Europe has made real progress on climate action, but one critical piece is still missing. While we regulate emissions and incentivise land stewardship, the tools designed to address climate damage operate in parallel, not as a unified system. The question is simple: who is responsible for restoring the damage caused by pollution?
The Externality Equation provides an answer. It links emissions, restoration, and liability into a transparent, measurable framework that can accelerate Europe’s path to net-zero while supporting agriculture, industry, and trade.
Externalities are the unintended side effects of human activity, costs that fall on society rather than the actor. Carbon emissions are a classic example: they drive global warming, disrupt ecosystems, and reduce agricultural resilience.
Europe’s current climate instruments address emissions and environmental impacts separately: carbon pricing (through the EU Emissions Trading System, ETS), border adjustments (Carbon Border Adjustment Mechanism, CBAM), and incentives for land management (Common Agricultural Policy, CAP). But these instruments rarely connect the emitter directly to the cost of repair.
This is where the Externality Equation comes in: it reframes environmental governance around restoration and accountability, rather than permission alone.
Europe has built a strong climate policy architecture. The EU Emissions Trading System (ETS) remains the backbone of carbon pricing, complemented by new instruments such as the Carbon Border Adjustment Mechanism (CBAM) and the Carbon Removal Certification Regulation (CRCR). Together, they help cap emissions, reduce leakage, and build trust in carbon removals.
In parallel, the Common Agricultural Policy (CAP) has increasingly integrated climate and environmental goals. Recent reforms promote eco-schemes, carbon-farming pilots, and improved soil and methane management.
Yet these two domains - carbon pricing and land stewardship - still operate in largely separate policy tracks. The ETS prices emissions; the CAP rewards sustainable practices. The result is a fragmented approach that treats emitters and land managers differently, even when they contribute to the same climate challenge.
The Externality Equation offers a way to unify this landscape.
Traditional carbon policy assigns the right to emit within regulatory limits. The Externality Equation flips the perspective: it focuses on liability and restoration.Key principles:
By applying a modernised version of the Coase Theorem, the framework provides fairness, legal enforceability, and economic clarity. Emissions are no longer merely allowed, they must be restored.
To operationalise the Externality Equation, the EU would align around five strategic goals:
These objectives build a more coherent and equitable policy landscape.
1. A Unified, Measurable Pathway to Net-Zero
The Externality Equation aligns emissions and restoration in one framework. Agricultural soils, forests, and ecosystems become recognised carbon assets, measurable parts of the solution, not just recipients of subsidies.
2. Market-Driven Investment in Restoration and Clean Technology
By turning restoration into a quantifiable obligation, Europe unlocks a new market for natural and technological carbon removal. This attracts private capital, supports green jobs, and accelerates innovation across farming, industry, and land management.
3. A Fair and Competitive Carbon Economy
Building on ETS, CBAM, and CRCR as an integrated architecture, the Equation ensures:
It also lays the foundation for a carbon passport, providing a product-level environmental profile for global trade that balances fairness, competitiveness, and climate integrity.
4. Incentive Alignment: Rewarding Results, Not Bureaucracy
Instead of compliance checklists, farmers and firms are rewarded for verified impact—real soil restoration, real methane reductions, real carbon removals. This turns climate action into opportunity rather than administrative burden.
5. Transparency, Credibility & Simplified Compliance
Combining emissions and restoration in one verifiable equation reduces fragmentation. Digital tools and independent audits streamline oversight, particularly for diffuse sectors like agriculture.
Europe has the ambition, the tools, and the momentum. The missing piece is integration.
The Externality Equation offers a strategic pathway to
The strategic question for Europe is simple:
Are we ready to evolve from simply reducing emissions to fully restoring the damage we cause?
The authors gratefully acknowledge Janez Potočnik and Milan Petit for their valuable comments and suggestions on earlier drafts of this manuscript. Any errors or omissions remain the sole responsibility of the authors.
Erik Tamboryn is a senior economist and a published author. Marc Rosiers is a senior economist with expertise in the agro-food sector. Milan Petit is steward of the Systems Transformation Hub. Janez Potočnik is co-founder of the Systems Transformation Hub, co-chair of the International Resource Panel, and partner at Systemiq.