Economics and politics - comment and analysis

Why the market approach fails to lower CO2 emissions. Part 1

A carbon price is a cost applied to carbon emissions to encourage polluters to reduce the amount of CO2 that they emit. Neoclassical economists consider the introduction of carbon prices the most effective instrument for the reduction of emissions. I argue that this is fundamentally incorrect. I will cite several problems, all of which are unsolvable within the dominant paradigm. In the second part I will give examples of failed or failing policies. The most important is the European Union Emissions Trading System (ETS), the biggest carbon market in the world. Mainstream economists praised the scheme as an almost ideal instrument to reduce emissions. It looks straightforward on paper: companies buy pollution permits according to prices that are being determined by supply and demand. Companies that pollute less or invest in green technology need fewer certificates or may even have some left over to sell. However, in reality, the ETS is a failure of epic proportions. Instead of reducing carbon emissions or generating low-carbon innovation, it has become a subsidy for polluters. Its distributional effects are incredibly unfair.

The first part does not deal with ETS. When reading, many readers will agree and say ‘of course.’  Hardly anyone talks about this any longer. That does not mean that any of these underlying problems have been solved. The ETS did not fail because there was too much influence from vested interests, although that is certainly the case. The ETS failed because the theory of perfect markets with rational actors and equal bargaining does not correspond to the real world. No such markets exist. The neoclassical market approach is light years away from creating anything close to the institutions we need to address climate change – precisely these institutions for which there is, by design, no role within the neoclassical framework: governments and democratic decision-making.  Before I start, it should be mentioned that combating CO2 is insufficient. CO2 is not the only greenhouse gas nor is it is the most potent one. We need a comprehensive strategy that cut CO2, chlorofluorocarbons, methane and nitrous oxide.

Those who want carbon markets evidently need carbon prices. The two main ways to price carbon are both fraught with error. This explains why prices vary so widely across countries and regions. The US government uses an estimate of $33 per ton of CO2, while Sweden proposes the strikingly high figure of $168. Within the ETS, prices have been around $10, then $7 and, at one point, zero.

The first pricing method tries produce an estimate of all damages that one ton of carbon creates. Then a carbon price high enough to offset these ‘costs’ is being proposed. This method is no longer in use for obvious reasons. It is simply not possible to monetise most damages. No methodologies – such as willingness to pay or willingness to accept (damage) or substitution – ever arrive at a ‘price’ that is even remotely realistic. The whole exercise is nonsensical. How much should CO2 be ‘worth’ on the ‘market’ to prevent the Greenland ice sheet from melting? What will the ecological, economic and social consequences be of the disappearance of the Greenland ice sheet 500 years from now?

Many economists favour a far simpler strategy. They choose a concrete goal (for example, limiting global warming by 2 degrees C by 2100) and subsequently estimate a carbon price that would achieve this goal. But this method does not work either. Who sets the goals that need to be achieved in which period of time on the basis of what? The objective of the world leaders in December 2015 at the COP21 conference in Paris was to limit the rise of global average temperature by 2 degrees C by 2100. The goal of keeping global average temperature below 2 degrees C by 2100 has no basis in science. It is entirely the product of political negotiations. Policy-makers decided, mainly because of their unwillingness and inability to tackle to the problem for the last 30 years, that a rise above 2 degrees C is considered the point at which climate change becomes ‘dangerous.’ Dangerous to whom? Is the situation not dangerous already, for example for low lying islands, for coral reefs, for thousands upon thousands of endangered species, for many countries in Africa and Asia that are either being confronted with severe droughts or extreme floods (or with both, i.e. Pakistan) and see their agricultural yields decrease year after year?

The second problem is that all goals are quantitative objectives. This point also goes to the heart of neoclassical mythology. The problem is that ‘the market’ is incapable of distinguishing between quantitative and qualitative outcomes. Quantitative objectives refer to reductions of emissions within a certain time period. Qualitative objectives are different. They refer to industrial and agricultural reconversion and energy substitution. According to (quantitative) cost-effectiveness, in a carbon market, one ton of carbon absorbed by a tree-plantation is the same as one ton carbon that is not being emitted by a factory. The only difference is price. If the first is cheaper than the latter, the market will choose the first. In other words, carbon markets do not see the qualitative difference between tree-planting and the phasing-out of fossil fuels as mitigation strategies. Cost-effectiveness leads to a ‘rational’ phasing of mitigation measures, beginning with the cheapest solutions like forest protection and biofuel production or to measures that make certain technologies more efficient, while deeper cuts would require scrapping that technology.  Biofuel production, although rational from a partial and quantitative point of view of cost, is completely irrational and counterproductive from the global point of view of basic human needs. This point has been made on several occasions by Daniel Tanuro of La Gauche (see for example here).

