Climate change has been acknowledged for many years now. A majority of people (about 70% of the population across the Western hemisphere) believe that it is a problem. It’s an impending catastrophe with a solution that is completely within grasp. The problem is man-made, and can hence be stopped if we had the willpower to do so.
The movie Don’t Look Up criticised this inaction. However, the movie was given its time in the sun, and climate action remains slow. There was a wave of action after Greta Thunberg spoke against it publicly, but that has receded.
Are we really that foolish as to sleepwalk into disaster? I would argue that it is a matter of economic incentives and the problem is far more persistent because of these economic incentives. Still, the solutions could lie in adjusting these incentives.
The tradeoffs
It is naive to imagine that climate change can be solved without sacrifices to present-day quality of life. Any move to reduce carbon emissions will mean more expensive goods as pollutive but efficient methods are curbed. Production of certain goods like meat that are higher in carbon emissions will also reduce quality of life if their production is reduced while demand stays constant.
There are some that protest that such tradeoffs are no-brainers; that the problem is so disastrous they it is worth making the tradeoffs no matter what. I would argue that this comes from a privileged perspective. It’s one thing to avoid taking a flight from climate concerns, it’s another to jack up prices of basic commodities because you impose curbs on palm oil, leading to aggravated poverty among the many consumers depending on products made from the cheap oil.
Given that there are tradeoffs, the reluctance to accept these tradeoffs in combating climate change boils down to the tragedy of the commons as well as the presence of negative externalities.
Tragedy of the commons
Anytime AI replacing workers is brought up, there will be a notion that firms are acting in a myopic manner. If firms are replacing workers, what demand will exist for the products they create? Who will they sell to when a permanent underclass of people are now unemployed?
It might sound silly of the companies, but this is the classic tragedy of the commons at play.
The tragedy of the commons refers to a situation where individuals, acting in their own self-interest, deplete shared resources, leading to long-term collective harm. This concept highlights issues that arise when externalities—costs or benefits incurred by third parties—are not reflected in market prices. The inherent conflict between individual incentives and collective welfare often demands solutions involving public goods funded by governments or other cooperative measures.
To address these challenges effectively, we must first evaluate whether they can be resolved through individual action:
- Can an individual’s behaviour significantly alter the outcome?
- If everyone adopted the same behaviour, would the issue be resolved sustainably?
Going back to the AI conundrum, even if corporate executives were aware that a collective shift towards automation and high unemployment would destroy demand for their products, they have every incentive to continue moving towards higher labour efficiency. If every other company pursues AI, but they do not, they will lose out while the overall wage across the economy tank and they still suffer the lack of demand. Unfortunately, a single firm is unlikely to be able to change the median wage much even if it swears off AI. Yet, they would be out-competed, and wiped out by higher operating costs.
If a business was pumping mercury into the water supply of a town, you would hear collective outrage. The affected people have a strong interest in stopping the pollution of their drinking water, and will beat on the war drums to spur the rest of us into action.
However, global warming is precisely difficult to spur action because of its global nature. Carbon diffuses through Brownian motion, distributing itself uniformly across the globe. Therefore, no one directly faces an uneven and excessive concentration of CO2, though some are more vulnerable to rising tides and unpredictable weather patterns.
It is irrational to act individually by spending more to reduce your carbon footprint – such as buying items manufactured with less damage to the climate – if everyone else is spending less while polluting. Neither do countries have an incentive to unilaterally crack down on heavy-emitters or compel them, for fear that businesses will leave, taking their economic activity with them.
While it has been popular to appeal to corporations to go green, or protect worker rights, consumer price sensitivity means that it is the firm with the lower costs that eventually survive market forces. The romantic notions that a company with a conscience can thrive is often insufficient to keep the company afloat – unless consumers are inherently discerning enough to reward those companies that do not maximise profit at the expense of other stakeholders. For instance, a fair-trade coffee brand may face difficulty in scaling operations due to higher production costs, despite its ethical appeal. As such, unless a company has achieved a critical mass of customers that are willing to pay a premium to support its mission, it will face an uphill battle to sustainable operations.
Negative externalities (geographical and temporal)
Climate change is projected to affect different areas at varying levels. Low-income countries reliant on agriculture are more likely to suffer from decreased crop yields without the technology to adapt, nor the funds to make up for such shortfalls. Small islands are also more at an existential threat of rising tides which could submerge them. As such, countries that are less affected have a lower urgency in addressing climate change.
