Economics and politics - comment and analysis

Why the market approach fails to lower greenhouse gas emissions. Part 3: Solutions

Why the market approach fails to lower greenhouse gas emissions. Part 3: Solutions

  1. Introduction

We had macroeconomic dysfunction for the last 40 years. Financial deregulation has been plaguing the world since the mid 1980s. We had the introduction of the market approach in literally everything, from education (students are ‘customers’ of knowledge who ‘invest’ in a degree), to health care (patients are ‘clients,’ that is, if they can pay) and labour markets (the unemployed are ‘clients’ of activation policies). The ‘market’ ran supreme in ‘free’ trade, energy, transport, housing, utilities, development, the arts and much more. Now both the IMF and the OESO say that it does not work, that it went ‘too far,’ (sic) that austerity is counterproductive to growth (see here and here). The IMF writes that the introduction of markets in the developing world lifted tens of millions out of poverty. This is not true, as Jason Hickel recently explained in the Guardian (see here).

The market approach also dominates climate change policies. As a result, we lost thirty critical years. The rich countries sabotaged climate change mitigation for decades. This battle is far from over. The worst possible scenario is that the market approach will continue to dominate climate change governance. There are signs that this will be the case. The IMF as well as the World Bank and the OECD favour carbon trading (cap and trade) (see here). China will introduce a nation-wide ETS-like (European Trading System) in 2018 (see here). If carbon trading is all we can come up with we will surely miserably fail (see here).

Thankfully, there is a lot of resistance. James Hansen argued that policies to trade carbon permits will only make money for banks and hedge funds and allow ‘business-as-usual’ for the chief carbon-emitting industries (see here). Market based climate policy, as it has been understood since the Kyoto Protocol, failed to produce significant real world reductions in emissions of GHGs. The model of carbon trading is structurally flawed. Chris Hope from Cambridge University calculated that for the ETS to work, the minimum price needed is about £85 per tonne, rising at roughly 2 to 3% a year. Prices now stand at roughly £9.50 per tonne of CO2 – 9% of what is needed and after the ETS price crashed already twice (see here). Calculations by the IMF give a lower figure, $ 42 a tonne of CO2 – still ca. 4.5 times higher than the current ETS price. Hope concludes that a market-based trading system is very unlikely to generate consistently high prices. This inability undermines the whole point of the scheme. The reason why is clear. As Stiglitz writes, the problem is that ‘Of course, polluting industries like the cap-and-trade system. While it provides them an incentive not to pollute, emission allowances offset much of what they would have to pay under a tax system’ (see here and here).

Efficient action against climate change is impossible without the developing countries. But why would they agree to cap-and-trade that gives companies the right to buy pollution credits from projects in the south? Most of the carbon credits being sold to industrialised countries come from polluting projects, such as schemes that burn methane from coal mines or waste dumps. This is not a strategy for reducing emissions. Tree plantations, meant to offset emissions in the developed world, often drive people off their lands and destroy biological diversity without resulting in any progress. This is a very far cry from international cooperation. Many developing countries are saying no to these schemes and rightly so.

Excellent proposals have been made for decades. They have been systematically ignored. David Wilson argued for the introduction of a carbon tax in 1973. U Thant, the third Secretary General of the United Nations, warned the world in a plenary session of the United Nations against climate change in 1973, urging countries to lower CO2 emissions. Hansen’s testimony about man-made climate change before the American Senate dates from 1988 (see here). Meyer published his Contraction and Convergence plan in 1989 (see here). Of course, Tyndall proved the existence of greenhouse gases and the possibility of a greenhouse effect in 1859. It is basic physics: increase atmospheric GHGs and temperatures will start to rise. The world has to end its subsidies to fossil fuel companies. Carbon taxes need to drive polluters out and a complete industrial and infrastructural reconversion has to take place. Developing countries need to be given assistance and some time to eradicate the most outspoken poverty and build up resilience and human welfare, even if this temporarily increases their carbon footprint.

  1. What needs to happen?

If the world stops subsidising fossil fuels companies and instead invests in renewables and CO2 neutral technologies it is (presumably) possible to bring GHGs back to ‘safe’ levels. An IMF study How Large Are Global Energy Subsidies from May 2015 estimates that the world subsidises the fossil fuels industry at $ 5.3 trillion a year (see here). This is ca. 6.5% of global GDP. (The breakdown per country or region is China $ 2.300bn, the US $700bn, Russia $335bn, India $277bn, Japan $157bn and the EU $330bn.) The IMF calls this figure an extremely robust estimate of the true cost of fossil fuels.  Stern from LSE contests the IMF’s figure, portraying it as a significant underestimate. The sum is greater than the total health spending of all governments together (see here).

