How to make a carbon pricing system work
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Carbon pricing is a good idea whose time has not yet come. But it has to do so. The world committed itself to keeping average temperatures at less than 2°C above pre-industrial levels and ideally to less than 1.5°C at the Paris climate conference in December 2015. If it is to achieve this goal, it will find the price mechanism the most powerful weapon in its arsenal.
Prices affect people’s behaviour powerfully and systematically. A price — via a cap and trade system or via simple taxation — on the carbon content of fossil fuels would influence the choices made by all producers and consumers of goods or services that demand commercial energy in their production and consumption. That is just about everything in a modern economy.
Moreover, carbon prices can achieve this outcome, without reliance on top-down command and control. They would also raise revenue, which governments can use to offset the burden of carbon pricing on vulnerable or badly affected groups, and promote investments in climate change mitigation and adaptation.
This combination of simplicity, comprehensiveness and effectiveness makes carbon pricing an ideal way to help bring about needed long-term changes in behaviour, across the planet. Yet, for all these virtues, progress has been limited.
On the positive side, according to the World Bank, 42 national and 25 sub-national jurisdictions now put a price on carbon emissions. However, 85 per cent of global emissions are still not covered by carbon pricing. Moreover, even where it is in effect, price levels are mostly significantly below the $40-$80 per tonne of CO2 by 2020 and $50-$100 per tonne of CO2 by 2030 recommended in the 2017 Report of the High-Level Commission on Carbon Prices, chaired by Nicholas Stern of the London School of Economics and Columbia University’s Joseph Stiglitz.
In all, in scope and scale, the carbon pricing now in use falls far short of what is needed to reach the globally agreed targets. So why has the adoption of carbon pricing been far less widespread and effective than it needs to be?
One explanation is that some jurisdictions — notably, the US of Donald Trump, at least at the federal level — reject the argument for tackling climate change. So Mr Trump has now repudiated commitments made by his predecessor’s administration, on the grounds that this would damage US growth.
Cap and trade
A government sets a ceiling, or cap, on the total amount of carbon emissions it will allow in a certain time period. Companies who want to increase their emissions must buy permits from those companies who are polluting less.
A fee imposed by the government on each tonne of CO2 emitted by companies. Simpler to implement than a cap and trade system, but less popular with companies.
Inevitably, this decision by the world’s second-largest emitter (after China) undermines the willingness of others to act effectively, partly because such freeriding on their efforts is unfair and partly because it increases the costs they have to bear, to achieve a given global outcome.
Another reason for the limited adoption of carbon pricing is that even countries which have made commitments to lower national emissions may not mean what they said. A rhetorical commitment is one thing; unpopular action is quite another. Such reluctance is inevitable. It is always hard to persuade people to pay a price for something they have historically received for free. The atmospheric carbon sink is a perfect example.
The complaints of the losers will also be loud. Some of those adversely affected by high prices on carbon emissions are relatively poor people who live in rich countries that depend on energy-intensive lifestyles, for example low-income Americans who need to drive. Still more politically potent are energy-intensive industries. The latter complain about the impact of higher energy costs on their competitiveness and threaten to move production to countries with lower costs. That makes the goal of reducing emissions even harder to reach.
This underlines a fundamental difficulty. The simplest of all policies would be to have a single global price. However, this requires agreement on that price (or tax or cap-and-trade system), which is impossible in practice and also raises questions of equity, in the absence of an efficient system to compensate losers who are poor.
In practice, prices are set nationally. Moreover, the obligations on rich countries, with higher historic emissions, higher emissions per head today and a larger capacity to protect their citizens from ensuing costs, are rightly greater than those on poorer ones. With differential obligations go differential policies. This adds to the likelihood that carbon pricing will be evaded.
Could pricing be made more effective? Any policy change must come quickly, or it will be impossible to remain under the recommended temperature ceilings. To speed adoption, governments need to promise to use some of the revenue they raise from carbon pricing to lower other taxes and, above all, compensate some of the hardest hit.
Also, carbon prices would not need to be quite so high if governments introduced complementary policies. Among the most important policies of this kind will be the elimination of subsidies to fossil fuels — effectively negative carbon taxes and estimated by the International Energy Agency at $493bn in 2014. Other complementary policies will be changes in the planning of urban development and of new energy-related infrastructure, along with higher regulatory standards on fuel efficiency.
Within the general approach of letting each country meet its own objectives in its own way, via “nationally determined contributions” (the only workable approach), countries can make up their own minds about whether to opt for a carbon price, a carbon tax or a cap and trade system. They may also create hybrid versions. Nonetheless, the notion of agreeing a global price system has obvious merits. A promising compromise, under discussion, is to link up the various national (and European) pricing schemes, on a voluntary basis.
A big practical and political difficulty is what to do about those who refuse to participate in the endeavour. To make the proposed carbon pricing schemes work politically, sanctions for the recalcitrant — countervailing tariffs, perhaps — will need to be considered. Otherwise, freeriding will make hitting the goal far harder.
Until now, therefore, carbon pricing remains a sleeping giant. Yet needed progress will not be achieved if it does not awake. The difficulties in meeting agreed objectives in our fractured world are enormous. The chances are high that the effort will fail. If so, our goose will be cooked.
50 ideas to change the world
We asked readers, researchers and FT journalists to submit ideas with the potential to change the world. A panel of judges selected the 50 ideas worth looking at in more detail. This fifth and final tranche of 10 ideas (listed) is about meeting challenges on a planetary scale and beyond.
- Oceans harnessed for carbon storage
- How to create a carbon trading system that works
- Lasers and bots track carbon in the forests and seas
- Cleaning up the plastic in the oceans
- Metal-organic frameworks create molecular ‘supersponges’
- Mobile phone networks help forecast disasters
- Invisibility cloak’ metamaterials reach the market
- Strategies to dodge space junk
- Asteroid ‘fuelling stations’ for space exploration
- Video: new techniques to find extraterrestrial life
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The FT enlisted the help of readers, researchers and entrepreneurs to find 50 new ideas that will shape the world in the future.
The ideas address the challenges of a growing world population, resource scarcity, handling information as well as healthcare, and look beyond our planet to explore new frontiers and solve common challenges.
Supported by Mitsubishi Heavy Industries Group