Economists love it, while NGOs have recently grown more sceptical… so does carbon pricing work? James Morrissey introduces a new Oxfam primer to help you weigh up the case for and against
If you open up the recent IPCC report, you’ll see the term “carbon pricing” appear no less than 180 times. This reflects its prominence as a policy for tackling the global climate emergency.
Yet not everyone is convinced. Favoured by economists as the cheapest pathway to address climate change, carbon pricing has seen recent pushback from a number of NGOs who are sceptical of the use of market forces to drive climate action, disillusioned with the current state of carbon pricing and worried about the potentially regressive impacts of a price on emissions.
While there are good reasons to be critical of carbon pricing, there is also some confusion about the exact advantages and failings of the policy. That’s why Oxfam has just published a primer to guide our staff and hopefully others in the development sector. Some key points are summarised below. (We should note that with gas prices on the rise, carbon pricing is an even more controversial topic than usual. Our primer is intended as a general introduction to the debate over carbon pricing which, for now, ignores the specific context of current high energy prices – though this is something we can address in a future blog.)
What is carbon pricing?
There are two broad ways to price carbon: make people pay a fee for the CO2 they emit – either directly or via a levy on the goods they consume – (known as a “carbon price”); or place a cap on the total emissions a society can produce and then sell the rights to emit CO2 up to that cap (known as “cap and trade”).
Though there are significant theoretical differences between these two approaches, political realities mean that the choice between them is unlikely to matter much, as we are likely end up with a hybrid of the two. So, it’s not worth getting bogged down in debates about the choice of a price or cap. It’s generally more important to know how any cap or price will be designed.
The core advantage of a carbon price is that it provides the flexibility to pick the cheapest pathway for you to reduce your own emissions. Since every individual, firm or industry will have a unique cheapest pathway to addressing their carbon emissions, and since no broad legislative action could possibly prescribe that pathway for every case, allowing this flexibility provides the cheapest pathway to addressing climate change. Importantly this is equally true for both carbon pricing approaches.
It’s clear that current carbon prices are too low
Before we get to the arguments about whether carbon pricing can work, it’s essential to point out that carbon prices are currently inadequate to address climate change. In the vast majority of cases, prices are too low, and not applied to enough of the economy to drive decarbonisation at the rate necessary. The graph below shows how prices are generally below $50 per tonne of CO2 (they need to be closer to $100/tCO2) and only cover 15% of the global economy (they need to be at 100%). Despite these problems, it’s notable that carbon pricing is seeing increasing uptake over time – with more and more countries adopting prices and more of the global economy under a price.
Exploring carbon pricing (per tonne of CO2) and coverage, by country, 2021
With that out of the way, let’s get on to the debates surrounding efforts to put a price on carbon. I’ll do this by setting out four prominent arguments often made against carbon pricing and then discussing the counter arguments.
1. Carbon pricing does not affect emissions
First is the argument that placing a price on carbon does not affect emissions. The empirical literature doesn’t support this claim. Numerous empirical studies of carbon pricing, using a variety of methods, demonstrate that carbon pricing has reduced emissions. There is some question over whether the emissions reductions have been large enough, but this really comes down to what you consider “large” and what sort of reductions might be expected at what prices. In general reductions in emissions have been small, but significant, especially considering the low prices in place.
2. It won’t be enough by itself to tackle climate change
The second argument against carbon pricing’s effectiveness is that alone, it is inadequate to tackle climate change, because consumers don’t behave like economists assume: as rational cost minimisers. For example, people don’t just buy the cheapest car for their needs; they buy cars based on ideas of status and brand loyalty, among others. This is true and uncontroversial, we need more than price signals to move consumers. However, this argument is also something of a straw doll: most of the literature on carbon pricing acknowledges that carbon pricing will need to be complemented with other policies if it is to be effective in averting climate catastrophe. To this end, advocates of a carbon price who suggest it’s the only policy we need should be viewed with scepticism.
3. It will hurt the poorest people wherever it’s implemented
A big concern around carbon pricing is that increasing the cost of energy derived from fossil fuels will drive regressive impacts.
