Climate change: the pitfalls of carbon pricing
13 February 2018 | Markets
Most economic players and informed observers have long advocated for carbon pricing at a single price. Although there has been an increase in local initiatives in the last few years [and some of them on a very large scale, like in China which is due to extend its emissions trading system to a national scale in the next few years], the pursuit of a single tariff appears increasingly difficult to achieve.
According to Pottier, a researcher at the Centre for Industrial Economics (CERNA) at MINES Paris Tech and author of “Comment les économsites réchauffent la planète”, the central importance attributed to a single price for CO2 in economic theory is very damaging.
Clouding the debate
“Economic scholarship gives the impression that the only possible means to reduce greenhouse gas emissions at a lower cost is to send a price signal, by putting a price on CO2 which must necessarily be a single price for all sectors,” said Pottier.
“It is more or less a dogma, a mandatory proposition that clouds the issue”, he added.
However, the price of CO2 is not the be-all and end-all of climate policy. Other signals are possible in terms of information, as guidelines for citizens, legislation, and investment funding decisions.
“But these are either not raised or not taken seriously,” says Pottier.” In energy efficiency, investments that would generate a return immediately are simply not being made”.
This clearly shows, if any further proof were necessary, that this is not just a matter of price but one that also requires training policies, the development of craft and industrial sectors and funding mechanisms.
China launched what will become the world’s largest carbon market on Tuesday (19 December), surpassing the EU’s flagship market mechanism to cap and trade emissions. The scheme is part of a host of major policies China is using to peak its GHGs by 2030.
Paris Agreement targets locally-based approach
However, some things seem to be moving in the right direction. For example, the debate is gradually taking into account the co-benefits in terms of health, and averted deaths, and global efforts to combat climate change are also having positive effects locally, such as for air quality.
The nature of the UN negotiations themselves have changed following the Paris Agreement. The Kyoto Protocol (1997) was based on a centralised approach. The aim was, through quota exchanges, to allocate efforts to countries where emissions reductions were the least expensive.
However, this only applied to the emissions of developed countries (although the United States never ratified the treaty), and the developing countries did not agree to extend this limitation to their emissions.
“The Paris agreement relies on a more locally-based approach. Each country participates with the level of effort which it is prepared to make. The goal of this is to build up momentum so that the effort involved gradually increases to meet the targets,” Pottier said.
Alternatives to the single price
“Even if everyone takes part, a gap will appear between the goals and the action taken at two levels.”
On the one hand between the contributions announced by the participating states and what needs to be done to stay below 2°C, but also between the contributions and the action actually taken.
“Emission trajectories do not reflect the expected reductions,” he added.
As for the single price of CO2 advocated by economists, it faces obstacles, particularly political ones. “Should we continue to reiterate this proposal that is unlikely to be implemented or try something different? “.
The European Emissions Trading System (ETS) has shown its limits, particularly when it comes to dealing with unforeseen events such as the 2008 economic crisis, which generated an excess of quotas on the market and led to a sharp fall of the price per tonne.
“As for the possibility of a tax, the level required in the medium term to stay under 2°C is very high. This will be even more difficult to accept at a political level because it generates significant revenue transfers that would have a strong distributive impact. In theory, we know how to offset it, but in practice it’s complicated, “Pottier warned.
This raises another question: “from a legal perspective how can we guarantee the evolution of a price over or at the end of a 40 period?”
The centre-left Socialists and Democrats (S&D) faction in the European Parliament are gearing up for a fight over EU car emission standards for 2030, floating a 40% cut in CO2 and suggesting a radical change in the way emissions are measured in the first place.
A combination of mechanisms
However, the combination of certain mechanisms leads in reality to differentiated prices.
“The existence of several different techniques in the mixture of legislation, taxes, and incentives leads to differences in the additional cost per tonne of CO2 avoided. That’s not necessarily a problem. We can even imagine differentiated prices according to the sectors, according to the speed of their response,” said Pottier.
On the other hand, the question is how to coordinate these different mechanisms at national and international levels to comply with the promised emissions trajectories.
Some states are already pursuing several objectives jointly, such as the European 3X20 objective, which targets a reduction in greenhouse gas emissions, a share of renewable energies in the energy mix and a reduction in consumption.
“To a certain extent, European states are supplementing the (weak) price signal sent by the EU-ETS market by other policies”, said the researcher.
Trying to avoid a tax backlash
Subnational actors, particularly at local government levels, are less sensitive to the single price dogma than the national government. “Since they have no price options available, they must find other ways to get their citizens to act,” said Pottier. Local initiatives are all the more important as they give a reason for pride to the population concerned.
“It makes them want to continue, to go further, which is why the challenge is to convince stakeholders of the intrinsic value of energy transition,” he insists. “It has to come from the people, and not just be a reaction to a price signal, especially since it has to be shown that certain external factors, especially financial ones, can weaken the intrinsic motivations.”
In this regard, the economist warned: “Without intrinsic motives, the imposition of a high price signal will result in a ‘tax backlash’.”