The threat to humanity posed by global warming only became apparent about 25 years ago as a result of a major scientific research effort. The global nature of this problem has posed completely new problems for policymakers, not just in Europe, but throughout the world. Action by individual countries cannot solve the problem and achieving a global coalition to take the necessary costly measures is exceptionally difficult to achieve.
The EU Commission recognised the importance of this policy task in the early 1990s and put forward proposals to tax the use of energy and emissions of greenhouse gases. This policy was designed to move the EU economy onto an environmentally sustainable growth path. However, this proposal was not adopted by the 12 members, even though it could have made a real difference to EU emissions of greenhouse gases over the last 20 years.
Emissions permits
The EU Commission did not give up and, after long and tortuous negotiations, agreement was reached over a decade ago on a series of measures designed to reverse the long-term trend increase in emissions of greenhouse gases within the EU. One element of the policy was a scheme where major industries, such as electricity and cement, would have to buy permits to allow them to continue emitting greenhouse gases. The intention was that this would restrict emissions as the price of the permits rose. In turn this would encourage firms to invest in less polluting technologies.
However, this policy has so far proved relatively unsuccessful. Firstly, the permits were given free to firms, in spite of the fact that the firms were expected to charge consumers for the permits.
This naturally bought the support of the industry through the prospect of a substantial windfall gain for shareholders. It also rewarded the bigger polluters and encouraged them to stay in business with the prospect of future free permits.
This windfall gain was made at the expense of European consumers of electricity, cement, and the other products covered by the scheme.
Secondly, after an initial rise in price, the allocation of permits proved to be too generous, and the price fell to a low level. The net result was a very limited reduction in emissions, below the level that would have been achieved without any policy intervention.
Supply too high
Learning from this experience, over the period to 2020 a higher share of the permits is being auctioned, ensuring that the price paid by consumers will accrue to governments that can return the revenue to consumers in the form of lower taxes or better public services. However, the supply of permits on offer is still too high, which means that the effect on prices is likely to be quite low. In turn, this is sending the wrong signal to investors.
One result is that today in Germany there is major investment in coal-fired electricity generation, in spite of the fact that this is the most environmentally damaging of the available technologies.
The EU could try establishing a guaranteed floor price for the permits. Such a scheme has been implemented unilaterally in the UK. But because the EU emissions limit will not be affected by the UK policy, such a single country scheme will not benefit the environment: it will only mean that emissions will be lower in the UK but higher elsewhere. However, if implemented at an EU level, such a policy would provide a more certain platform for investors in clean technologies.
An alternative mechanism being considered by the EU Commission would involve a reduction in the permit supply, hence raising price. However, this approach will still mean that the price of polluting is uncertain, making life difficult for those who might want to invest in clean technologies.
The experience of the last 20 years suggests the failure of governments to adopt a tax on carbon in the early 1990s was a bad mistake. It would have sent a clear signal to investors and consumers that governments were serious about tackling climate change. The higher price of energy and related commodities would have encouraged lower consumption and emission of greenhouse gases.
Most importantly, it would have incentivised expenditure on research to find new carbon saving technologies. The prospect of a profitable return on investment in new technologies is likely to be the most effective way of galvanising firms into making the necessary investment.
Innovation
This is what happened in the 1970s, when the oil price rose encouraging huge investment in energy saving technologies across the world. These energy efficiency innovations came on stream in the mid-1980s, resulting in a major fall in oil demand, and hence in the oil price.
However, in the case of carbon, the price of emissions has risen by a limited amount in the EU, meaning the return on successful innovation may be lower than it was in the 1970s. As a result, relying on private sector research will not be enough. Investment by governments in basic science will also be necessary.
The EU and member governments are currently developing policy for the period to 2030. Whatever measures are adopted, if they are to be successful they will make the use of energy more expensive for everyone in the EU. However, climate policy should also aim to achieve the maximum reduction in emissions for the necessary increase in price for consumers.