There are other problems. It is a fact that our actions and inactions with regards to GHGs will have repercussions on the ecology of this planet for at least the next ten thousand years. Will anyone anytime soon devise a cost-benefit analysis capable of assessing and monetising damage for the next ten millennia? Still, the fact remains that our actions and inactions do affect that future – all other new generations, nearly every living being on this planet, will bear the burden of what we do today.

Such criticisms are being ignored by the mainstream, as everything else which shows the intrinsic limitations of markets. When markets produce nonsensical results, the neo-classicists call it a ‘market failure.’ More often than not, this is a complete misnomer. The market does not fail, it is simply incapable of producing results that are in the interest of society as a whole. Their models assume perfectly operational markets and equal bargaining power by rational actors ‘arguing’ for property rights (permits or quotas). The market will produce the most efficient outcome. Efficient to whom, according to what? Markets are only perfect in books, in reality they are imperfect social institutions like everything else. There will always be trade-offs between equity and efficiency and everybody knows that there is no equal bargaining power anywhere. To the neo-classicists, the reasons for ‘market failure’ are always the same: governments, trade unions, interest groups. But this is just mere pro private sector ideology.

This is also evident in the case of pollution. The buyers and the sellers that meet on markets have opposite interests. Sellers want prices to be high and buyers want them to be low. This is true for all markets. But it is not true for pollution. No one wants pollution. Everybody wants the price to be as low as possible. In fact, the great majority of actors (be they producers or consumers) do not want to pay a price at all. (One can argue that this is not true in that actors are not interesting in trading carbon as a goal, but as a means to continue to live in a liveable world. This assumes that these actors are interested in long term objectives, which they are not. At least, there is very little evidence for this.)

What will be the price of a ton of carbon dioxide or its ‘equivalent’? In the real world, the price will be the result of what the strongest market actors are willing to pay. This does not work. We therefore need non-market actors, such as international governmental organisations and governments. But governments are also interested in a good business climate. They completely depend on it. Apart from the entanglement of corporate interests with government, how are GOs and governments supposed to know whether the pollution prices that they advocate will be sufficient to safeguard us from climate change? It is the same problem as above. The truth of the matter is that carbon pricing will always remain a function of economic feasibility of major global corporations – down to earth economic interests – not ecological considerations far into the future, let alone ecological justice or social justice. Apart from lip service, the social justice component has completely disappeared from the discourse on sustainability (it suffices to recall Lawrence Summers’ dictum ‘Let them eat pollution’ to see this).

Another inherent failure of the market approach refers to the fictional character of market actors. We understand that our pollution imposes huge risks upon future generations. Many people agree that we have a moral duty of leaving behind a habitable world to those who come after us. But how far do we need to go in this? We don’t know. It is extremely likely that future generations want us to implement extremely efficient policies. Shall we leave the world in such a state that it will still be possible for the world population to have sufficient drinking water in 2300? How should we approach this? Should it matter to us that humans in 2300 can still enjoy the pleasure of watching elephants in the wild or should we leave videos behind? Which neoclassical genius will ‘calculate’ the monetary value of watching elephants in the wild as compared to watching these extinct creatures on a computer screen? These are not silly questions. Climate change policies bring a large range of ethical issues to the fore. Any estimation of ecological and social costs implies value judgements.  There is no consensus over how to value equity, on how to share the burden of costs for mitigating climate change and deciding upon the welfare of current and future generations (of course both intra- and intergenerational equity is at stake). Nor, it should be said, do economists have professional expertise in making ethical decisions. Nor, in fact, does anyone else. Ideally, such decisions should be made by the world community in democratic fashion, but that certainly will not happen.

I do not know what future generations want either, but it cannot be a big secret and both logic and the present provide ample clues about their ‘preferences:’ millennials increasingly hold the post-WWII baby boom generations (from the 1950s and 1960s) responsible for leaving them behind on a polluted, impoverished and dysfunctional planet. What will young people in 2100 say about how we managed earth’s heritage, our common ground? What are people in the poor countries saying today about how the developed world exhausts resources for which there are no substitutes and creates global pollution?

You can read in part 2 how the European Union Emission Trading Scheme and the European Clean Development Mechanism are structuring policies so that European companies are able to satisfy their commitments using ‘clean’ investment credits from outside the union without reducing their own emissions. The World Bank, the IMF and the OECD are all pushing for the creation of carbon markets. A joint new report to this effect was published by these institutions a few months ago. The EU’ Emissions Trading System covers 2 GtCO2e (equivalent) of emissions. It is the biggest system in the world so far. Even so, the great majority of emissions (85 percent) are priced at less than US$10 per tCO2e, far too low to make an impact. Globally, the existing schemes are now worth ca. $ 50bn. About 40 countries and 23 cities or regions use carbon prices. This still only represents ca. 12 percent of annual global CO2 emissions. Meanwhile, as I will explain in part 2, CO2 and other emissions are rising and not despite carbon markets, but, in part, because of them.