An Economic Solution to Climate Change

Source: https://aptnnews.ca/2016/05/04/trudeau-offers-full-federal-assistance-to-fire-ravaged-fort-mcmurray/

The threat of climate change is not as instinctively terrifying as a global war or stock market crash, but the stakes are just as dire. While its consequences may seem far off, the 2 degree Celsius increase in global temperatures that scientists warn against will ravage regions which are currently on the brink; Pakistan, India, and the Middle Eastern Gulf already suffer deadly heat waves that can exceed 49 degrees Celsius, but if global warming continues on its current trajectory, then by 2070 those regions will be on the verge of being uninhabitable. Coupled with growing problems like food insecurity, a worsened climate will culminate in famine, mass migration, and potentially war, all of which destabilize the world. Global warming isn’t simply an inconvenience or a risk to economic growth, it is a national security crisis which will affect everyone.

Scientists inform us that the cure for climate change is clear - we need to drastically reduce our greenhouse gas emissions - but the path to get there is anything but straightforward. To understand why that is the case, it is necessary to consider the tragedy of the commons and the free-rider problem. The tragedy of the commons is a dilemma that arises when a group has access to a common resource that no one person owns. Each individual can profit from the shared resource, but in the process they incur a cost which is borne by the community. As a result, they over-use the common resource, and it is eventually degraded to the point of worthlessness. The free-rider problem is the tragedy of the commons in reverse. The benefits of one person’s investment in the common resource are experienced equally by all, but the costs of that investment are not shared. As a result, individuals are under-incentivized to invest in the common resource.

The climate is a shared resource. Most countries can profit from the production of greenhouse gas emitters like coal and livestock, but in the process they incur an environmental cost which the global community has no choice but to absorb. Any country could invest in improving the environment, but they have little reason to do so because the benefits would be public and the costs private. This being the case, it is not surprising that many governments talk a big game on climate change while dragging their feet.

To mount a global response to the climate crisis, the United Nations has held annual conferences to discuss climate science and potential mitigation strategies. In recognition of the free-rider problem, the emphasis of these conferences has been placed on encouraging joint action. At the 2015 Paris conference, the vast majority of nations volunteered plans to reduce emissions. Their collective goal was to maintain the rise of global temperatures below a 2 degree increase on pre-industrial levels, with a preferred target of 1.5 which scientists suggest is necessary. However, while the Paris climate accord certainly moved global climate cooperation in the right direction, it is likely not enough because it lacks enforcement mechanisms. As a result, it would not be surprising if many of the 197 nations that signed on to the climate accord renege on their promises. With enforcement mechanisms off the table, climate-conscious countries need a tool that will allow them to unilaterally impose on other countries the costs of their carbon emissions.

Carbon tariffs could be that tool. A carbon tariff is a tax imposed on imports from countries which do not sufficiently reduce their carbon emissions. Carbon tariffs privatize the social cost of emissions, thereby ending the tragedy of the commons. Furthermore, carbon tariffs can give climate wary governments the breathing room to regulate their local industries. For example, the recently inaugurated president of the European Commission, Ursula von der Leyen, laid out a green deal to regulate the emissions of local industries and make Europe climate neutral by 2050. However, those regulations potentially make European companies less competitive on the global marketplace and could increase imports from more climate-reckless countries like Australia and Brazil. For that reason, the EU is considering carbon tariffs. Carbon tariffs will likely slow down European trade, but they will ensure European companies remain competitive and give the EU revenue to invest in green infrastructure.

Economists are typically wary of tariffs - their use by one country against another often precipitates an economy-slowing trade war - but carbon tariffs can be designed to incentivize compliance rather than retaliation. Imagine that the Canadian government decided to levy a tariff on carbon emitted by countries it trades with to negate the impact of their emissions. Using mini carbon-monitoring satellites to observe the quantity of carbon emissions coming from countries around the world, Canada could apply a tariff on each dollar of imported goods equal to the social cost of carbon multiplied by the carbon emissions intensity of the country in question. In Canada’s trade with India, for example, that would mean applying a tariff of approximately 1.36 cents per dollar of imports because the Canadian government values the social cost of carbon at $41 dollars per ton and India emits .00033 tons of carbon per dollar of GDP. 

In order to avoid a trade war, Canada could discount its carbon tariff for countries who already have their own carbon taxes. For instance, the EU has a cap and trade system that  recently charged companies €28 per ton of carbon emitted. Adjusting for the exchange rate, Canada’s carbon tariff would be fully discounted and European importers would not be charged anything. Crucially, this system offers affected countries an avenue to reclaim tariff revenue by imposing their own carbon taxes and tariffs. Furthermore, if a critical mass of countries engaged in such a system, other countries would likely follow suit because the cost of not doing so would be too burdensome. The beauty of carbon tariffs is that they lead to global climate action without international diplomacy. If a country backed away from reducing their emissions, the tariffs would automatically charge it for doing so.

It is important to remember that in implementing carbon tariffs, climate conscious countries could also disproportionately burden developing countries, which often rely on dirty energy and trade to liberalize their economies. If implemented without any concessions, carbon tariffs could push developing nations into recession before they have time to retool their economies. Recognizing this problem, it is necessary for advanced economies to couple carbon tariffs with large investments of renewable technology in developing economies. The Gulf Region, currently a hub of oil production and heat waves, could be the launching point of a massive commitment to solar power.

Some suggest that penalizing greenhouse gas emitting industries to aid the fight against climate change will damage an otherwise perfect economic system. In reality, however, market failures like the free-rider problem and the tragedy of the commons are intrinsic to the free market and, if left unaddressed, will culminate in a climate catastrophe which will harm everyone. The question is not whether we should act, or to what extent, but how climate conscious countries can be effective in their fight against climate change in the face of uncertain global cooperation. Economics provides a solution. While carbon tariffs must be deployed with caution, if enacted, they would be cause for realistic hope in the fight against climate change.