06 Jan 2021
Visible climate damage and the Invisible Hand
A Happy New Year to everyone. With COP26 scheduled for November 2021, one of the key themes of the blog this year will be the environment. Today I start with what I consider to be one of the most important issues – clarifying the role of markets within the energy transition.
An engaging and well-argued series of Reith Lectures delivered by Mark Carney, former Governor of the Bank of England, formed part of my Christmas listening. In them, he reflects on the topics of Covid, credit, and climate change. The unifying theme is the idea that, slowly and silently, Adam Smith’s Invisible Hand has progressed at the expense of his Moral Sentiments. The former promotes the wonders of markets, the latter the need to integrate greater social capital into our economic lives. We forget this second imperative at our peril, as reflected in current crises.
Unfortunately, Carney’s nuanced message is often distorted by others, especially in the context of environmental issues – with proclamations asserting that we cannot leave climate change abatement to the market. We are encouraged to believe that markets ‘fail’, in various ways. Firstly, the traditional ‘tragedy of the commons’ - a free-rider problem where, for example, if several farmers share a pasture, the result is usually overgrazing. This plays out with particular force when the common resource is the biosphere, which we are all prone to overuse. Secondly, a potential ‘tragedy of the horizon’ - myopic decision-making, as the current generation has little incentive to abate carbon emissions on behalf of future generations. Finally, amoral markets pay no heed to wealth distribution - a root cause of social malaise in the first place.
It is true that markets have limitations (although these can sometimes be countered by smart regulation), and their participants may well suffer from behavioural biases. Moreover, they are not necessarily ‘right’ in any moral sense. However, if we want to insist on failure, we have to suggest the alternative.
"Markets offer a potentially powerful institutional arrangement to help society meet whatever carbon objectives it sets itself."
Allocation of scarce economic goods can be managed in other ways – distribution by lottery, rationing by a centralised agency, or, less pleasantly, allocation by an authoritarian (and usually corrupt) regime. Each option has its problems. The fact is that, in terms of facilitating cost-effective exchange for a wide range of goods and services in different geographical and cultural contexts, no one has ever come up with anything better than markets. They are less random than lotteries, allow for informational advantages relative to governments, and impose no hierarchical structure on participants. Indeed, it is not clear that markets ‘fail’ at all relative to likely alternatives.
The key message is that markets do what is ‘on the tin’ – they facilitate trade at low costs. As such, they offer a potentially powerful institutional arrangement to help society meet whatever carbon objectives it sets itself (‘net zero’ or other), freeing us from the huge vested interest groups that currently dominate the climate debate.
Hopefully I am not the only one who is increasingly tired of the endless litany of carbon ‘solutions’ proposed by businesses, if only appropriate subsidies are made available. As Sir Dieter Helm put it in Net Zero: ‘it is hard to imagine any coherent decarbonisation strategy without a price of carbon at its core’. The single greatest thing our society could do now, given our net-zero target, would be to allow unencumbered carbon markets to flourish. That would help to resynchronise markets in the way Carney suggests, merging society’s values on climate damage with the independent test of the market place.
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