COP 21 has been over for about 6 months. Most observers were pretty optimistic back then, and it seemed clear to everyone that action was urgently required to tackle climate change. Some clarity is however still needed now, in order to better understand why economic agents didn’t already take action long ago, without waiting for governments to step up, and thus determine how we can effectively lead our society to improve toward a greener path of development.
We are (almost) rational agents
The very basis of how we perceive climate change, is the same mechanism that drives most of our actions: we choose paths that lead to a higher ‘utility’. That is, we try to increase our happiness and well-being. This is how we choose between work and leisure, according to the traditional neoclassical approach. It is also how we make the choice between buying one good or buying another. Our economic behaviour is therefore not the fruit of chance or hazard, but the result of a well-founded choices. Of course, the calculus is unconscious: we don’t actually use our pocket calculator to measure the utility of a particular purchase. This choice is made through a calculation process, during which we assess each possibility and determine which outcome is more desirable, which outcome yields more benefits to us.
This calculation doesn’t only occurs between a basket of various goods, it also accounts for a strong preference for present. Indeed, we would rather receive the pleasure right now, and the pain later. At a given moment, a pain that will occur in a distant future feels like a lesser pain than if you were to go through it tomorrow. This concept is well established in finance theory, and it is common practice to decrease the value of future cash flow: a profit made next year is worth less to us today than a profit that will be made next month. In particular, the preference for present is materialized in interest rates, that represent how much we favour present over future: interest rates are a compensation for not having the leisure of spending today the money you own but lent.
To sum it up, the decisions that we make in our life are driven by calculations which have for goal to improve our happiness, if possible in the present rather than in a distant future.
Why haven’t we strongly acted yet?
This process, as beneficial as it can be, has its flaws. The biggest one is probably the strong bias that makes us discard some events in our calculation because they have a very low probability of occurrence, and might take place is a far distant future, even though the cost of such occurrence would be gigantic. Climate change is one of them. We do not correctly account for climate change in our daily lives, and firms underestimate its importance as well. Thus, we take non-optimal decisions which lead to greater costs than expected. Martin Weitzman has closely studied this question, and he has shown (“Additive damages, Fat-Tailed Climate Dynamics, and Uncertain Discounting”, 2009) that the cost of doing nothing about Climate Change, a behavior close to ours today, amounts to “uncomfortably big numbers”. In other words, it would be worth it to spend a large part of our resources today to avert the future consequences of Climate Change. Though the conclusions of Weitzman have been question by other prominent economists, such as William Nordhaus (“An Analysis of the Dismal Theorem”, 2009), it still has the merit to show that we underestimate the potential consequences of climate change, and that our current course of action is far from appropriate to address this problem.
Nassim Nicholas Taleb also pointed out this issue (The Black Swan: The Impact of the Highly Improbable, 2007). When we analyze our environment, we typically believe that it is characterized by what we see, and that what happens the most often defines it. But in some cases, it is what we do not see that matters. Take the example of a turkey growing up in a farm. Her environment seems friendly enough. Her masters feed her in abundance. Every day that comes confirms that she has a lovely life. But comes December, and the farmer slays the turkey. This event, from the perspective of the turkey, was the only one worth caring about, as it was by far the most consequent of her life. It was the one that mattered. We act in a similar way with climate change: as we cannot directly appreciate it, nor witness it on a day-to-day basis, we tend to discard it from our decision-taking process. Yet, we know that it might change life on earth, and have irreversible consequences on humanity as a whole.
Furthermore, the fight against climate change poses another challenge: the free rider problem. Indeed, all humans on earth are concerned by climate change. It is thus tempting to hold the following reasoning: ”My individual contribution in attempting to affect climate change is negligible. I can therefore do nothing without impacting the global effort .” Agents try and will try to benefit from the efforts of others, without contributing to the costs. Indeed, we could consider that the fight against climate change is a sort of non-excludable public good -a category of goods and services defined by Mancur Olson (The Logic of Collective Action, 1965): Street lamps belong to that category as well, in the sense that even though you do not pay your taxes, you will still enjoy the street light when the night comes.