The IMF figure reflects to a very large degree the fact that polluters are not playing ‘the true ecological price,’ but impose it on each of us instead. Reform would increase energy costs, but both the IMF and the World Bank note that existing fossil fuel subsidies overwhelmingly go to the rich, with the wealthiest 20% of people getting six times as much as the poorest 20% in low and middle-income countries. If we want to avoid catastrophic and irreversible climate change, new reserves of oil, gas and coal must be left in the ground. Today, however, a lot of the subsidies highlighted by the IMF go toward finding such reserves. Nothing is being done about this. Christiana Figueres, the UN’s climate change chief referred to the IMF study at pre-COP21: ‘The IMF provides five trillion reasons for acting on fossil fuel subsidies. Protecting the poor and the vulnerable is crucial to the phasing down of these subsidies (…) the multiple economic, social and environmental benefits are long and legion’ (see here). The latest Climate Change Agreement (COP21) was signed in December last year. It aims to keep global average temperature rise below 2 degrees C by 2100. The words ‘fossil fuels’ do not appear in the final document of COP21. That is outright criminal.

  1. A carbon tax

A carbon tax levies a fee on the production, distribution and/or use of fossil fuels based on the amount of carbon that they emit. Hansen argues to tax producers (when products leave mines or factories or at the entry point at ports). The tax makes fossil fuels more expensive and therefore encourages utilities, businesses and individuals to reduce production and consumption while making renewables more competitive. From an economic perspective, carbon taxes are a Pigovian tax. Pollution is a negative effect on a party that is not directly involved in a transaction. To confront parties with the issue, Pigou proposed taxing the goods or the infrastructures (his examples – from 1920 – deal with the externalities of factories and the sale of alcohol), which are the source of the externality so as to accurately reflect their cost to society.

The theory of externalities gave rise to the study of the social cost of carbon (SCC). The SCC refers to the marginal cost of emitting one extra tonne of carbon at any point in time. To calculate the SCC, the atmospheric residence time of CO2 must be estimated, along with an estimate of the impacts of climate change (see here and here). Ideally, a carbon tax should equal the SCC. Estimates differ enormously from one author to another. Estimates of the SCC have an average of $43/tC with a standard deviation of $83/tC in the peer-reviewed literature. Some have put the SCC at over $ 1.500/tC (see here). It depends upon uncertainties in climate change science, different valuations of economic and non-economic impacts, treatment of equity and the estimation of potential catastrophic impacts (see here). These are un-resolvable problems. Ideally, the SCC estimates the monetary value of world-wide damage due to CO2 (see here). As Ackerman notices, “The profundity of human and ecological loss implied in the portraits of climate change (…) is only cheapened and diminished by pretending that all of it has a price” (see here). Baumol argues that the best solution is to set a minimum standard of acceptability for negative externalities and create tax systems to achieve those minimum standards (see here). The question is of course whether these minimum standards will be sufficient.

A carbon tax is regressive. It negatively affects low-income groups disproportionately. However, it can be made progressive easily. It then positively affects low-income groups disproportionately. Stiglitz is a great proponent of this. As he said:

“There is a way out, and that is through a global environmental tax on emissions.  (…) (E)ach country could (…) (use its) revenues to replace taxes on capital and labour: it makes much more sense to tax “bads” (pollution, like greenhouse gas emissions) than to tax “goods,” like work and saving” (see here).

It is necessary to make carbon taxes progressive. The poor spend a greater proportion of their income on energy-intensive goods and fuel and cost increases impact them more than the rich. If governments retain the revenue from its carbon taxes, the result will be regressive. The straightforward solution consists of redistributing the fee to the public as a lump sum payment. People in the lower income brackets will perceive a positive impact on their household welfare. Companies cannot pass the costs of the carbon tax onto customers. Carbon taxes can be made neutral or progressive from a redistributive point of view at will. The will just has to be there. Needless to say, the neo-classicists disagree.

