How Carbon Pricing Can Drive Green Recovery and Growth
Carbon pricing – the cost of the damage caused by climate change – can be an important part of a broader climate policy that creates incentives to reduce emissions.
The recent economic downturn reduced global greenhouse gas emissions by a scale larger than that seen during the financial crisis of 2009-10. This decline was, unfortunately, only temporary, and emissions have already reached pre-pandemic levels. The threat of climate change persists.
Countries in Asia and the Pacific need to plan their recovery over the medium and long-term. In this context, it will be important to reduce emissions cost-effectively while safeguarding government budgets.
Carbon pricing is a central element of the broader climate policy architecture and, if designed well, is one solution. The cost of the damage caused by climate change is not typically incorporated into the price of goods and services, based on the greenhouse gas emissions that they cause. This market failure results in a lack of incentives to reduce the emissions that cause climate change. Carbon pricing helps address this imbalance.
The two-primary carbon-pricing policy instruments are a carbon tax and an emissions trading system. A carbon tax creates a financial liability for emitters, giving them incentives to innovate and transit to clean energy and energy-efficient operations. An emissions trading system typically involves a government-set cap on permitted greenhouse gas emissions, with the system leaving the price for emissions to be determined by the market.
The use of carbon pricing in Asia and the Pacific is increasing, with six carbon pricing initiatives implemented on the national level, consisting of four domestic emission trading systems and a carbon tax in two jurisdictions.
Japan imposed a ‘Tax for Climate Change Mitigation’ on the consumption of fossil fuels and uses the revenue to mitigate energy-related emissions. Singapore uses a carbon tax for certain industrial facilities and plans to spend the revenue on carbon-abatement projects. The Republic of Korea established the region’s first nationwide emissions trading system in 2015, whereas the People’s Republic of China has, most recently, launched its national emissions trading system. For countries like Japan, Republic of Korea, and the People’s Republic of China that have announced net-zero targets, carbon pricing is expected to be a key element in the climate policy toolbox to help them achieve their climate ambitions.
Baseline and crediting mechanisms are another form of carbon pricing where the emission reduction is given a value, compared to the approaches where there is a cost to emit. The region also has successful experience participating in baseline and crediting mechanisms, through the Clean Development Mechanism, associated with the Kyoto Protocol, and the Joint Crediting Mechanism, initiated by Japan in 2010, which facilitates the diffusion of advanced low-carbon technologies for mitigating greenhouse gas emissions. Such mechanisms channel additional finance to low-carbon investments and could do so also during a recovery phase.
For carbon pricing to be viable in the long-run towards net-zero emission pathways, there is a need to transform not just the industrial sectors but also emphasize on research and development for low carbon technologies as well as incentivize behavioral change.
In the present context, policymakers may be concerned that deploying carbon pricing instruments during a recession may choke-off a recovery and hamper growth. However, they can be designed to align with desired characteristics of stimulus in developing countries and to not negatively impact low-carbon businesses.
An effective approach would be to initially implement a policy with a low price to incentivize the development of much needed policy infrastructure for carbon pricing instruments. Further, they should be simple to implement and administer, and they should not just be designed urgently, but also smoothly and sensibly to foster not just a green recovery, but also green growth aligned with net-zero emissions.
For example, carbon tax and allowance auctions from emissions trading systems can help governments collect revenue. A carbon tax clearly generates revenue for a jurisdiction, but an emissions trading system can do so as well when the jurisdiction sells some or all emissions permits, typically through auctions, rather than allocating them freely (which is also an option and can have advantages early in the lifetime of the emissions trading system). Further, such a system is countercyclical in that the demand and price of allowances will go down in a recession, just when regulated firms need relief.
Making carbon pricing politically viable may also require additional policies to mitigate the adverse economic and social consequences of carbon pricing policies. For example, distributing revenues in the form of a fixed “dividend” to family and individuals generates political support for the policy.
In cases where carbon pricing initiatives are implemented in parallel to removing monetary or financial subsidies for carbon intensive products (such as fossil fuels), there would be a fiscal benefit from reduced budgetary expenditure. While it would probably be difficult to convert such a saving stream to a financing instrument, the reduced budgetary burden could still create fiscal space.
For carbon pricing to be viable in the long-run towards net-zero emission pathways, there is a need to transform not just the industrial sectors but also emphasize research and development for low carbon technologies as well as incentivize behavioral change.
Irrespective of the choice of the carbon pricing instrument and other design considerations, it is critical to ensure that the price of carbon and the policy mix are sufficient to address the costs caused by climate change. Building stakeholder consensus and effective communication are other key elements.
By doing so, carbon pricing in combination with other policy instruments can provide motivation to make investment decisions and innovation that favor low carbon technologies, goods, and services, while helping countries to not only meet their short-term climate mitigation targets but also long-term net-zero targets.
Policymakers should not wait – they need to evaluate the options, consult stakeholders, and do the preparatory work for carbon pricing such that carbon pricing instruments can be launched once the conditions are right.