Economics climate

Markets must be used to help fight climate change. Here is why.

©David Rooney

Harsh financial reality often rides roughshod over good intentions when it comes to corporate and national balance sheets. Climate change is no exception, for though it may rouse worldwide concern, it also makes people uneasy because of how much it might cost and who should pay.

The trouble is, climate change is itself a harsh reality. And with the world economy set to double over the next 25 years, it is clear that a business-as-usual approach is no longer an option. New policies are needed and it is high time economic tools were made to play a fuller role in the antidote.

The latest OECD Environmental Outlook to 2030, issued in March, has been the focus of wide media and policy attention, including at the 2008 OECD environment ministers’ meeting in April. Its central message is a positive one: we can afford to tackle climate change, but new (and cost-effective) policies are needed sooner rather than later.

The report suggests some possible policy packages, and market-based instruments are the lynchpin in the strategy, including taxes and carbon trading. According to the OECD Environmental Outlook, early intervention could keep costs in 2050 down to about 2.5% of world GDP, or slowing annual growth by less than 0.1 percentage point on average between now and then. Mitigation would not be cheap, but it would be affordable, particularly in light of the expected costs of inaction and a projected three-fold increase of world GDP by 2050.

The OECD’s aim is to make globalisation and growth an ally of the environment, and this depends on keeping the cost of action manageable. Given the complex nature of the challenge of climate change, however, a mix of policies will be needed which, while varying in detail by country, may include economic instruments such as taxes and carbon trading, as well as regulations, voluntary and sectoral approaches, and information-based tools.

But to keep the costs of action low, the policy mix should put a strong emphasis on price-based instruments. A market-price on greenhouse gas emissions (GHGs) gives an economic incentive to reduce emissions across all sources, increase efficiency and also spur innovation. They provide polluters the flexibility to reduce emissions wherever they cost the least.

Putting a tax on GHGs may seem a straightforward way of curbing emissions. Taxes can work (and be made politically more attractive) if their revenues are used to reduce other taxes, on labour for instance. They send a clear price signal, and most OECD countries levy some kind of fuel and energy taxes, and a few even specific carbon taxes.

The problem is many of these taxes are weakened by a plethora of exemptions or reduced rates, in particular for energy-intensive industries; at last count, there were 845 exemptions for fossil fuel taxes and 524 for motor vehicles taxes in OECD countries. To fight climate change effectively, policymakers should focus on reducing such exemptions. Subsidies are tricky too. Energy producers in OECD countries currently receive US$20-30 billion in subsidies, the majority going to fossil fuels. The most harmful of these subsidies should be reduced or cut altogether.

Public support for basic R&D, to stimulate new technologies and innovation, is needed, however, but otherwise subsidies have to be handled carefully because they tend to lock-in specific production methods and interest groups, and are hard to reform later on.

Carbon markets
Emissions trading is one market instrument that is spreading rapidly across OECD countries. More players have become involved, as more people now see a chance of making the market work profitably. The World Bank estimates that emissions trading tripled in a year, up from $10 billion in 2005 to $30 billion in 2006. Of all trading schemes, the largest and most familiar is the EU Emissions Trading Scheme, which covers some 10,000 facilities belonging to sectors responsible for 52% of carbon emissions in Europe. But it has had its teething problems: Phase I (2005-2007) has come to term, and Phase II (2008-2012) is being revisited in light of criticism over the generous free allocation of emissions permits, which diluted the market and let the price fall too low. Carbon markets work best when they not only fix the amount of carbon to be reduced, but also provide clear long-term signals for the price of carbon.

Emissions trading schemes now cover at least 20% of the GHG emissions produced by the countries that ratified the Kyoto Protocol.

click here for larger graph

A truly global carbon market must bring more countries into the marketplace. Something of this sort already exists in the CDM (Clean Development Mechanism), which allows firms to invest in emission reductions in developing countries and earn “credits” from these to put against their own emissions allowances. Governments have set aside over $10 billion for CDM projects, a sum expected to skim 2 billion tonnes off expected GHGs by 2012. However, there have been some questions regarding the effectiveness of CDM projects in reducing emissions below business-as-usual.

