Why net zero policymakers need global solutions
The final part of NZI’s Putting a Price on Pollution series looks at how globalisation and inequality complicate ambitious policies
So far, NZI's 7-part series looked at the challenges policymakers face when it comes to putting a price on pollution at the national level.
Parts II and III examined the influence of lobbying activities, while part IV explored the “short-termism” that makes policymakers reluctant to introduce measures that could inflate prices and/or create job losses for ordinary citizens in the near term.
However, in an unequal, globalised world in which nation-states compete against each other, policymakers also worry about putting their individual jurisdictions at a competitive disadvantage, especially for high-emission sectors such as steel or chemicals.
If one jurisdiction 'penalises' its economy though, say, carbon and biodiversity taxes – measures that could effectively price in the negative externality of pollution – then its products might become less competitive vis-a-vis laxer jurisdictions, or so the theory goes.
To solve this problem, the IMF has proposed an international carbon floor price (ICPF) that “could speed the world’s transition to green energy without compromising countries’ competitiveness”.
Under the scheme, the world’s largest emitters would pay a floor price of $25-$75 per ton of carbon depending on their level of economic development.
The proposal also recognizes that some countries may use alternative policies to carbon pricing—regulations, for example—but these alternatives should achieve at least the same emissions reductions as the carbon price floor.
If all countries introduced an ICPF simultaneously – with tiered price floors based on income floors – then the emissions reductions targets would be much easier to achieve, the organisation claims.
However, sources said this was unlikely to happen anytime soon due to the significant co-ordination problem of getting all the relevant parties on board at the same time and a potential negative impact on poorer countries.
It is worth mentioning that the 'anti-competitive' argument is not universally accepted.
There is also a strong counter-argument that the sustainable transition is inevitable and so jurisdictions that move first will foster early mover businesses that triumph in the future legal-economic landscape.
That future gain will ultimately offset any short term disadvantages of phasing out or reducing the competitivity of highly pollutant sectors.
“Although we can’t deny the competitivity argument completely, it’s also true that greener industries will create lots of new jobs,” said Patrick Simion, chief of staff at BNP Asset Management.
“Even now, we’re seeing a great advantage for countries that have state-of-the-art research on batteries for new types of electric cars. Hydrogen is another hot new technology.”
In BNP Paribas Asset Management’s assessment, carbon taxes and transition pathways, even if they were unilaterally imposed, would be beneficial, given their ability to accelerate the green transition.
Other sources cited the “innovation through limitation” argument: that setting clear limits is a powerful way to boost innovation.
Even if the political stars aligned, and an ICPF were implemented, some experts worry that poorer countries would incur an economic disadvantage.
A recent technical paper from Boston University’s Global Policy Centre states that the IMF’s ICPF, would be an “efficient and effective means of reducing emissions”.
However, it would also place additional responsibilities of emissions reductions, as well as additional economic costs, on developing countries.
The paper calls for improvements to incentives for low- and middle-income countries. Without such considerations, it is “unlikely” that the ICPF would be accepted by many developing countries in practice.
It’s noteworthy that COP26 and the Bridgetown Initiative have stressed the importance of a just transition in which developed countries help developing countries get to net-zero.
To achieve this, the Bridgetown Agenda calls for radical change to the global financial infrastructure, especially institutions such as the World Bank, which could be doing much more to support developing countries with their climate challenges.
The incorporation of climate risk into sovereign credit ratings is one climate policy that has already had a negative impact on developing countries, especially those impacted by climate change.
Carbon Border Adjustment Mechanisms
Given the difficulties in establishing an ICPF, to ease the level playing field problem, states could enact carbon border adjustment mechanisms (CBAMs) that price in an extra carbon tax on goods imported from laxer jurisdictions.
Border adjustments can also include rebates or exemptions from domestic policies for producers that export their goods. They would also prevent companies based in the EU from moving carbon-intensive production abroad to countries where less stringent climate policies are in place.
The EU, US, and UK are already considering CBAMs, with tentative proposals being made, despite the many political and technical challenges. The UK’s recent green finance announcements even include a potential timeline for a CBAM (from 2026 onwards) – which highlights how serious the debate has become.
“The UK is committed to ensuring that efforts to decarbonise industry are not undermined by carbon leakage, and currently does so through free allocation under the UK ETS,” the government wrote.
“While the best solutions to carbon leakage are international, options for domestic action must be considered in parallel to support efforts to decarbonise the UK economy and reduce UK and global emissions.”
One political challenge is that a CBAM may be seen as a protectionist measure that violates World Trade Organization (WTO) rules, particularly if it discriminates against certain countries or sectors.
Another challenge is that a CBAM requires a robust system for measuring the carbon content of imported goods, which can be difficult to establish.
A CBAM may also increase the cost of imported goods, leading to higher prices for consumers, a difficult outcome for policymakers to stand behind, especially in a time of inflation. It may also place an additional burden on importers and exporters, which would need to comply with the new regulations.
“During its Green Day last week, the UK Government signalled that CBAMs are on the table and will likely be one of the tools they use to ensure the level playing field that businesses need to compete fairly,” said Karen Ellis, chief economist at WWF.
Co-operation or competition
It’s generally easier for states to carry a cost than create one. That means states have so far been reluctant to introduce carbon or biodiversity taxes (creating a cost) but are starting to consider green subsidy packages (carrying a cost), such as the US’s Inflation Reduction Act or the EU’s Net Zero Industry Act.
Green subsidies, whose costs are borne less visibly by the taxpayer, and whose positive “green growth” message is relatively easy to transmit, tend to be seen as more politically palpable.
“If all states followed the US’s example, and pursued their own green industrial moon-shot, then the green transition stands a good chance of taking off in a serious way,” said Alejandro Litovsky, CEO at Earth Security.
“While divisions along national lines create challenges for co-ordinating biodiversity protection and climate action, the race to incentivise green technology could be an example of healthy competition.”
The US government claims that its green subsidy programme could slash US carbon emissions by 40% by 2030.
“Going green can be a way to boost a country’s competitiveness,” said Ellis. “The Inflation Reduction Act seems to be stimulating a race to net zero, rather than the opposite, with the EU responding with its own policy package to support the net zero transition, and calls on the UK Government to do likewise.”
Investors speaking to Net Zero Investor said they were carefully monitoring the “incentives race” for investment opportunities.
However, while many financial-legal sources are optimistic about the IRA's potential to catalyse the green transition, some worry that the "us versus them" approach could also have unintended consequences.
This was the final instalment in NZI's 7-part series. Please find the entire series here:
Part I: Seven reasons why policymakers aren't accelerating the green transition
A brief overview of the challenges of more ambitious policymaking
Part II: Global firms call for transition pathways and carbon tax
An exploration of the anti-pollution advocacy landscape
Part III: Due Diligence laws divide financial firms
Another look at the advocacy landscape, this time focusing on the EU's due diligence and deforestation laws
Part IV: Co-ordinated policymaking will solve short-termism
This part shows why joined up thinking - strong anti-pollution measures combined with changes to labour policy and other areas - are essential for a successful transition
Part V: Policymakers struggle to mitigate transition risk
The longer policymakers wait, the greater the risk of a disorderly transition. This part explores some of the financial stability issues associated with the green transition
Part VI: Why a market-led transition may be insufficient
So far, policymaking has mainly focused on improving ESG-related information; however, diverse stakeholders caution over-reliance on the soft approach of a market-led transition
Part VII: Why green policymakers need global solutions (above)
This instalment looks at the IMF's international carbon price floor, carbon border adjustment mechanisms, challenges for developing countries, and the potential impact of a green arms race spurred on by the US's Inflation Reduction Act