Furthermore, not everyone believes that climate change will have a huge adverse impact on them. This is especially so as projections often go out into decades later. Someone who is hoping to live another ten years will not worry about 2050, which sits more than double that time away.
Some people are intrinsically concerned with humanity’s ability to live. Others, in particular the young, foresee that they will be affected by climate change within their lifetimes. Unfortunately, with ageing populations afflicting many developed countries, the general incentive to reduce present quality of life for a better future decades down the road is less of a priority for many people.
In order to surmount these economic disincentives, the best way is to make people pay a price that considers the total negative impact generated by their actions. In economics, this is known as internalising the externality. The two main mechanisms are through taxes and quotas.
The theoretical efficient mechanisms
There are two main mechanisms: Taxation and quotas.
Pigou (1920) introduced the concept of a charge on pollution as tax. More generally, a Pigouvian tax is a levy imposed on activities that generate negative externalities — costs that are borne by society rather than the individual or firm responsible for the activity. The aim is to internalise these external costs, aligning private incentives with social welfare. In the context of carbon emissions, a Pigouvian tax is applied to the production, consumption, or use of fossil fuels to reflect the social cost of the resulting greenhouse gas emissions. By increasing the cost of carbon-intensive activities, such taxes encourage firms and consumers to reduce their carbon footprint, switch to cleaner technologies, or adopt energy-efficient practices. Theoretically, the optimal Pigouvian tax would equal the marginal social cost of the pollution, ensuring that firms and consumers only emit carbon when its value to them exceeds its cost to society. Carbon taxes are seen as a more predictable and transparent alternative to carbon trading schemes, although setting the “correct” tax level is a key policy challenge.
Quotas: Carbon credits are tradable certificates that represent the reduction or removal of one metric tonne of carbon dioxide (CO₂) or its equivalent in other greenhouse gases from the atmosphere. They are a key component of market-based climate strategies aimed at mitigating global warming. Companies, governments, and individuals can purchase carbon credits to offset their emissions, thereby supporting projects like reforestation, renewable energy, or methane capture. There are two main markets for carbon credits: compliance markets, where companies are legally required to offset emissions, and voluntary markets, where businesses and individuals do so as part of corporate social responsibility or sustainability initiatives.
On the legal front, governments can set quotas on the total amount of carbon emitted. The European Union’s Emissions Trading System (EU ETS) does exactly that. So does China, which has a carbon market with quotas set relative to output. This means that someone living in the UK can emit 1kg of carbon dioxide if they pay to grow enough trees to sequester that 1kg. Based on the Coase Theorem, this helps to increase efficiency in the market. From a problem enmeshed in a global tragedy of the commons, quotas enforced rigorously would force individual incentives. This creates a new market where the invisible hand can drive optimisation across costs and carbon.
Tax vs Quota
We know that there are mechanisms to limit the amount of carbon to an optimal amount. However, what is the optimal amount? Despite all the resources pumped into climate science, this remains an uncertain quantity.
Weitzman (1974) found that when there is uncertainty about the optimal quantity of pollution, taxes are better when the cost of making a mistake is low. Weitzman illustrated that when we cannot precisely predict the optimal level of pollution, taxes are more effective if the cost of deviating from the optimal level is relatively low. This is particularly true when the marginal cost of reducing pollution rises steeply compared to the marginal benefits of doing so. For example, imagine a scenario where reducing emissions slightly beyond what is necessary causes a sharp rise in costs, but the additional environmental benefit is small. In such cases, a tax is more flexible because it sets a consistent price on emissions, allowing polluters to make their own cost-benefit calculations about how much to emit without rigidly capping the total quantity.
On the other hand, quotas are preferable when errors could lead to severe consequences, such as crossing a dangerous environmental threshold. This applies in situations where the marginal benefits of pollution reduction increase rapidly as emissions approach critical levels, even if the costs of achieving those reductions also rise. For instance, if exceeding a certain concentration of atmospheric CO₂ would trigger irreversible climate tipping points, quotas can provide more certainty by directly limiting the total emissions, even if enforcing those limits comes at a higher cost.
Applying Weitzman’s theory to climate policy, the decision boils down to the stakes of uncertainty. If we are relatively unsure about the precise costs of carbon emissions but confident that catastrophic outcomes are unlikely in the near term, carbon taxes may be a better tool because they provide predictability and encourage gradual reductions. However, if we believe that crossing specific thresholds poses an existential risk to ecosystems and societies, quotas become essential, as they guarantee emissions stay within safer bounds. Given the increasing awareness of the urgency of climate change, quotas may be a natural evolution from taxation.