Regulation and information tools–such as energy efficiency labels on appliances–also have a role to play, and can complement market price signals by providing information and overcoming other market barriers (see interview with Finland’s transport minister, Anu Vehviläinen). For more efficiency, a number of improvements can be made at very low or no cost, such as phasing out incandescent light bulbs or setting an international “1-watt” standard for all standby power.

One way to encourage the use of renewable energy through the marketplace is to follow the example in some OECD countries of allocating “green” and “white” certificates to energy suppliers for each kilowatt of electricity they produce through renewables or through greater end-use efficiency.

What about regulations? Some people may distrust them as much as taxes, yet rules that set standards, such as building requirements, insulation, or energy supply have already started to unleash new markets for goods, services and skills. Indeed, stipulating the rules of the game, rather than say, specific technologies or suppliers, can empower markets.

So can basic R&D. Between 1992 and 2005, OECD countries increased budgets for renewable energies and energy efficiency by 51% and 38% respectively, but will need to be raised further–after all, public R&D budgets for fossil and nuclear energy are still about double those for renewables and energy-efficient technologies.

There is also adaptation to the changing climate. Some climate change is already locked-in due to past emissions, and from Europe’s ski resorts to farming in northern Canada, or coastal settlements in rich and poor countries, adapting will bring costs and opportunities.

The developing world will be hit hard though. Bangladesh, Egypt, Fiji, Tanzania, Uruguay and Nepal are among the countries expected to suffer major economic losses as a result of climate change. And around 150 million people could be exposed to a 1-in- 100 year coastal flood event by 2070, up from 40 million today.

Development aid must adapt too. The OECD has found that a large portion of official development assistance (ODA) is directed at activities that are exposed to climate risks, notably water supplies, sanitation and transport infrastructure. Such aid needs to be “climate-proofed”.

This raises the thorny question of how to tackle climate change most cost effectively, and who should lead? OECD countries are historically the largest emitters and many consider that they have a particular responsibility for ensuring further emissions reductions. The trouble is, they have invested heavily in reductions already, and more cuts will cost far more without necessarily stabilising climate change.

The most cost-effective mitigation potential is therefore likely to be in developing and emerging countries, which will churn out three-quarters of emissions by 2030, although financing and technology support may be needed to achieve some of these emission reductions.

Many developing countries will need aid, more lenient reduction targets than those for developed countries, deferred engagement, financial support, technological co-operation, and so on. Some question whether all of these countries are that poor though. Take China. Since 2000, it has emerged as one of the world’s largest economies and its largest emitters, overtaking the US. However, a closer look shows that its car ownership and GHG emission per capita in China are nowhere near OECD levels, reflecting a much lower level of development.

As ever, while carbon traders are eager to get going, sorting out a truly balanced, acceptable and effective global carbon market will demand political skill and compromise as much as market prices or business acumen.

No-one knows the precise costs of inaction, but can we afford to wait? What we do know is that we can move to a sustainable growth path, but to help that happen, markets need clear price signals. As philosopher Francis Bacon said, “a wise man will make more opportunities than he finds.” Climate change demands us to find those opportunities fast.  LT/RJC

 

References

  • Ellis, J. and Kamel S. (2007), “Overcoming Barriers to Clean Development Mechanism Projects”, OECD/IEA, available at www.oecd.org/env/cc/aixg; see also “Market power: Can Clean Development Mechanisms work?” in OECD Observer No 264, December 2007 at www.oecdobserver.org
  • OECD (2008), OECD Environmental Outlook to 2030, Paris.
  • OECD (2007), Climate Change in the European Alps: Adapting Winter Tourism and Natural Hazards Management, Paris.
  • OECD (2004), Bridge over Troubled Waters: Linking Climate change and Development, Paris.
  • Philibert, C. and Reinaud, D. (2007), Emission Trading: Trends and Prospects, OECD/IEA, available at www.oecd.org/env/cc/aixg


©OECD Observer No 267 May-June 2008 




Economic data

E-Newsletter

Stay up-to-date with the latest news from the OECD by signing up for our e-newsletter :

