Climate Change

The economic justification for tackling climate change

13/03/2019 | 17:43 GMT

By Andreas Formosa |

Climate change is generally thought of by most as an environmental problem, with endeavours to fight the effects of climate change traditionally being driven by environmental activists. Unfortunately, most people, especially those in government and business, are not particularly moved by environmental considerations and prefer to focus on measures to improve the economy. It is a shame therefore that the argument is not framed more as an economic problem, which would probably have a better chance of obliging environmentally sceptical actors to act.

The environmental justification for tackling climate change is clear and the scientific evidence that humans are the main factor behind climate change and global warming is overwhelming. The scientific evidence also supports the argument that there is an economic injustice as well as an environmental one. This article sets out some of the principal economic arguments for combating climate change which include:

  • The economic theory behind externalizing externalities;
  • The displacement of costly fossil fuel imports;
  • The increased severity and cost of extreme weather events; and
  • The health benefits of avoiding fossil fuels.

I do not intend to delve into too much detail in each of the arguments, but merely intend to stress that climate change should be treated as an economic problem with economic solutions if we are to effectively decarbonise our economies ahead of the catastrophic results that are predicted later this century.

The economic theory of internalizing externalities

Economists such as Nobel laureate William Nordhaus have argued that the environment is a public good which we all benefit from but we do not adequately pay for. According to the polluter pays principle, greenhouse gases are pollutants which are not appropriately being paid for by the pollutant. The cost is currently socialised throughout the global population (even though for example emissions might be more concentrated in one part of the world) and intergenerationally- i.e. future generations are also paying this cost (and arguably they have the heaviest financial burden).  

One of the basic ideas in economics is that the best results are achieved if the decision-making process is fully informed of the full range of benefits and costs. Emitters of greenhouse gases in most parts of the world do not pay for these externalities as there is no relevant carbon price applied. In places where they do pay for the greenhouse gases they emit, such as in the EU under the emissions trading scheme, the price is arguably not fully reflective of the cost and there is therefore still a significant element of free riding.

Nordhaus argues that as environmental pollution is an economic problem there is, therefore, an economic solution, which can most efficiently and effectively come from the market. Nordhaus describes the market as “one of the most powerful systems on earth”. Take the fossil fuel industry- based on this principle, fossil fuels are being unfairly subsidised and are distorting the energy and transport markets. The true price of fossil fuels and other activities producing greenhouse gases (e.g. the cattle industry) would be much higher if they paid for costs they imposed on society and the environment. Markets need to attach a premium on goods and services produced with a high GHG component and this can be achieved through a cost-reflective carbon tax for example. This would have the effect of making their respective products more expensive relative to environmentally friendly alternatives (such as solar panels or vegetables) to factor in the externalities.

“Markets need to attach a premium on goods and services produced with a high GHG component and this can be achieved through a cost-reflective carbon tax for example”

Other economic arguments

Apart from the theoretical economic arguments described above, there are other convincing economic reasons for countries to take decisive action against the threat of climate change.

Firstly, as most countries are energy importers, renewable sources of energy replace costly (and very volatile in price) imports of oil, gas and coal. The price of solar panels and wind turbines have come down dramatically since the beginning of this decade, and technologies and methods to balance grids with high percentages of variable renewables are becoming cheaper, more sophisticated, and reliable. I write this article from Costa Rica, a developing Central American country, which relies on renewables for 98% of its electricity demand and has a plan to be carbon neutral by 2021. There is no excuse for developed energy importing countries do not take the same steps.  This argument will only become stronger with more appropriate carbon taxes which will make fossil fuels look even more expensive compared to cleaner fuels such as electricity and hydrogen in transport, and renewable energy technologies in power generation.

Another economic argument for tackling climate change is that it is almost without doubt that climate change is increasing the frequency and ferocity of natural disasters. One just has to ask the insurers who are either increasing premiums or no longer ensuring certain coal assets. For example, in 2017 the insurance industry paid out a record USD135 billion from natural catastrophes, almost three times higher than the annual average.  

There are many other arguments, including the health benefits associated with avoiding the use of oil and diesel in transport and coal in power generation. But the principal point is that in a capitalist world it is more effective to recognise that climate change is also an economic problem that must be solved largely through economic solutions as that is the only way to appeal to governments and businesses to tackle the problem head-on and as a matter of urgency. We are quick to ensure businesses account for negative externalities in most areas- why not apply the same principle to those emitting pollutants?

About the Author

Andreas Formosa is an energy lawyer at Clifford Chance LLP where he advises on energy projects and regulation, predominantly in the power and renewables sector. He has extensive experience in energy regulatory law, having also worked at Ofgem, the GB energy regulator as a senior legal advisor. He has written about in published books and articles and presented on at several conferences and during guest lectures, he has given on the energy and natural resources LL.M at Queen Mary, University of London. 


Categories: Climate Change, Opinions