Practical Difficulties: Verification and Scams
In order to avoid crushing regulations, governments often allow for carbon offsets to reduce the amount of carbon being regulated under a quota or subject to a tax.
Karbon Beijing has been accused of misrepresenting carbon credits projects – facilities deemed to be green turned out to be an abandoned chicken coop. Meanwhile, auditors were found to have reported inaccurately – even on basic facts such as the number of tanks present at a site.
A levy to cover the use of fossil fuels was avoided by buying carbon offsets from Colombian emission reduction projects, though the impact on preventing deforestation has been reported to be overstated.
This means people may 1) Spend more to assuage themselves of the guilt of carbon emissions, only to line the pockets of the conniving 2) Result in increased prices, again to the benefit of scammers.
Practical Difficulties (II): Miscalculated Benefits
What is the benefit of planting a tree? Carbon sequestration definitely mitigate climate change. But the devil is in the details. When we act for climate reduction, we need to keep conservation and maintenance in mind too. There are cases where huge swaths of monocultures of fast-growing trees are grown as an offset to the deforestation of diverse tree ecosystems. This adversely impacts conservation efforts, as the lack of tree diversity supports a vastly reduced range of flora and fauna. The monocultures are also more susceptible to disease outbreaks.
The limited effectiveness of marketing to combat tragedy of the commons
Some may suggest that instead of appealing to the rational side, we can pursue the layperson to pursue climate change through their votes and their consumption patterns. Marketing efforts often appeal to consumers’ desire for self-fulfilment, suggesting that purchasing certain products contributes to societal well-being. However, such strategies typically fail to address the mass market. Most individuals are unlikely to incur higher costs to mitigate shared problems, especially if they perceive that others are not contributing similarly. This behavioural inertia exacerbates the tragedy of the commons.
The fundamental lack of demand is masked in good times – when interest rates are low and business confidence is high, companies can stay in the growth stage and bask in the positive media attention. Consumers also have the wealth to pursue brands that identify with their purpose, as their basic needs as the base of Maslow’s Hierarchy have been met. However, in hard times of recession and economic gloom, people abandon their commitment to ESG in a bid to stretch their budget.
BlackRock quit Net Zero Asset Managers, due to membership which “subjected us to legal inquiries from various public officials”, according to the vice-chair Hildebrand. Many top banks have also started leaving a similar group for the banking industry.
The darlings of the pandemic that espoused ESG – Beyond Meat, for instance – are now finding that the absolute functionality and value of the product are far more core to their business than the feel-good factors. Beyond Meat faces customer complaints about taste, nutrition, and high prices. The notion of saving animals from death is just a minor consideration in guiding consumers’ meat demand.
Behavioural economics
Instead of using the price mechanism or marketing, we can harness behavioural tendencies to promote collective action:
- Herd mentality: Visible examples of sustainable behaviour can encourage broader adoption. For instance, research shows that living within 500 meters of additional visible solar panels increases the likelihood of installing solar panels by 6.5%.
- Nudges: Subtle behavioural prompts can influence decision-making. One effective method to reduce energy consumption is sharing data on median usage within a community. Highlighting excessive energy use compared to neighbours often motivates reductions. However, this approach can backfire. Katharine Hayhoe notes that individuals who feel shamed but lack alignment with environmental causes might react by increasing their consumption.
The Way Forward
When you take the theoretical economics lens – carbon quotas can appear to be a superb method for reducing carbon emissions to avert a climate disaster at the smallest possible loss of quality of life around the world. We should move towards such price mechanisms for the market to resolve climate change rather than appeal to the goodness of people’s hearts. Otherwise, it would only be fools who are willing to let themselves be taken advantage of who reduce their quality of life while others refuse to do their part.
That said, when you introduce new metrics to judge businesses, the practical effect is that people are going to use these metrics to obfuscate and profit from the confusion. After all, the difficulty is translating an audit from an on-the-ground observation to data on a screen. Solutions boasting tamper-proof records miss the point; it doesn’t matter how secure your data is if the data source is corrupted from the start.
We must invest in strengthening verification of carbon credits as well as improve measurement systems. This will involve higher compliance costs. The alternative is to impose harsh penalties – theoretically, if you could lop the heads off those who game the system, it would create serious disincentives to not do that. While the death penalty is a hyperbolic extreme, we should definitely ensure that perpetrators are adequately deterred. This would better correct the market mechanism and prod consumers to seek a more optimal path between sacrificing current quality of life and reducing carbon emissions.