Twitter feed

Suscribe now

<b>Subscribe now!</b>

To receive your exclusive print editions delivered to you directly


Online edition
Previous editions

Don't miss

  • Africa's cities at the forefront of progress: Africa is urbanising at a historically rapid pace coupled with an unprecedented demographic boom. By 2050, about 56% of Africans are expected to live in cities. This poses major policy challenges, but make no mistake: Africa’s cities and towns are engines of progress that, if harnessed correctly, can fuel the entire continent’s sustainable development.
  • “Nizip” refugee camp visit
    July 2016: OECD Secretary-General Angel Gurría visits the “Nizip” refugee camp, situated between Gaziantep and the Turkish-Syrian border, accompanied by Turkey’s Deputy Prime Minister Mehmet Şimşek. The camp accommodates a small number of the 2.75 million Syrians currently registered in Turkey, mostly outside the camps. In his tour of the camp, Mr Gurría visits a school, speaks with refugees and gives a short interview.
  • OECD Observer i-Sheet Series: OECD Observer i-Sheets are smart contents pages on major issues and events. Use them to find current or recent articles, video, books and working papers. To browse on paper and read on line, or simply download.
  • Queen Maxima of the Netherlands gives a speech next to Mexico's President Enrique Pena Nieto (not pictured) during the International Forum of Financial Inclusion at the National Palace in Mexico City, Mexico June 21, 2016.
  • How sustainable is the ocean as a source of economic development? The Ocean Economy in 2030 examines the risks and uncertainties surrounding the future development of ocean industries, the innovations required in science and technology to support their progress, their potential contribution to green growth and some of the implications for ocean management.
  • OECD Environment Director Simon Upton presented a talk at Imperial College London on 21 April 2016. With the world awash in surplus oil and prices languishing around US$40 per barrel, how can governments step up efforts to transform the world’s energy systems in line with the Paris Agreement?
  • Happy 10th birthday to Twitter. This 2008 OECD Observer interview with Henry Copeland said you’d do well.
  • The OECD Gender Initiative examines existing barriers to gender equality in education, employment, and entrepreneurship. The gender portal monitors the progress made by governments to promote gender equality in both OECD and non-OECD countries and provides good practices based on analytical tools and reliable data.
  • Once migrants reach Europe, countries face integration challenge: OECD's Thomas Liebig speaks to NPR's Audie Cornish.

  • Message from the International Space Station to COP21

  • COP21 Will Get Agreement With Teeth: OECD Secretary-General Angel Gurría on Bloomberg

  • The carbon clock is ticking: OECD’s Gurría on CNBC

  • If we want to reach zero net emissions by the end of the century, we must align our policies for a low-carbon economy, put a price on carbon everywhere, spend less subsidising fossil fuels and invest more in clean energy. OECD at #COP21 – OECD statement for #COP21
  • They are green and local --It’s a new generation of entrepreneurs in Kenya with big dreams of sustainable energy and the drive to see their innovative technologies throughout Africa. blogs.worldbank.org
  • Pole to Paris Project
  • In order to face global warming, Asia needs at least $40 billion per year, derived from both the public and private sector. Read how to bridge the climate financing gap on the Asian Bank of Development's website.
  • How can cities fight climate change?
    Discover projects in Denmark, Canada, Australia, Japan and Mexico.
  • Climate: What's changed, what hasn't, what we can do about it.
    Lecture by OECD Secretary-General Angel Gurría, hosted by the London School of Economics and Aviva Investors in association with ClimateWise, London, UK, 3 July 2015.

  • Climate change: “We should not disagree when scientists tell us we have a window of opportunity–10-15 years–to turn this thing around” argues Senator Bernie Sanders.

  • In the long-run, the EU benefits from migration, says OECD Head of International Migration Division Jean-Christophe Dumont.
  • Is technological progress slowing down? Is it speeding up? At the OECD, we believe the research from our Future of ‪Productivity‬ project helps to resolve this paradox.
  • Is inequality bad for growth? That redistribution boosts economies is not established by the evidence says FT economics editor Chris Giles. Read more on www.ft.com.
  • Catherine Mann, OECD Chief Economist, explains on Bloomberg why "too much bank lending can slow economic growth".
  • Interested in a career in Paris at the OECD? The OECD is a major international organisation, with a mission to build better policies for better lives. With our hub based in one of the world's global cities and offices across continents, find out more at www.oecd.org/careers .

Most Popular Articles

Poll

What issue are you most concerned about in 2016?

Unemployment
Euro crisis
International conflict
Global warming
Other

OECD Insights Blog

NOTE: All signed articles in the OECD Observer express the opinions of the authors
and do not necessarily represent the official views of OECD member countries.

All rights reserved. OECD 2016