Ethos Perspectives
Climate Change
Pricing Carbon to Reflect its Full Social Costs
Carbon has to be properly priced to place the economy on a more sustainable, energy-efficient trajectory. If carbon is priced correctly, we can incentivise a more efficient use of resources, and force users of carbon-intensive energy to internalise the attendant social costs. A price on carbon can be put implicitly through regulation or explicitly through trading or tax.
In an international cap-and-trade system, an upper limit is placed on GHG emissions while trading between countries and companies of the permits (or carbon credits) ensures an efficient allocation of the rights to produce carbon emissions. In a global emission trading scheme, we can focus on the overall quantitative reduction targets and let the market find the price that will deliver those reduction targets. Trading reduces the costs of mitigation by allowing the required reductions in emissions to be achieved as cost-effectively as possible. The resulting carbon price across sectors and countries will spur private sector R&D and investment in low-carbon technologies by persuading investors that there will be demand for these technologies. Moreover, it also enables financial flows to the developing countries, incentivising the latter to participate as well as invest in low-carbon development.
A carbon tax is an alternative way to put a price on carbon, but it is arguably more suited to domestic than international policy as tax-setting is generally considered to be a domestic issue that needs to be adapted to individual countries’ circumstances. From the standpoint of both equity and global efficiency, a carbon tax will not automatically channel finance for low-carbon development towards developing countries.
Investments in Renewable Energy
The general market for energy is huge. At present, the world’s population consumes about 15 terawatts of power which translates into a business worth US$6 trillion a year—about a tenth of the world’s economic output. By 2050, power consumption is likely to rise to 30 terawatts.
While a transition from a fossil fuel-based economy to one based on alternative energy is likely to be slow, the scale of the market provides opportunities for alternatives to prove themselves at the margin and then move into the mainstream. Already, the rise in the cost of electricity (which follows the rise in the price of natural gas and oil) has led to some to view wind- and solar-powered alternatives as competitive by comparison.
There is also economic value to hedge against the future price of fossil fuels resources by incorporating some renewable sources into the energy mix. The future price of renewables—zero—is known, and this certainty has economic value even if the capital cost of wind and solar power stations is, at the moment, higher than those powered by fossil fuels.
This value of alternative power sources has led some to posit that the next technology boom may well be based on alternative energy. If so, early movers in renewable or other low-carbon forms of energy will secure competitive advantages for themselves. They can insulate themselves from energy supply problems, eliminate the risks of fuel price volatility, and earn carbon credits to sell to competitors. Emerging economics such as China, Brazil and South Africa are also exploiting opportunities in renewable energy.
A Global Deal on Climate Change
Climate change is global in its causes and consequences, and the response requires international collective action. Nicholas Stern (the economist behind the Stern Review, a 2006 climate change report widely regarded as the most widely known and discussed report of its kind) has proposed that the overall global policy framework should satisfy the following three key principles:
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Effective: The framework must involve action that can affordably keep risks from climate change at acceptable levels. |
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Efficient: Mitigation should be undertaken where it is cheapest, with carbon pricing and markets playing a central role in determining type and origin of mitigation. |
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Equitable: Commitments must be perceived as equitable which requires rich countries taking a lead, since this is a shared problem with differential responsibilities. |
He argues that the challenge, as far-reaching, comprehensive and global as it is, is still manageable. The technological transformations and flows of funds required across countries and sectors will be large, the institutional and implementation challenges significant, but the costs of action are affordable and entirely consistent with sustainable growth and development. By contrast, the alternative of inaction or delay is not.
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