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Climate Change Policy and Neoclassical Economics: Part 2/2

Many economic impacts of climate change are not expected to occur for decades or even centuries, and even then their occurrence is subject to uncertainty (Johnson & Dawson, 2019, p. 121). The degree of uncertainty about what future emissions will be leads to future costs of carbon emissions to be discounted and reduced in value through a mathematical technique that coverts future costs into an equivalent present-day value. But discount rates are one of the most contentious aspects of calculating the social cost of CO2e emissions. One way to value today the costs and benefits of the future is ‘social time preference’, which reflects human impatience. People would rather have a certain amount of money right now than the same amount of money in a decade’s time. A second approach that environmental economists take is the ‘social opportunity cost’ of a choice between alternative investments; some economists argue that investing in climate mitigation ought to give a better rate of return than the market. (Evans, Pidcock, and Yeo, 2017). The current SCC in the U.S. ranges from $10 at a 5% discount rate through to $50 at 2.5%. Conservative institutions call for higher discount rates, which would reduce the overall SCC, while others argue that heavy discounting of future carbon emissions is unethical as it suggests that future generations are worth less than those alive today. The Stern Review took the latter stance and called for a low discount rate of 1.4% in order to address this issue of intertemporal and intergenerational equity.

The neoclassical economic tendency to favour short-term profits over long-term gains is at odds with arguments in favour of intertemporal and intergenerational equity with regards to climate change. In a neoclassical economic system driven by short-term profit incentives, the long-term strategy that climate change mitigation requires tends to get side-lined. Therefore short-term profit is not the value neutral phenomenon it is purported to be; it inevitably leads to a devaluing of future climate change impacts on the well-being of future generations. But perhaps it is understandable for actors within neoclassical economic systems to value short-term profits over long-term climate change mitigation strategy, since this is a reflection of human nature: businesses usually opt for short-term financial gain; news media give more coverage to new and sudden events rather than gradual long-term trends; and politicians tend to act in their short-term interest because they depend on re-election every few years (Withgott & Laposata, 2018, p. 102). This explains why taking action on climate change is so fraught with difficulty – it involves working against the neoclassical tendency for short-term perspectives and arguably against human nature itself.

Carbon trading is another market-based instrument that aims to reduce carbon emissions in order to mitigate climate change. The neoliberal ideal of the free market is at odds with regulation, so carbon trading is compatible with neoliberalism since it is not regulation but the formation of a new market for trading private property rights; the neoliberal philosophy that underpins carbon trading policy is best described as the commodification of the atmosphere. Carbon trading involves treating the atmosphere as an economic good, through the application of mechanisms to appropriate and standardise this good, thereby enabling ‘chunks’ of the atmosphere to be sold at a price determined through market exchange (Bakker, 2007, as cited by Lohmann, 2014, p. 160). Firms are allocated the right to use this property as a dump for their GHGs up to a limit that does not result in a rise in the global mean temperature. Once the state has established the market and allocated the property rights – these permits can be distributed for free or through an auctioning system – then trade can take place freely (Johnson & Dawson, 2019, p. 133). Theoretically, carbon trading should provide companies with the incentive to produce less carbon emissions because they can sell their surplus allowances to other companies.

This incentive drives the world’s largest carbon-trading scheme, the European Union Emissions Trading Scheme (EU ETS). This scheme puts a cap on the CO2 emitted by business and creates a market and price for carbon allowances. The cap on CO2 will decline by at least 1.74% a year until 2020, so that emissions in 2020 will be at least 21% below their level in 2005 (Carbon Trust, 2020). Participating power plants are required to surrender one pollution permit, known as an EU allowance (EUA), for each metric ton of CO2 that they emit, therefore there is an incentive for participants to reduce their emissions up until the point at which there is no difference between buying one permit at the market price and paying the cost of reducing emissions by one additional ton of carbon (Muûls et al, 2016, p. 4).

Theoretically, a scarcity of carbon permits pushes up their price, which companies buy or sell on the market. But on the other hand, a bountiful supply of permits will reduce their market price and therefore reduce the incentive for companies to buy and sell them. This happened during Phase 1 and 2 of the ETS. In 2005, companies’ emissions were unexpectedly far below the cap, thus pulling down the price of permits from €5-10 per tCO2 to just a few cents. This price collapse was due in part to the decreased demand to buy extra permits since all plants had plenty to carry out their desired activities. This demonstrates a weakness with this neoclassical environmental policy; staunch neoliberals may dislike regulation, but poorly regulated markets may lead to market failure with regards to reducing carbon emissions. But the ETS was able to correct this price collapse, and a 2016 evaluation by Imperial College London found that it had indeed led to a reduction in industrial carbon emissions while having no detrimental effects on economic performance, as well as being partly responsible for the increase in low-carbon ‘cleantech’ innovation (Muûls et al, 2016, p. 1). So while carbon trading may have its risks, in the case of the ETS it seems to have been successful in reducing carbon emissions overall.

This essay has discussed market-based policy responses to the threat of climate change, as influenced by neoliberal political thought and neoclassical economics, but many other approaches to policy exist, including ‘command-and-control’ style regulation, technology-based standards, and voluntary agreements, which all warrant investigation and scrutiny.

There are strengths and weaknesses to neoliberal and neoclassical economic arguments, and it is a contentious issue whether policies influenced by these schools of thought will indeed mitigate the worst impacts of climate change. Perhaps it is desirable to adopt the optimism of the Brundtland Commission (1987), which seemed convinced that humanity does have the ability to make development sustainable to ensure that it meets the needs of the present without compromising the ability of future generations to meet their own needs, and that technology and social organisation can be both managed an improved to make way for a new era of economic growth.


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Brundtland Commission (1987). Our Common Future. s.l.:Oxford University Press.

Carbon Trust (2020). EU Emissions Trading Scheme (EU ETS). Available at: (Accessed 29 October 2020).

Evans, S., Pidcock, R. and Yeo, S. (2017). Q&A: The social cost of carbon. Available at: (Accessed 28 October 2020).

International Monetary Fund (2019). The Economics of Climate. Finance & Development, December. 56(4).

Johnson, V. and Dawson, G. (2019). Chapter 3 Climate Change: economic valuation and policy, in P. Jehlička & D. Humphreys (eds) Environmental policy in an international context: Book 1. s.l.:The Open University, pp. 99-144.

Lohmann, L. (2014). CHAPTER SEVEN Performative Equations and Neoliberal Commodification: The Case of Climate, in Nature Inc.: Environmental Conservation in the Neoliberal Age. s.l.:University of Arizona Press, pp. 158-180.

Muûls, M., Colmer, J., Martin, R. and Wagner, U. J. (2016). Evaluating the EU Emissions Trading System: Take it or leave it? An assessment of the data after ten years, s.l.: Imperial College London.

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Withgott, J. H. and Laposata, M. (2018). Chapter 5: Economics, Policy, and Sustainable Development, in Essential Environment: The Science Behind the Stories. 6th ed. s.l.:Pearson, pp. 90-114.

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