posted in
December 11, 2019

A lost opportunity to effectively fight climate change

written by Marcus Schreiber & Sebastian Moritz
A lost opportunity to effectively fight climate change

Economics is ignored in government pledges to “unite behind the science”.

Following the increased public awareness of and media attention on the climate change topic in recent months, a political response was called for. All around the world governments have started tackling the issue after an impetus from climate change activists. German Chancellor Angela Merkel in particular has expressed her sympathy with Greta Thunberg’s statement to “unite behind the science”. However, this recognition of scientific insights is not reflected in the recent decisions of the German government. Rather the opposite is true. Economic insights seem to have been ignored.

INEFFICIENT DE-FACTO TAX IS BEING MARKETED AS A MUCH-NEEDED CO2 CERTIFICATES TRADING POLICY

The German government decided on a package of measures and labelled them an ‘emissions trading scheme’. Looking at it from an economic perspective though, the scheme appears to be more of a tax rather than an efficient and effective trading mechanism. The government will start putting a price on CO2 emissions in 2021. However, at this point total emissions will not be limited or capped at the level committed to under the Paris Climate Agreement. The introduction of the carbon pricing system in 2021 thus creates a pool of unlimited pollution rights, where any excess demand for pollution will be offset by ‘buying those from other European countries’. Only from 2026 onwards will there be trade in certificates with an annually shrinking cap placed on CO2 emissions. The price per ton, however, would still be regulated by the government with lower and upper price limits put in place.

From an economic perspective, the proposed package of measures is unlikely to achieve the desired outcome. Germany will only by chance meet future levels committed under the Paris Climate Agreement.

Merkel defends the proposed solution as a step in the right direction feasible in the current political environment. Others reflect that such climate measures are too short-sighted and do not take scientific truths into account.

AN EFFICIENT SOLUTION WOULD AUTOMATICALLY MEET THE COMMITTED LEVEL

The fact that human-linked activities contribute to climate change is well established, at least in Europe, and is not debated in scientific circles. However, economic research on incentive schemes surrounding the climate agenda is oftentimes ignored. In the German case, politicians are using the terminology of economically convincing solutions, but only to relabel and market other inferior measures.

Economics is about the efficient use of scarce resources, including the limited resilience of our environment. The biggest question politicians face is therefore how to achieve committed climate targets with the lowest impact on wallets and national wealth.

Given Germany’s commitment to the Paris Climate Agreement, the country’s international reputation is at stake in case the obligations cannot be fulfilled. The safest way to guarantee a genuine reduction in the CO2 emissions would be to implement a genuine certificates trading scheme from the start. In this case the government would set the supply levels of permitted carbon emissions and consumers will determine the price according to the laws of demand and supply. Given market prices individuals could then decide on their levels of emission given affordability. Such a mechanism would ensure, by definition, the fulfilment of set targets.

QUESTIONABLE SUBSTITUTION EFFECT AND CUSHIONED INCOME EFFECT

Germany’s federal government, on the other hand, has proposed to set a fixed price for carbon emissions, thereby imposing a de facto CO2 tax. In the transportation industry, for example, this price will inevitably increase the demand for alternative transportation methods such as rail travel and electric vehicles. This means that the use of internal combustion engines will by and large be substituted away. This is what economist would call a substitution effect. On the other hand, an imposed tax will make individuals poorer such that they can afford less consumption overall, a so-called income effect.

In order for a carbon tax to have an effect, the substitution of consumption by itself will need to amount to hundreds of billions of Euros. As the tax level at which sufficient CO2 reductions would be achieved is not known, it is impossible to estimate whether the climate targets would be under- or over-achieved in reality. An observation of consumer behaviour can offer some insight. A simple test of consumer responses to gasoline and oil prices would show that individuals would probably not reduce their demand significantly in the next few years. This could even be the case with much larger price increases than the agreed 10 Euros per tonne of CO2 in 2021.

Every government carefully weighs and considers the impact of new regulations on consumer behaviour. In the case of the de facto CO2 tax, the government decided to cushion customers. It offset the negative income effects of the tax by relieving tax burdens elsewhere. This reimbursement of consumers could even allow the same levels of consumption as before. This would in turn imply that the implemented measure is not effective to begin with as the consumer is protected against losing income.

The package decided by the German government is therefore disappointing from three perspectives.

  1. A great opportunity has been missed for Germany to implement effective measures and to become a frontrunner in fighting climate change in Europe and the worldIf the intended scheme fails, the reputation of economically sound
  2. trading schemes will be burned for a long time – not because they are ineffective, but because of a misuse of terminology
  3. …and frustratingly for economists, Economics seems not to be considered as a science