Climate change has been called “the greatest market failure in the history the world has ever seen”. As is the case with most market failures, the reason is an externality – the CO2 (and other greenhouse gases) dumped seemingly free of charge into the atmosphere. To correct for this economic system error, a price must be set for emitting carbon dioxide and other greenhouse gases, one way or another. The relevant questions are: who is to set the price, how should it be done, and how high? In the following I am going to explain why the answer to the first question is: governments and consumers, but not private firms.
It could be argued that, since the recognition of anthropogenic climate change is widespread, also among those running private enterprises, it could be expected that they correct their production (and thus the prices of their products) in such a way as to possibly minimize emissions of greenhouse gases. Many corporations have been aimed at by environmentalists (e.g., there is currently a Greenpeace campaign against VW running) because of their climate damaging production processes or products. Though these activities by environmental groups are important in shaping public opinion, it is actually naive to expect that firms behave climate-friendly of their own accord. The reason for this is, ironically, something that we generally agree is beneficial – market competition.
As long as there is no externally (from the viewpoint of the private sector) set carbon price (or, with other words, an internalization of the greenhouse gas emissions externality), the only possibility for firms to correct their prices is to do so voluntarily. There are firms doing exactly that – offering climate or more generally environmentally friendly products. If they are truly environmentally sound, these products’ prices are likely to be significantly higher than normally. However, the demand for such products, although significant in some rich countries, is limited. Most consumers, even in more affluent societies, look mainly after the price when they shop (for instance, 46 per cent consumers in Austria and Spain take prices as the most important shopping criterion, as well as 43 per cent Germans and Italians). So, if a firm tries to include the environmental external costs in its prices and fails to find environmentally aware niche customers, it soon gets outcompeted by others and drops out of the market. This is an iron law of competitive markets. This leads producers to largely ignore climate change and other environmental issues – they fear market loss. And, from their own viewpoint, they rightly do.
However, there are initiatives of private corporations that try to define certain environmental, social and other standards of conduct – e.g., the so-called Global Compact. This appears to be a way to avoid market losses by engaging in such activities together with competitors. However, after a closer look two problems appear. First, since such initiatives are always voluntary, they tend to be hardly more than “greenwashing” and have only little potential for real change. Secondly, only big players are mighty enough to engage in them and expose themselves to the risk from competitors reluctant to follow suit.
Thus, it cannot be expected from firms that they behave really environmentally responsibly (i.e., beyond legal standards and commonly agreed upon consumer demands) – in a market economy, they wouldn’t survive. The “big guys” certainly have the capacity to include some environmentally responsible activities in their production processes and thus force competitors to follow suit – but they won’t and cannot be expected to do it at the expense of their market position.
This leads to the recognition of the role of the government, on the one hand, and the consumer, on the other. It is generally agreed that the most effective way to correct market failures is regulations by the government. In the case of climate change, these would include: a carbon tax and/or a cap-and-trade scheme, product and production process standards and similar instruments.
The main problem of a sole concentration on the role of the government is (aside from the more general issues of bureaucracy, political opportunism etc.) globalization. As I already once discussed, free trade with all its facets constrains the national government’s ability to run a truly effective environmental policy – by raising standards it risks outsourcing and a general loss in the country’s competitiveness. These risks are often exaggerated by corporations when they expect new regulatory legislature, but they nevertheless are present and do constrain the government’s policy space.
This leads us to the role of consumers in tackling climate. Disperse as we are, together we have the capacity to change the whole economy – simply by choosing particular, climate-friendly products and dismissing other. Moreover, the role of consumers is hardly constrained by the hyperglobalization problem – since the demand in a given market is what determines supply, it is of no meaning who is the supplier and where he does come from. The only important thing is that she meets consumer demands. Otherwise she drops out of the market. Because climate change and greenhouse gas emissions are a global problem without hot spots, it doesn’t matter who and where does reduce emissions.
Of course, consumers are not homogenous. Furthermore, in the case of climate change, they have strong information deficiencies. Thus we get back to the role of the government – among the main tasks of any government are education, information and the promotion of public good. Thus, while governments certainly have to put in place regulatory standards as to induce climate-friendlier production processes and products, they are also inclined to inform their citizens and to try to convince them that price is not the mere important consumption criterion. Together, consumers and governments have the potential to change production and consumption patterns and thus contribute to the solution of the global climate challenge.