Raising carbon prices, eliminating fossil fuel subsidies, reducing pollution-related health care costs. These three economic changes will transform climate change into a global wealth creation engine.
The most important of the three changes is eliminating today’s US$5.3 trillion of annual world fossil fuel subsidies. The Group of Seven has pledged to do that for the world’s largest economies by 2025. The rest of the world can follow. Everyone will gain.
The second is to raise carbon prices on the world’s 40 billion tonnes of annual emissions from $3 per tonne (the current weighted average) to $50 per tonne.
Fifty dollars a tonne is a future level many energy corporates already budget for in the future investment planning.
As subsidies disappear and carbon prices rise, economic behaviour will change. Carbon emissions will fall, spurring a virtuous circle: reduced heath costs, better investment decisions and heightened economic growth.
These reforms will more than pay for themselves. When finished repairing the damage of climate change, they can be applied to paying for an aging global population.
Consider some numbers:
By 2031, eliminated fossil fuel subsidies will free up $5.3 trillion. By that year, falling health costs of dealing with climate change will yield another $1-2 trillion in savings. Raising carbon prices to $50 per tonne will free up another $2 trillion.
Together, these policy changes and their economic benefits will free up $9 trillion a year (roughly seven percent of the world economy) to better uses.
After that, revenue will fall as fossil fuel subsides will hit zero and shrinking emissions yield smaller and smaller carbon revenue. Even with this shrinkage, however, reforms will still produce annual redeployable capital of roughly five percent of the global economy in 2050.
The indirect benefits will be enormous. Shifting energy markets toward cleaner, more abundant renewable energy resources will reduce global geopolitical tension.
Rising territorial tension in the South China Sea, for instance, can be viewed as a battle over dwindling fossil fuel resources.
China’s ambit claim Nine-Dash line in the South China Sea and its rejection of UN Tribunal jurisdiction in the sea also can be seen this way.
So can China’s recent placement of high-tech oil exploration equipment in waters claimed by Vietnam, as can China’s ham-fisted effort to auction off oil and gas exploration blocks in waters claimed by Vietnam.
Over time, redeployable capital created by properly pricing climate change can be plowed into infrastructure to raise economic growth. This will raise the global economic growth rate, reducing the medium-term drag of higher carbon prices and eliminated price subsidies.
Never in the history of economics has a global macroeconomic problem presented such a clear and unambiguous set of policy solutions.
The policy mix is clear. The world needs certainty. Eliminating fossil fuel subsidies and creating a multi-decade rising price curve for carbon will enable clearer discounting of future investment.
For their part, fossil fuel subsidies can be reduced on a straight line basis. Achieving predictability in carbon levies can be achieved through carbon trading applied to an ever greater proportion of carbon emissions coupled by a minimum floor price below which carbon prices can’t fall.
This has been the fatal flaw of carbon markets to date.
To fix this, forward-looking jurisdictions like Alberta, Canada are now considering hybrid systems of floating carbon prices underpinned by a minimum price. Australia implemented such a system briefly and may resurrect it.
The European Union is well aware of the minimum price problem. The EU almost certainly will include that in 2020 reforms to the European Union Emissions Trading System (EU ETS). China’s also taken note, and plans to incorporate price floors into its various regional carbon trading markets.
With greater policy certainty such as the above, carbon futures markets can allow better management of private risk. America’s NASDAQ already offers futures contracts out to 2020 on the EU ETS. Longer-dated futures will no doubt be introduced after the EU ETS’s 2020 reforms are agreed.
China also is working on a regional futures exchange. Economic reform coupled with zero sum financial market risk management products can solve climate change with capitalism.
Climate change has been the devastasting result of a failure to apply orthodox economics.
The sooner it all gets back on track, the better for everyone.