Climate Change 2：Harnessing Economic Policy to Combat Climate Chang

Harnessing Economic Policy to Combat Climate Chang

Climate change constitutes a paramount challenge within the contemporary era, wherein carbon emissions are critically implicated as a primary causative factor and simultaneously represent a central target for prospective policy measures. Market failures, where the unregulated market fails to allocate resources efficiently, are central to understanding the ineffective control of emissions. This report delves into the economic concepts of private and external costs, examining how market failures manifest in the context of carbon emissions, particularly looking at cases such as wildfires in the American West. It also analyzes how policy tools, such as carbon caps and subsidies, can potentially address these failures by realigning market incentives with social and environmental well-being. The analysis utilizes a multidisciplinary approach, drawing on current literature and empirical studies to assess the efficacy of various economic policies. The aim is to offer a concise comprehensive overview of how economic theory and policy can inform strategies to mitigate climate change.

Within the framework of climate change, private costs are incurred directly by entities or corporations participating in economic operations, notably those involving the production of fossil fuels. However, these entities often do not account for the external costs - the negative spillovers of their actions on third parties, which include the broader impacts on public health, property damage from increased natural disasters, and loss of biodiversity (Fullerton & Stavins, 1998). These externalities are central to market failures, as they represent costs not internalized in the market transactions of goods and services.

A prime example is observed in the increased frequency and intensity of wildfires across the American West. The direct costs of firefighting and property loss are enormous, yet they pale in comparison to the wider environmental and health impacts spread across populations who are not party to the initial activities that exacerbated these wildfires, such as inadequate forest management and excessive carbon emissions (Abatzoglou & Williams, 2016). To be exact, as shown in Figure 1, Federal fire suppression spending on federal lands alone averaged $2 billion between 2016 and 2020, with 2017, 2018, and 2020 being particularly costly years due to wildfires (Wildfire Financial Cost, n.d.). Meanwhile, the Annual 2021 Wildfires Report indicates that over 7 million acres were affected by wildfires in 2017 and about 8 million acres, on average, were burned each year in wildfires between 2017 and 2021 (National Centers for Environmental Information, 2021; Congressional Budget Office, n.d.). This disjunction between private gains and public losses is a classic case of market failure where the market does not reflect the true social cost of economic activities.

Figure 1 Firefighting Expenditures and Deforestation During 2017 and 2020

Economic theory suggests that without intervention, the market will not achieve an optimal allocation of resources in the presence of externalities (Pigou, 1920). Pigou proposed a tax equal to the external cost - now known as Pigouvian tax - to correct this type of market failure. Similarly, Coase (1960) argued that under certain conditions, parties can negotiate to address externalities, though this is often impractical at the scale of climate change due to transaction costs and the diffuse nature of those affected by emissions.

The fashion industry vividly illustrates market failure through the dichotomy between fast fashion and sustainable garments. Fast fashion, characterized by rapid production and a high turnover of cheaply made clothing, thrives on externalizing its environmental costs. These costs are not accounted for in the pricing of garments, leading to overconsumption and waste (Joy, Sherry, Venkatesh, Wang, & Chan, 2012). Figure 2 illustrates that tackling the ecological and societal challenges posed by the fashion sector may yield an aggregate economic advantage estimated at $192 billion globally by the year 2030, while the yearly economic loss attributed to clothing disposed of prematurely surpasses the $400 billion mark (World Resources Institute, n.d.). As shown in Figure 3, the production process is resource and emission-intensive, leading to considerable water use, chemical pollution, CO2 emissions, and textile waste. The industry produces over 92 million tonnes of waste and consumes 79 trillion liters of water annually (Nature Reviews Earth & Environment, n.d.). On the other hand, sustainable garments, which are made with eco-friendly materials and ethical labor practices, often come with a higher price tag that more accurately reflects their true cost of production.

Figure 2 Overall Benefit and Annual Discarded Clothing by 2030 of Fashion Industry

Due to these differing cost structures, the market tends to fail by overproducing fast fashion while underproducing sustainable garments. The demand for cheap clothing is met at the expense of the environment, with the textile industry being one of the largest polluters worldwide (Niinimäki et al., 2020). This misalignment of market prices and social costs leads to a significant market failure in the form of environmental degradation and exploitation of labor.

Public goods, exemplified by clean air and biodiversity, exhibit the characteristics of non-excludability and non-rivalry; the former denotes that consumption by a singular entity does not diminish the quantum available to the collective, while the latter indicates an inherent inability to preclude individuals from utilization. These characteristics lead to market failures as the free-rider problem prevents markets from supplying these goods in adequate quantities (Samuelson, 1954). Ecosystem services, like pollination and climate regulation, are classic examples of public goods that are undervalued or ignored in market transactions.

Despite their critical importance, markets often fail to protect or adequately produce ecosystem services. As shown in Figure, the total urban area is growing year by year from 2000 to 2018 in Europe, while others (including cropland, grassland, forest, and woodland areas) are flat or declining year by year. The services provided by forests, for example, which include carbon sequestration, habitat for biodiversity, and water cycle regulation, are often not compensated in market systems (Costanza et al., 1997). This failure leads to deforestation and loss of biodiversity as the land is converted to uses that the market values more, like agriculture or urban development. The concept of ecosystem services and their value to human welfare should be incorporated into economic policies to correct this market failure.

Figure 3 Ecosystem Extent Trends from 2000 to 2018 in Europe

To effectively address greenhouse gas emissions, carbon cap-and-trade systems set a cap on emissions, allowing market forces to determine the price of carbon, aligning it with its social cost (Stavins, 2008). Governments can incentivize emission reductions by gradually lowering this cap and redirecting subsidies from fossil fuels to renewable energy, correcting market distortions and fostering a greener economy (Parry et al., 2014). Concurrently, the shift from fossil fuels to green energy, driven by the need for sustainable practices, presents a dual challenge. While it promises reduced emissions and alignment with environmental goals, renewable energy faces hurdles in efficiency, energy storage, and supply consistency. This transition requires significant financial investment, risks to fossil fuel-dependent industries, and demands comprehensive policy frameworks and infrastructure updates. Navigating this complex shift requires a harmonized approach that balances the benefits and challenges, emphasizing strategic foresight, innovation, and cross-sectoral collaboration.

Effective economic policies are essential in combatting climate change. Market failures associated with carbon emissions can be addressed through tools like Pigouvian taxes, carbon caps, and shifts in subsidies. The potential of these policy tools to mitigate climate change is substantial, but their implementation must be carefully designed to align market incentives with the long-term sustainability of the planet.

References

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