals a twofaced nature. On the one hand, the Modernisation and Innovation Funds represented initial steps toward more granular interventions in specific sectors and regions, moving beyond the regulatory logic of the ETS. From 2010, the ETS included a small program called NER 300, which repurposed a minor share of the revenues from allowances auctioned to fund demonstration projects for lowcarbon technologies. During two selection stages, NER 300 funded 39 projects with a total of €2.1 billion (Marcantonini etal.2017). The Innovation Fund was meant to significantly scale up this model by providing greater funding and by propagating the use of more diverse financing instruments. It signified a spirit that deviated from the regulatory vision underlying the single European price for carbon. In the latter, increased costs for carbon would—through marketled adjustment—induce lowcarbon innovation and the reallocation of resources. In the realm of the Innovation Fund, by contrast, European institutions would (directly or indirectly) fund green industrial activities in member states on a project basis. The final implementation of both funds was subject to intense political negotiation. The debate about the Modernisation Fund, targeted at poorer eastern European member states, centered on the question of to what extent funds would be allowed to be spent on coal power plants and gas generators. The final agreement contained language limiting the fund's purpose to the modernization of energy systems and precluding primary generators from burning solid fossil fuels—with limited carveouts for lowincome member states (Wettestad and Jevnaker2019). Both funds were subject to consultations with business sectors, experts, and other societal groups. The summary report on the initial 2017 expert hearings in preparation for the Innovation Fund hinted at the problems of business reluctance to shoulder the risks of green technology development highlighted in the literature on the green derisking state: groups pleaded for the funds to be used to finance and insure risky ventures (Climate Strategy and Partners2017, 16). The Innovation and the Modernisation Funds have massively expanded in size and sophistication since their initiation—not least due to the revived ETS actually laying open a source of quasifiscal space. The Innovation Fund's net assets grew from €1.33 billion (50 million allowances) at the end of 2020 to €4.14 billion (through an additional 40 million allowances) by the end of 2021 and €5.43 billion (through an additional 15 million allowances) by mid2022 (European Commission2022a). 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