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Market failure and climate change

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  • Chapter 2: Microeconomics/
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  • Market failure and climate change

10 economic issues from Cop26

The weight of expectation hangs heavily on world leaders as they meet for the global climate summit in Glasgow this week. Reaching an agreement that limits global warming to 1.5 degrees is a challenging target, but one climate scientists believe has to be achieved.

Here are some thoughts on 10 Economic issues from Cop26:

1. Sustainability is a key factor influencing the policies used to reduce carbon emissions. Using fossil fuels to benefit people now has important negative consequences for future generations.

2. Burning fossil fuels for energy has significant negative externalities in the present (just look at the quality of air in many major cities) but it also has external costs for third parties in the future as the climate becomes more unstable and sea levels rise.

3. The atmosphere is a common pool (access) resource. Its non-excludability means there is an over-allocation of resources in a free market because without government intervention firms do not have to pay a price for emitting carbon into the atmosphere.

4. There is a free-rider problem in trying to reduce carbon emissions. Individuals, firms and governments that take action to reduce their carbon emissions will incur a high cost for doing this. Other individuals, firms and governments can choose not to limit their emissions and ‘free-ride on the actions of those who do.

5. Commercial pressure is building on businesses to reduce their carbon emissions. Banks, major investors and pension funds are increasingly moving funds away from businesses associated with the production of fossil fuels.

6. There is significant global growth in Investment and Innovation in sustainable sources of energy such as hydrogen, wave, wind and solar power.

7. Development of battery technology to make renewable energy transportable and storable will be a significant breakthrough in the use of renewable energy.

8. The poorest in the world will suffer the most significant negative impact on their welfare, but even the welfare of the richest people will be adversely affected. The political influence of the wealthiest people in the world could be a significant factor in successfully tackling climate change.

9. China is crucial to achieving the 1.5-degree target. They are the largest carbon emitter and any significant reductions they make will be very important. China’s political system means they can probably switch to more sustainable sources of energy more quickly than other countries.

10. Climate change is a truly global problem that affects everyone on the planet. Successfully achieving the 1.5-degree target will need an unparalleled level of international cooperation.

Possible points of discussion

a. To what extent is climate change a problem of market failure?

  • An explanation that economic activity has led to negative externalities as the world has used fossil fuels as a dominant form of energy.
  • An explanation that societies desire to increase their welfare in the present will adversely affect peoples' welfare in the future.
  • An explanation of where climate change has been caused by the economic activity of state-managed enterprises such as in planned economies. 
  • An explanation that climate change might be the result of government policies such as road building and the construction of airports.
  • Evaluation might include discussion of the relative importance of the market failure causes of climate change and the influence of governments on climate change.

b. Discuss the problems of trying to develop a global policy to reduce climate change.

  • An explanation of the different government policies that might be used to reduce carbon emissions such as policies to increase the use of renewable energy, nuclear power, and hydrogen.
  • An explanation of government policies to reduce carbon emissions such as carbon taxes, tradable permits and regulations.
  • An explanation of government policies to reduce carbon emissions targetting consumers such as encouraging the use of electric vehicles and solar panels.
  • An explanation of government policies to encourage innovations to reduce carbon emissions such as filtering sunlight and cooling the icecaps. 
  • Evaluation might include discussion of the problems for governments of applying these policies such as the cost of monitoring regulations, the cost of subsidising renewable energy, the cost the consumers and producers of increasing tax on fossil fuels and the cost to consumers and producers of using more expensive renewable energy. The discussion could also include the problems of getting an international agreement because governments can free-ride on each other's policies.