  1. Neoclassical ‘objections’

One counterargument goes as follows. Suppose that a household consumes a dirty good (D) and a clean good (C) that can substitute for D. The government taxes D and uses the earned revenue to lower the labour income tax. As a result of the tax, the price of D increases. Assume that the lowered income tax and the higher consumer prices cancel each other out. The real wage remains the same and consumers will now prefer C over D. The problem is that the tax base erodes the government’s revenue. The government cannot afford to keep the labour income tax down. Once labour taxes are restored and real wages are falling, some within the labour force will quit working. The conclusion is that a carbon tax decreases output and overall welfare and that labour ultimately bears the cost of public goods (see here and here).

In 1998, Fullerton and Metcalf explained this ‘theory’ more thoroughly (see here). They define the net wage as the pre-tax wage minus the income tax divided by the price of consumption goods.  Any rise in prices for consumer goods or any increase in income tax decreases the net wage and this, in turn, reduces the supply of labour on the labour market.  The reason is that some people will stop working because making less money is no longer worth their time, so overall employment decreases. Neoclassical theory throws at a carbon tax that, yes, it helps to bring emissions down, but output (GDP) and welfare suffer in the longer term and low earners suffer disproportionately. Following this ‘theory’ and some recent economic developments, it is absolutely amazing that anyone is still working. Why don’t we all stop and collectively ‘prefer’ (sic) leisure instead?!

Still, this is what the neo-classicists come up with. Stern famously described climate change as ‘the greatest market failure ever seen,’ meaning, of course, that the market is central to its solution and that entrepreneurs and businesses need to take the lead in correcting this failure, assisted by economists arguing for more market (see here). The main assumptions behind the mainstream have been the subject of systematic ecological critique (see here). Spash went so far as to criticise the concept of externality itself. Given that companies are meant to maximise profits and that individuals seek self-interest, avoiding costs and the pushing of damages onto others is to be expected normal, rational and prevalent. This is how successful economic actors act. To Spash, terming pollution as an externality is to engage in double-speak (see here and here for more information).

There is, in fact, no reason why governments cannot achieve the provision of public goods with revenue-motivated taxes and the protection of environmental quality with corrective taxes. The pursuit of these two goals through taxation can enable government to justify doing more of each. It has also been argued that carbon taxes may lead to an increase of employment (see here).

There are other reasons why a carbon tax is essential. Fossil fuel use can be reduced by shifting towards renewables and by increasing energy efficiency. The first option is much more efficient than the latter.  Instruments aimed at improving efficiency have done virtually nothing to stimulate investment in energy infrastructure needed to eliminate reliance on fossil fuels. For example, the cost of solar energy dropped by about two-thirds from 2009 to 2014, but at the same time, fracking made fossil fuels cheaper and it increased the amount of fuels that can be tapped into (see here). In the US, oil reserves expanded with 59% and natural gas reserves expanded by 94% between 2000 and 2014. Cheaper renewables were outpaced by even cheaper fossil fuels. Currently, battery costs for an electric vehicle are about $325 per kilowatt-hour (KwH). At that cost, it has been calculated that the price of oil would need to exceed $350 per barrel to make an electric vehicle cheaper to operate (see here) In 2015, the average price of oil was $49 per barrel. Apart from this, increased energy efficiency can – and does in certain cases – lead to higher CO2 emissions (see here).

This means that the only real solution – and especially given that time is running out – is a carbon tax.  As Hansen said in 2011, “The essential step (…) is to phase out coal emissions over the next two decades. And to declare off limits artificial high-carbon fuels such as tar sands and shale while moving to phase out dependence on conventional petroleum (…) This requires nothing less than an energy revolution based on efficiency and carbon-free energy sources. (…) There is an alternative (…) and that is a carbon fee (…) I prefer the ‘fee-and-dividend’ version (…) in which all revenues are returned to the public on an equal, per capita basis, so those with below-average carbon footprints come out ahead’’(see here).

  1. Convergence and climate change justice

Contraction and convergence is a structured approach to reduce the concentration of greenhouse gases in the atmosphere to a ‘safe’ level. Contraction refers to the global reduction in greenhouse-gas emissions. Convergence refers to an equal per-capita entitlement to the global emissions budget for all countries. Stiglitz supported this proposal years ago: “The only principle that has some ethical basis is equal emission rights per capita’’ (see here). To Meyer, the architect of contraction and convergence, the one cannot be seen separate from the other. As he said, “Climate change is an issue of survival, and equity is the price of that survival”(see here).

