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Against the Tide: A market solution to climate change

Market mechanisms, not inflexible penal taxation, are the way to deal with global warming. And market approaches also open profitable channels for investors.

In May, the Intergovernmental Panel on Climate Change issued its fourth report on the risks to the world of global warming. The main conclusions were that global greenhouse gas emissions had increased by 70% since 1970, far faster than would have been expected without human activity. And the annual emission rate was still rising.

The scientists also concluded that this would have an increasingly detrimental effect on physical (weather) and biological (plant and animal species) systems around the globe. Global temperatures are rising, melting polar ice and increasing the risk of a cataclysmic event that could kill hundreds of thousands and disrupt the lives of millions.

What was noticeable about this report was the support for its conclusions that came from the US and China, countries that up to now have refused to endorse the scientific majority’s conclusions or consider any serious action to control emissions.

But now the issue is concentrating the minds of the politicians and the business community, not just the green lobby and environmentalists. Climate change is fast becoming the issue of the decade, if not the century.

Whether you agree or disagree with the conclusions of scientists or economists on climate change, government and corporations are set to spend billions on trying to mitigate or abate greenhouse gas emissions. The report argues that there is a serious risk of a 20% fall in world GDP by 2030 unless action is taken, and the cost of action would be no higher than 3% of GDP in 2030. So the money will be spent. This is a great investment opportunity.

One key question is whether global warming and increased pollution can be contained better by taxation designed to deter people’s activities or by market mechanisms designed to encourage people to take the right measures. I believe the latter approach is best.

Feel the heat

Global CO2 emissions from fossil-fuel burning and smoothed average near-surface temperature – difference compared to the 1961-90 average

Source: CDIAC, CRU

Markets such as cap and trade are the efficient tools to deal with the environment and will create wealth in doing so. Markets will ensure that the environment is protected and bettered at minimum cost and with the most efficient technologies. Taxes, such as a carbon tax, cannot do this job. Only the market mechanism can regulate the amount and type of resources needed to achieve the goal of an acceptable quantity of emissions. Taxes, being a fixed price, cannot do that and are, moreover, subject to the vagaries of the political process. Environmental taxation and public spending have the disadvantage of empowering politicians to select the new environmental technologies.

But environmental markets, like those for auto insurance, mobile phones and medical care, can only be created by public policies that set quantitative standards around which they can trade. If that happens, then carbon trading, for example, will become the biggest virtual commodity market on the planet, dwarfing many traditional physical ones. It will create wealth for market participants just as derivative markets do. It will ensure that the job of reducing emissions is done at minimum cost and maximum efficiency.

Carbon trading will create profits for companies that are efficient at mitigation (whose mitigation costs are less than the carbon price) and minimize environmental costs for companies that aren’t. That will maximize the probability that the economic benefits of global greenhouse gas policy will outweigh the costs (as happened with the US acid rain markets).

Many products that benefit the environment (for example, hybrid cars, LED lighting, use of carbon fibre in ultra-light forms of transport) will be superior to their traditional "dirty" peers and will gain market share because of the technological advance they represent.

Letting markets price the environment also means that such resources as water and emissions are traded at economic values rather than at prices determined by bureaucratic fiat. Market pricing of environmental inputs will reduce corporate costs and increase profits. Resources will get used more efficiently.

Climate change is a political idea whose time has come and policies to deal with it, even if they prove costly to the consumer, will get votes. The next US administration will want to address the issue of climate change. It will reconfigure the Kyoto protocol and join a remodelled Kyoto II.

Then a huge piece of the world’s environmental policy jigsaw will fall into place. Investors will have to adapt their portfolios to take advantage of these new opportunities, which will be just as big as the hi-tech, dotcom boom of the 1990s.

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