Economic policy measures for climate change

1. Context and definition of the concept

  • The complexity, gravity and urgency of the fight against climate change means that all possible levers should be used as soon as possible, because the later that action is taken, the more complicated and expensive the solution will be.
  • Economic policies aim to provide incentives for economic operators (companies, consumers) to adapt their behaviour in order to achieve set targets, in this case measures that are geared towards mitigating or adapting to climate change.
  • Economic policy instruments for climate action can make a major contribution to value creation in a broad sense. A policy with an additional restriction (environmental protection) may lead to higher production costs but on the other hand, internalising a problem such as climate change in economic behaviours will generate significant future savings due to the damage avoided (mitigation measures) or the adaptation activities that are carried out. In this regard, there are numerous reports that explore the matter in considerable detail. The best known of these is the Stern Review.
  • These measures can and should come from all layers of public institutions, i.e. at international, regional, national and municipal levels.
  • We will now go on to explain some of the types of measures that are available from the perspective of economic policy. The goal is to provide a general list without going into detail or assessing their effectiveness.
  • In general economic policy, there are three major types of instruments: market-based, command and control and other miscellaneous tools.

2. Market-based instruments

  • Market-based instruments aim to internalise the costs that the damage caused by an activity causes to society and which are not being borne by the source. In the jargon of economics, it is what is usually referred to as “internalising externalities”. In other words, it is including in the value chain of a product or service the damage it causes to society.

In climate change, this translates into a very important principle: The “polluter pays” principle. It means that polluters take responsibility for the pollution they produce. This also guarantees that efficient, comprehensive signals are sent out, so that all economic operators make the right decisions.

  • In the case of climate change, the damage is what is caused by the numerous major external climate events (hurricanes, storms, droughts, flooding, etc.): lower output in the agricultural sector, impact on health, higher costs of adaptation (public works, higher air-conditioning costs, etc.), intergenerational costs (the current generations are causing the problem and the future generations will bear the brunt of the main impacts), etc.
  • There are two general types of market-based tools for limiting greenhouse gas emissions: quantity-based and price-based tools. The former seek to limit emissions (restrict emissions) and the price is to be set by the market; the latter seek to assign a cost to those emissions and the quantity of the emissions is to be set by the market.
  • The best example of quantity-based tools are CO2 In these markets, certain operators (normally sectors of activity) have a regulated global cap on emissions. In order to be able to produce emissions, they have to purchase a permit from an emissions market in which they are participants. The number of permits is equivalent to the particular cap on emissions.  The advantage of this instrument is that emissions will always be in line with what has been set as the target and that a higher degree of economic efficiency will be achieved (carbon will be reduced where it costs the least). On the other hand, these systems are very costly to set up and complex to design: if the design is not effective, the price signal may not match the goals (for example, a price that is too low may not incentivise clean investments and one that is too expensive may incur costs that are too high for society).
  • The best example of price-based tools are taxes. In this case, all of those that produce emissions have to pay for them, in terms of $/tCO2, for example. This cost for having produced emissions should reflect the cost (damage) that the emissions cause to society. The advantage of this instrument is the low roll-out cost. The drawbacks to it are essentially due to the difficulty in calculating the cost of the damage and that possible deviations may cause a drift away from the target emissions.  Another practical drawback is that in many regions, a tax is seen as a cost that is detrimental to the economy.

Subsidies are another type of price-based instrument. Fiscal policies may encourage more sustainable behaviour by providing subsidies for more sustainable activities (energy efficiency, renewable energies) or which are based on adaptation (conducting studies on impacts and mitigation). The advantages of subsidies are social acceptance and ease of implementation. On the other hand, the main drawback is the creation of a cost in public budgets.

  • Given that internalising costs increases the cost of energy for end consumers, two types of complementary measures could be considered: 1) measures designed to protect vulnerable consumers and 2) corporate policy measures designed to offset the possible loss in competitiveness by companies compared to other markets where the policies for internalising the cost of CO2 are different.
  • On the other hand, it is crucial to eliminate subsidies for energies that produce pollution. It does not make sense to combat climate change while providing incentives in the form of various types of grants for the consumption of emission-producing energies. This is an additional cost that is detrimental to the general goal.


3. Command and control instruments

  • Command and control instruments are intended to have a direct impact on the climate characteristics of various processes, items of equipment, materials, etc.
  • There are several examples of these instruments:
    • Emissions standards: the various products or services cannot produce more than a set quantity of emissions. For example, an electricity generation plant in gCO2 per kWh of energy produced, a vehicle in gCO2 per km travelled, etc. These limits could be set for each facility, at national level, for each company, etc.
    • Clean energy: obliging companies to produce or use clean energy. For example, for X% to be from renewable sources or free of CO2
    • Energy efficiency: increasingly strict technical building regulations provide obligations as regards design and materials that considerably reduce energy consumption by buildings.
    • Indirect limitations, which are able to reduce emissions. For example, restricting vehicle speed on roads, limiting permits for building high-emissions facilities if there are other cleaner alternatives available, restricting the use of high-pollution vehicles in cities, etc.
    • Standards for adaptation may also be defined, for example, in the requirements for new buildings, industries or public works.


4. Education and awareness measures

  • It is fundamental for the general public to know and be aware of the problem of climate change. This will help people adapt their behaviours so as to minimise their emissions on a day-to-day basis. Given the greater level of acceptance, it will also make it more feasible and encourage people to demand new policies to combat climate change, even if they generate more inconveniences (for example, traffic restrictions) or higher costs for some products (for example, renewable energies).
  • There are also many examples of this type of measures:
    • Energy labelling for electrical appliances, homes, etc.
    • The obligation for companies to conduct environmental audits.
    • Citizen communication campaigns explaining the problem and how to address it.
    • This matter should be included on the school syllabus.
    • Obligations regarding information for companies: risks of climate change for companies, assets that may be affected, strategy for mitigation or adaptation in the short and long term, etc.


5. Other concerns

  • Given the characteristics of the energy sector, with its extensive regulations and the participation of both public and private operators, and its central importance for the smooth functioning of modern societies, public-private relations and alliances take on special importance. In this regard, it is crucial to implement best practices, such as the principles of proper regulation, mutual trust, transparency, etc.

The model used for governing all of these measures will be essential for their credibility and effectiveness.

  • As we said, the complexity and gravity of climate change mean that all possible measures need to be adopted. Differing circumstances may mean that certain measures are more suitable or more feasible in some geographical areas rather than in others.
  • The complexity of the measures may mean that a combination may be more suitable. For example, instead of the “pure” alternatives of taxes or an emissions-trading scheme, there are “hybrid” systems that aim to combine the best aspects of each one.  For example, in California there is a carbon trading system that guarantees a minimum price to encourage clean investments (a “floor”) and a maximum price that may not be exceeded so as not to incur excessive costs for society (a “ceiling”).
  • Normally, other general measures may be applied to the problem of climate change. For example, R&D policies should target this issue so as to speed up the time-to-market of new products or services that are adapted to it or which help to address the problem.
  • We should also bear in mind that given the scenarios that lie ahead, it is now inevitable that climate change is going to generate important impacts. This means that as well as taking mitigation measures to reduce them, it will also be necessary to implement adaptation measures that can help cope with them.