I will not get into the contraction part of Meyer’s plan. He proposes to calculate the global average amount of carbon that each person emits per year and to calculate by how much it has to be cut to stabilise GHGs emissions. The result is each individual’s output threshold to force future climate change. A large part of the world’s population produces GHGs emissions below this threshold and therefore provide a ‘credit’ to the rest of the world. With ‘contraction,’ the poor countries would be enabled to sell these credits to the developed world. This would provide them with income, while in the rich countries the cost of emissions would rise. According to Meyer, no other trading scheme makes ‘markets forces’ work effectively for the poor and against climate change.

It is convergence that is essential. Entitlements need to converge towards equal per capita entitlements across the world, but the pace in which this happens has to depend on certain factors. We cannot demand of developing countries, which are not responsible for climate change, to cut their meager emissions thereby making development impossible in order to stay within the very small carbon budget that is left to the world in order to avoid dangerous climate change, if this still can be avoided, which is very much the question. A phased process is therefore necessary: while there will be a rapid move to equal per capita entitlement of carbon emissions, during the transition period the per capita entitlements of developed countries will decrease while those of most developing countries will temporarily increase. Many experts agree with this. Ideally, given that the industrialised nations are historically responsible for climate change, there should be retribution to poor countries. Meyer accepts this point, but, referring to Mandela, he pleads for ‘Climate Justice without Vengeance.’ This is what Vandana Shiva has to say about it:

“Historically, the major polluters were the rich, industrialised countries, so it made sense that they should pay the highest price (…) (Carbon Trading schemes) are more about privatising the atmosphere than about preventing climate change (…) Carbon trading uses the resources of poorer people and poorer regions as “offsets” for richer countries: it is between 50 and 200 times cheaper to plant trees in poor countries to absorb CO2 than it is to reduce emissions at source.  (…)  The burden of “clean-up” falls on the poor (…) Thanks to industrialisation, the rural poor in China and India are losing out on their land and livelihood. To count them as polluters is doubly criminal. When global firms outsource to China or India, they need to be responsible for the pollution they carry overseas’’ (see here).

Meyer does not disagree, but he finds it ultimately unhelpful. It just leads to a stalemate and there is no time for this.  This does not mean that everything is fine with convergence. Certainly, poor countries should be given the chance to ‘catch up,’ but is there sufficient time left? Obviously, without radical deceleration, we are heading towards disaster. It will never be possible to agree upon a global and efficient plan as long as power relations do not change. The influence of big corporations, fossil fuel companies, banks, defense and aerospace industries is too big. If this would change, many things would become possible, not only contraction and convergence. Instead of relying upon ‘the market’ to transfer resources to developing countries, debts can be reduced or cancelled, technologies can be shared, intellectual property rights can be suppressed, patent laws can be changed. Development aid can be linked to both development and climate change mitigation and made conditional upon democratisation, respects for human rights, the rights and the positions of women, the pacification of ethnic and religious communities and the fight against corruption. The whole point is that power relations need to change. Social scientists act like sorcerer’s apprentices, trying to find the magical formula which will solve the conundrum once and for all. But the conundrum cannot be solved without systemic change.

The fundamentalism of market fundamentalism is that it says to the world that there is only one way out of poverty and dysfunction and that is to emulate the West. It is axiomatic that poor countries are poor because capitalism did not penetrate well enough. There is not the slightest interest for potentially divergent paths of development and speaking out about Western policies that structurally obstruct the developing world from developing is a complete anathema. And so, no progress is being made. Reinert’s critique of the Millennium goals as mere palliative care remains as poignant and relevant as ever (see here).

Meanwhile, in Africa, people mine rare earth minerals under conditions of near or complete slavery. The ores are being refined in India. The materials end up in Chinese factories, while American and European engineers figure out how build obsolescence into mobiles. We buy phones from companies that are among the biggest tax evaders on the planet. Governments do nothing, afraid as they are that the companies would relocate if they did. Several governments do not want Apple and co. to pay their arrears taxes (see here). Eventually, we use the technology to remind our sweethearts to buy advocados harvested in Peru from our local supermarket. Since the climate change top in Rio de Janeiro (1992), no consideration of the impacts of trade on climate change can be addressed in climate change talks. Aviation falls outside any carbon trading scheme and climate change agreements. Fossil fuels and their subsidies are being ignored. Developing countries are used as dumping grounds for our pollution. This madness will stop one day, one way or another. It is up to us to make it stop in such a way that humanity has a future left.