Climate change is the biggest market failures the world has seen. Every year, fossil fuels add about six billion metric tons of carbon, in the form of carbon dioxide, to the atmosphere. Emissions are highest in industrialised countries but are now increasing in developing countries too. Carbon dioxide has a long-lasting effect on Earth, quite literally—once emitted, it remains in the atmosphere for 200 years.
Studies from Antarctica shows that, carbon dioxide level varied between 270 and 290 parts per million for thousands of years before the beginning of the Industrial Revolution.
Where are we at?
Climatologists have, nonetheless, attempted to estimate the cause of climate change. Today, climate models suggest that doubling carbon dioxide concentration would raise global temperatures by 1.5 to 4.5 degrees Celsius. No climate model predicts zero warming. Estimation of past greenhouse gas impact on present global temperatures is also a difficult process. Present evidence suggests that climate change can be found in historical data.
The Intergovernmental Panel on Climate Change (IPCC) 2018 special report states that human activities are estimated to have caused approximately 1 degree Celsius of global warming above pre-industrial levels, with a likely range of 0.8 degree to 1.2 degrees Celsius.
Global warming is likely to reach 1.5 degrees Celsius between 2030 and 2052 if it continues to increase at the current rate. Predicting the emissions of carbon dioxide depends on many factors, such as population growth, income growth, technological change and energy prices.
One of the major outcomes of Katowice talks was the countries agreeing on the rules of implementation of 2015 Paris Agreement. The ‘rulebook’ can also be called as a detailed ‘operating manual’ of the Paris Agreement.
Even though the member countries accepted the rulebook, they did not agree to welcome IPCC’s report on global warming of 1.5 degrees Celsius. It was also agreed among the countries that future pledges should cover a ‘common time frame’ from 2031.
The economics of climate change
The economics of climate change aims at modeling the implications of emission growths and, it analyses the economic efficiency of a policy. It examines the feasibility of technological options; calculating ‘social cost of carbon’ and exploring tax, markets, and other institutional structures.
Proper designing of viable economic policies helps to generate strong international action. To achieve this, the standard economic policy should be a market-based instrument, such as tax on emissions or tradable permit system.
Many empirical studies have shown positive advantages of market-oriented policies over command and control initiatives in abating the larger pollution problem. Specific market-oriented approaches by economists include tradable permits and emission taxes.
The tradable-permits approach sets a specific target on total emissions and allocates necessary number of pollution permits or allowances to the polluter to achieve the goal. The polluters are able to reduce their emissions most cost effectively, which motivates them to do more to sell their excess emission allowances to others facing a higher cost of compliance.
This approach creates a market for pollution permits, with price discovered by demand and supply. Unlike other regulatory standards, the permit system offers flexibility to polluters in accomplishing their goal.
This leads to the development of innovative solutions and minimises costs to the society with limits. The system faces shortcomings, too. Through this approach, it is difficult to measure pollution levels. There exists potential for hiding pollution levels or shifting production to other countries with looser environmental standards. The biggest carbon trading scheme is the EU Emission Trading Scheme.
Emission taxes is a tax-based regulatory system, which gives incentives to polluters to find cost-effective solutions for emissions control. In the case of emission taxes, the cost of compliance is known, but emission levels may be uncertain in nature.
This approach is an attractive policy, as it supports the ‘polluter pay principle’. Although the system seems to be more effective than a permit system, tax has a major political liability; it causes large transfers of income from firms to government.
In fact, firms will end up in paying more taxes than their expenses on reducing emissions. Taxes do not adjust with the changing inflation and external price shocks, whereas the permit system automatically adjusts itself with the changing macro-economic conditions.
The way forward: a hybrid policy
Market-oriented approaches can have serious economic and political disadvantages when used alone. Such problems can be addressed by a proper hybrid policy that accommodates the best elements of both the approaches.
For efficiency, a hybrid policy should act like an emission policy at margin; it should give incentives to the polluter to reduce emissions at low costs. At the same time, it should provide flexibility in total abatement.
For political viability, the hybrid policy should avoid unnecessary transfers and have distributional flexibility of a permit system. One hybrid policy can combine a fixed number of tradable, long-term permits with an elastic supply of short-term ones, good only for a while.
The hybrid policy combines the key advantages of tax and permit policies. Like taxes, it places an upper limit on the marginal cost of abatement. It also avoids distributional issues of an emission tax.
The perpetual limit principle can help to avoid large transfers associated with the pure emission tax. The policy has an in-built mechanism for monitoring and enforcement. This reduces the need of international monitoring of the policy.
Overall, a hybrid policy is an economically efficient and politically realistic approach to address climate change. It does not demand a major sacrifice of sovereignty by participating member countries, and it reduces emissions without requiring countries to undertake rigid targets. All these points together remove the most formidable obstacles to the development of a sound and viable international climate change policy.
Climate change and India
India has a great potential to offer substantial mitigation efforts for climate change at a relatively low price. Under the Paris Agreement, India’s present target is to cut down the emission per unit GDP by 30-35% compared to 2005 levels, to create an additional carbon sink of 2.5-3 billion tons of carbon dioxide, and to increase the share on non-fossil fuel-based power to 40%, by 2030.
India is a large developing economy with divergent climatic zones. The climate change vulnerability and lack of proper economic and political will reduces the enhanced efforts in mitigating environmental problems.
The costs of not addressing climate change or to adapt to it are very uncertain, but their welfare consequences are enormous. Efforts are made to extract energy and other resources from industrial and urban waste. Unless the country develops an indigenous green technology, it cannot attain sustainable development.
Beyond discussions, there exist many promising initiatives across the world in mitigating climate change patterns. And economics and economists will be needed, particularly if the criteria of efficiency and equity are to be implemented efficiently.
Richin S Kottaram is a Postgraduate in Economics and Sociology and specialises in Environmental Law at NLSIU, Bangalore.