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This article seeks to appraise the potential innovation impacts that may be triggered by the European emission trading system starting on 1 January 2005. To this end, our paper provides a review of the theoretical and empirical literature on the potential innovation effects triggered by the pioneering US emission trading schemes (ETS). Our review's basic empirical results are that the innovation effects were initially limited, partially because of lenient or even non-constraining targets in the first years, but there is empirical evidence on a vast range of low-cost compliance strategies. Yet, the substantial body of theoretical literature provides no consensus on the issue of whether or not emission trading generally triggers more innovation than other policy instruments, such as regulation standards. Copyright © 2005 John Wiley & Sons, Ltd and ERP Environment. [ABSTRACT FROM AUTHOR]