How can we solve these problems? How can we have agents fully take climate change into account? Two options stand out. The first, efficient mostly in the short run, is to alter the input of our calculation by levying taxes. The second solution, which should be our medium-run goal, consists in a global rise in awareness and an emphasis on individual responsibility toward climate change.
Taxes are often hard to recommend, as they have a lot of negative effects. First of all, it is hard to precisely determine who, between the supplier and the consumer, actually bears the economic burden of the tax. It is indeed not enough to legally impose the tax on the producer to have him bear the weight of the tax. It is a matter of price-elasticity: the more an agent is sensible to a change in price, the smaller the share of the tax will he carry.
Economists such as Harold Hotelling have argued that excise taxes are less efficient that taxes on income (“The General Welfare in Relation to Problems of Taxation and of Railway and Utility Rates”, Econometrica, 1938). Undeniably, they affect the relative prices of goods, leading consumers to choose a non utility-maximizing basket of goods to consume. Thus, for a same level of increase in government revenue, excise taxes decrease the happiness of the society more than income taxes would. Yet, we do not focus here on government revenue, but on consumption habits. We want people to change their habits and back away from heavily polluting behaviors. Same goes for firms: we want them to be more energy-efficient and to favor renewable resources over fossil fuels.
Hotelling stated that “When the question arises of building new major industry, or of scraping the old, we shall face, not a historical, but a mathematical and economic problem”. There is no doubt that taxes are hence an appropriate instrument to parry undesirable tendencies. However, we must be very careful with the use of taxes in fighting against climate change. Indeed, taxes fetter freedom. They must be implemented in a democratic, bottom-up process and be collectively agreed upon as a part of the new social contract that holds society together. A number of associations, political parties and individual concerns seems to point out that such taxes are acceptable in today’s world.
Taxes will generate additional revenue for the government which should put it to good use. Hopefully, that money should be invested in research on energy efficiency and renewable energies. Philippe Aghion (Philippe Aghion, David Hemous & Reinhilde Veugelers, “No Green Growth without Innovation”, 2009) has shown the positive effects of such subsidies: they create a strong incentive to quickly develop the sector. The goal shall therefore be to create a “green path” of economic development and technological progress.
Subsidies are not sufficient: consistent political support and coherent regulations must also be enacted to create a framework encouraging ‘green’ innovation. The Financial Stability Board (FSB), an international organization composed of major regulators throughout the world, along with Central Banks, ministries of finance, and other institutions, set up a Task Force to make propositions on climate-related financial disclosure. The aim is to have firms make additional disclosure, beside the regular financial ones. The FSB hopes to be able to incite firms to report on several kinds of risks related to climate change as well as on the transition toward a cleaner economy.
Emphasizing individual responsibilities
Looking further, more actions than taxing and subsidizing are required. These actions and changes will not all come from the government. A global rise in awareness about the risks of climate change is necessary. Individuals want to make better choices by themselves, without the government guiding them with taxes. We need to choose willingly goods that are more energy-efficient, and produced through the use of renewable energies that are less polluting. Similarly, firms must contribute to this shift in mentality.
To achieve it, we need several elements: insiders in the firms who strongly believe in the “green path” that we have described, ready to lead the firm toward it. We also need consumer pressure to force the firms to adapt, even reluctantly. Finally, finance also has a role to play. Particularly, large investment funds such as pension funds and sovereign funds must use their power to leave a print on the firms they partly own. They must play an active role, and reckon that their interest is not only to maximize the financial gain of their investors, but also to seek the long-term well-being of the investors of today and tomorrow.
Overall, we would want the sentiment of individual responsibility toward this great issue to be much stronger. Research has shown (Thomas Roulet & Samuel Touboul “The intentions with which the road is paved: Attitudes to liberalism as determinants of greenwashing” Journal of Business Ethics, 2005) that individual responsibility is a very strong levy to push firms into real actions, rather than marketing symbolic actions, as far as CSR is concerned, and climate change is a large part of it. Therefore, putting a particular emphasis on individual responsibilities should be a key element of our reflection on how to curb climate change’s tendency.