Saturday, June 3, 2023

It’s been a good week for carbon pricing


This article is an on-site version of Martin Sandbu’s Free Lunch newsletter. Sign up here to get the newsletter sent straight to your inbox every Thursday

Can we call it C-day? The European Commission yesterday published its massive plan to achieve a carbon-neutral EU by 2050 and the intermediate goal of reducing carbon emissions by 55 per cent below 1990s levels before the decade is out. The plan, called “Fit for 55” and expertly reported on the FT’s Climate Capital hub, covers a range of sectors and policies.

While you are digesting Fit for 55, do not neglect another important development. Over the past weeks and months, there has been a notable increase in support by influential institutions for creating a meaningful price for carbon. Strikingly enough, commission president Ursula von der Leyen herself centred her announcement of the Fit for 55 package on the need for an effective carbon price. More on this below, but first let us look at how carbon pricing is popping up as a central concept almost everywhere else, too.

Last weekend, the finance ministers and central bank governors of the G20 large economies met in Venice, and signed off a communiqué that included an endorsement of carbon pricing “if appropriate”. The qualification is a nod to governments whose domestic politics discourage them from thinking about carbon pricing, most importantly the US. Cautious and non-committal as the phrasing may be, my colleagues highlight that it was the first time the G20 — as close to a world government as we may ever get — collectively expressed support for the policy at all.

The day before the G20 meeting, the European Central Bank published its strategy review (here is my assessment that it ends an era of the ECB sticking out like a sore thumb among other central banks). Among the bigger announcements was the little-noticed detail that as part of its determination to incorporate climate change in its policymaking, the eurozone’s central bank will start to include technical assumptions about carbon pricing when working out its macroeconomic projections. Free Lunch hopes the ECB will publish the carbon price paths it uses.

Finally, the IMF has long been pushing for carbon pricing as a necessary if not sufficient part of a policy package that also includes investment in green technology and redistribution to help the worst-off cope with the financial burden. The fund’s staff have now proposed a global minimum carbon price — along the lines of the global minimum floor on corporate taxes which has recently secured agreement — as explained in a recent IMF blog post.

This is necessary, the authors write, given that “four-fifths of global emissions remain unpriced and the global average emissions price is only $3 per ton”. They suggest the minimum carbon price can be differentiated between more and less developed nations, and that in countries where domestic policies stand in the way of explicit carbon pricing (the US again), one could devise a carbon price-equivalent measure of other policies such as bans and regulations of high-emissions activities.

The EU, of course, is well placed to achieve comprehensive carbon pricing given that it already has a carbon price for those sectors covered by its existing emissions trading system. It is now strengthening its focus on the approach, expanding emissions trading to new sectors (aviation, shipping, road transport and buildings) in a bet that by redistributing some of the revenues that a higher carbon price would raise, it could calm the opposition from people facing higher costs of living. That is a bet the US, in particular, is so far unwilling to take.

I think there are good reasons to think the EU will be proved right on this. The first is that the closer you get to a single public carbon price across the economy — whether through emissions trading as in the EU or a carbon tax — the easier it will be to reduce emissions. That is because the price signal creates the strongest incentives to implement the cheapest ways and places to reduce (or capture) emissions. Coupled with redistribution, this amounts to using the social market economy (as von der Leyen also emphasised) to achieve decarbonisation, which is both more efficient and fairer than the command-and-control approaches the US looks set to rely on.

Second, the flip side of this are incentives for technological development. The EU is very consciously using decarbonisation measures, coupled with investment subsidies, as an industrial policy. And the signs are that it is working: many car manufacturers now think electric vehicles are more profitable to produce than conventional ones, for example.

And finally, it allows for a straightforward way to prevent other economies from taking unfair advantage of those who take decarbonisation seriously. As the EU’s carbon tariffs (proposed as part of the Fit for 55 package) illustrate, a domestic carbon price can be extended to apply to imports. I have argued that the EU should aim to lead a “carbon club” of economies committed to ambitious carbon pricing at home and conditioning access to their market on similar carbon pricing elsewhere. That came one step closer this week.

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