Since energy is central to the functioning of the global economy, and we currently generate around 83% of primary energy from fossil fuels, a carbon price will make almost all goods in the economy more expensive. Because low-income groups tend to spend a greater portion of their income on energy-intensive goods, a carbon price will have a disproportionately large negative impact on their well-being compared to wealthy households – making the policy notably regressive.
However, a huge advantage of carbon pricing is that the price also generates revenues. Importantly, wealthy groups tend to consume more energy-intensive goods than low-income groups (even though they spend a smaller proportion of their income on these goods). What this means is that, despite regressive cost-side impacts, you can use the revenues to make carbon pricing substantially progressive. There are a number of ways to do this, but the simplest is to just return all the revenues to everyone, equally (ie on a per capita basis). Doing so would result in low-income populations receiving more than they pay in increased prices, while the opposite would be true for wealthy populations.
4. Politics will keep carbon prices so low they will never work in practice
This argument is not that carbon pricing doesn’t work, it’s that carbon pricing has such bad politics around it that it will never be able to achieve the prices and coverage needed to address climate change. As the image above (showing low coverage and prices) makes clear, this critique has real merit.
There are numerous explanations for this bad politics, but two of the main ones are:
- The public are generally hostile to the implementation of new taxes or increased energy prices. This is in contrast to, for example, public subsidies, which tend to draw more support.
- Putting a price on carbon makes the cost of addressing climate change explicit. Anyone can look up the price they are effectively paying for their emissions. That makes carbon pricing an easy target for political opponents of climate action as they can simply point to the increased costs and taxes being paid by the public. By contrast, the costs of, say, laws simply banning certain types of carbon-intensive technologies are much harder to determine and spell out by opponents.
So though pricing might be an effective policy, it makes a bad priority for climate advocacy. This argument has a huge amount of merit, and some opinion research to support it.
However, alternative approaches to addressing climate change are also struggling for support. For example, laws banning certain fuels, subsidies for renewable energy, and efficiency standards – are also turning out to be inadequate to completely meet the climate challenge. Thus a complete rejection of carbon pricing on the basis that is has not yet solved climate change might be premature.
Our conclusion? Don’t dismiss carbon pricing: it can be part of the solution
So where does this leave us? Well first I need to stress this is a brief taster of the debate around carbon pricing and do look at our carbon pricing primer to get to grips with the full arguments, (you’ll find an in-depth section covering much of what I’ve mentioned in this blog, starting on page 53).
But briefly, here are five takeaways that can help us towards a nuanced view on carbon pricing.
- If the political momentum is not with carbon pricing in a country, starting a campaign for a carbon price is going to be challenging, because of the bad politics mentioned above. At the same time, if carbon pricing has political momentum it should be pursued, so long as it meets the additional criteria, below.
- There must be a way to collect the revenues from carbon pricing – some configurations of a cap-and-trade approach allow carbon permits to be given away. This should be resisted as it results in a simple windfall to the groups receiving the permits, and limits the possibility for addressing regressive impacts.
- The revenues produced by carbon pricing must be used to effectively address all regressive impacts created by the price.
- Prices must either be set high enough to drive ambitious emissions reductions or, if prices are to start low and increase over time to overcome political opposition, the process for increasing prices needs to automatic and insulated from political push-back.
- Carbon pricing can be effective but, by itself, it will not be enough to address climate change. Any carbon price will require complementary policies. The most important will relate to addressing other market failures (such as the need for public investment in research and development) and addressing network problems (such as supporting electric vehicle charging infrastructure), but will also include policies for numerous markets where price signals are insufficient to shift behaviour.
The frequent mention of carbon pricing in the latest IPCC report makes clear the extent to which carbon pricing remains a prominent policy tool for tackling climate change. Yet, carbon pricing has not been adopted at the levels or prices required to address climate change.
So, can carbon pricing work? NGOs should certainly not dismiss it as it could be a vital tool in the battle against climate change – but it needs to be done right and it won’t be enough on its own.